Behavioral economist Richard Thaler explains why financial professionals need to be familiar with psychology.
Daniel Kahneman and Amos Tversky legitimized behavioral economics—the study of how people really behave around money, as opposed to how economists say a rational person ought to behave.
Then Richard Thaler and Cass Sunstein applied the lessons of behavioral economics to everyday life with their book Nudge. The duo nudged so successfully that in recent years, their prescriptions have been put to work in corporate retirement plans—and even public policy—on a global scale.
When I spoke to Thaler to discuss his newest book, Misbehaving, a series of stories documenting the rise of behavioral economics, he told me that he has a message for those who seek to employ his methods:
“Nudge for good.”
And why does he say that?
“Not all of the applications of behavioral science in the private sector are being used to the benefit of the consumers,” explains Thaler, a professor at the University of Chicago’s Booth School of Business.
It’s a plea that Thaler extends to financial advisers. He and Sunstein didn’t invent nudging, says Thaler. “People have been trying to nudge people for a long time,” he says, “and you can do it to try and help people out or to swindle them. Bernie Madoff was an expert at nudging.”
Here are three compelling directives from Thaler to us financial advisers. They serve as guidance for how we, collectively, can do good well:
Understand the lessons of behavioral finance for your work with clients.
“If the main thing that a financial adviser does in a session with a client involves looking at spreadsheets, then they’re not doing their job,” says Thaler. “It is as much psychology as it is finance.”
“No one would think that somebody’s qualified to be a financial adviser if they don’t know the difference between a stock and a bond,” he continues, “but people think it’s perfectly fine to be a financial adviser without knowing the difference between ‘System 1’ and ‘System 2’ [Kahneman’s shorthand for two different ways that people think] or loss aversion.”
Unlike the Fed’s counsel, Thaler’s advice is refreshingly discernable. But most of us weren’t trained in the behavioral sciences. How do we learn? For starters, we’ve got to educate ourselves, and there are a number of excellent books out there.
Consider beginning with the broad perspective and historical view offered in Misbehaving. Follow that with Daniel Kahneman’s Thinking, Fast and Slow. It provides a deep but surprisingly readable dive into the science—illuminated through the device of the brain’s “System 1” and “System 2.” The Heath brothers’ Switch, as well as Thaler and Sunstein’s Nudge, then help us envision how to apply the science. Malcolm Gladwell puts his mark on the field in Blink and Daniel Pink provides a primer on the science of motivation in Drive. There are many more, but this list will undoubtedly spur some insight into how behavioral finance can be applied in your practice.
Do the work.
It is, of course, at this point—the application of wisdom directly into practice—where most advisers become stalled. We will ultimately fall into our behavioral ruts, or in Thaler’s parlance, our default systems. But in much the same way that financial planning recommendations not implemented by clients aren’t doing them any good, knowledge that isn’t actively applied in our advisory practices accomplishes nothing.
Here is where skilled practice management consultants and thought leaders like Carol Anderson of Money Quotient, Kinder Institute founder George Kinder, and Susan Bradley of the Sudden Money Institute have helped advisers shape their practices with an eye for the unseen behavioral elements of our work.
So if our client meetings aren’t spent poring over data, where should our focus be? According to Thaler, it begins with “simply recognizing that the job of understanding what your clients’ goals and fears and needs are is at least as important as crunching the numbers.” He continues: “If you understand how people think, then it’ll be easier for you to communicate with people and devise strategies that they will be able to implement.”
Embrace the fiduciary standard.
I didn’t bring it up; he did. And while Thaler didn’t want to get into the details of any proposed rules or regulations, he spoke with crystal clarity regarding the industry debate over whether or not financial professionals should be held to a legal standard that requires them to act in the best interest of their clients, as fiduciaries. “The principle should not be controversial,” he says. “Anybody who doesn’t think that a financial adviser should be acting as a fiduciary should find another line of work.”
Finally, I asked Thaler how he might sum up his advice for financial advisers.
“You can’t do your job well unless you understand how your clients think,” he said.
And once we do, let’s remember to nudge—for good.
Financial planner, speaker, and author Tim Maurer, is a wealth adviser at Buckingham Asset Management and the director of personal finance for the BAM Alliance. A certified financial planner practitioner working with individuals, families and organizations, he also educates at private events and via TV, radio, print, and online media. “Personal finance is more personal than it is finance” is the central theme that drives his writing and speaking.