How Behavioral Finance Can Help You Set and Keep Financial Goals

Dr. Daniel CrosbyDr. Daniel Crosby, President, IncBlot Behavioral Finance

If you’re ever having trouble sleeping, spend some time researching financial goal setting online and you’re sure to be snoozing in no time. It’s not that the advice you’ll find is bad per se, it’s just that it is fundamentally disconnected from an understanding of how people behave. Most resources will give you some great meat-and-potatoes stuff about setting specific, attainable and timely goals. You will nod your head, go home, and forget all about it, doing what you’ve always done before.

If financial goal setting is to be truly successful, it must account for the way in which people behave, including the really stupid stuff we all do from time to time. What’s more, it must be infused with elements that make it motivational, because let’s face it, you’d probably rather get a root canal than lay out a spreadsheet with some dry figures about Set Your Goalsyour savings goals. To help in this important step, we’ve mixed some best practices in financial planning with some truths about human nature that will add a little, dare we say it, excitement into your financial planning process. After all, your financial goals are only as good as your resolve to adhere to them is strong.

The next time you go to set a financial goal, consider the following:

Plan for the Worst – Cook College performed a study in which people were asked to rate the likelihood that a number of positive events (e.g., win the lottery, marry for life) and negative events (e.g., die of cancer, get divorced) would impact their lives. What they found was that participants overestimated the likelihood of positive events by 15% and underestimated the probability of negative events by 20%.

What this tells us is that we tend to personalize the positive and delegate the dangerous. We think, “I might win the lottery, she might die of cancer. We might live happily ever after, they might get divorced.” We understand that bad things happen, but in service of living a happy life, we tend to think about those things in the abstract. A solid financial plan cannot assume that everything will be wine and roses as far as the eye can see.

Picture Yourself at 90 – One of the reasons that we tend to under prepare for the future is that we value comfort now more than we do in the future. Simply put, the further out an event is, the less valuable we esteem it to be. Let’s say I offered you $100 today or $110 tomorrow. Odds are, you’d use a little bit of self-restraint and go for the extra ten dollars. What if I changed my offer to $100 today or $110 in a month? If you are like most people, you’d take the $100 today rather than wait the extra 30 days. The official term for this devaluation over time is “hyperbolic discounting” and it can have disastrous consequences for managing wealth over a lifetime.

Crosby_BeFi_Help_Set_Goals_2After all, if today’s needs and today’s dollars always perceived as more valuable than tomorrow’s wealth and wants, we’ll make hay while the sun shines. While this can be fun in the moment, your older self is not going to be too happy eating Top Ramen every night. One of the ways to decrease our tendency toward hyperbolic discounting is to make the future more vivid. Researchers at New York University did this by using a computer simulation to age peoples’ faces and found that “manipulating exposure to visual representations of one’s future self leads to lower discounting of future rewards and higher contributions to saving accounts.” Basically, if you can picture yourself wrinkly, you’re more likely to save. Making your own future vivid might include having conversations about your future with your partner, speaking with aging relatives or simply introspecting about your financial future.

Bake In Motivation – Daniel Pink’s seminal work, “Drive” is a concise treatise on what he believes are the three pillars of human motivation – mastery, autonomy and purpose. By including each of these three pillars in the financial goal setting process, you “bake in” motivation, thereby increasing the likelihood of meeting those aspirations. Mastery is all about fluency with the language of finance. While you may never be Warren Buffett, achieving mastery is the first step toward staying motivated. We procrastinate what we don’t like or don’t understand. Once you are facile in the language of numbers, you’ll stop putting your finances on the back burner.

The word “autonomy” is derived from the Greek word “autonomia”, the literal translation of which is “one who gives oneself their own law.” Being autonomous does not mean going it alone. What it does mean is having enough of an understanding of financial best practices that you can select financial professionals whose goals and approaches mimic your own. Finally, and most importantly, is purpose. One of the biggest culprits in bad financial planning is disconnecting the process from the things that matter most to the person making the decisions. Coco Chanel said it best when she said, “The best things in life are free; the second best are very expensive.” Financial solvency facilitates all manner of good, from charitable giving to family vacations to funding an education. If your financial goals are intimately connected to things that matter most to you, saving will cease to be a chore and begin to be a joy.

Views expressed are for illustrative purposes only. The information was created and supplied by Dr. Daniel Crosby of IncBlot Behavioral Finance, an unaffiliated third party. Brinker Capital Inc., a Registered Investment Advisor

Is America’s Retirement System Broken?

SimonBill Simon, Managing Director, Retirement Plan Services

In an article earlier this week, Mr. John Bogle, founder of the Vanguard Group, decreed that America’s current retirement system is broken. As far as a fix, he offers only two suggestions. The first is to increase the current level of taxable income subject to Social Security taxes to $140,000-$150,000. The second is a reduction in the automatic cost of living adjustments that are used to calculate benefits.

While both would generate significant increases and savings to Social Security, they do not address the larger issues with our retirement system. As Bogle notes, the three pillars of retirement are Social Security, Defined Benefit plans and Defined Contribution plans—and they are in bad shape. In order for defined contributions plans to work better, we need to continue to automate as much of the functionality as possible, incentivize larger contributions, and make sure that an appropriate investment option is selected based on the participants age and realistic expectations about goals and markets.

5.15.13_Simon_BogleArticleHere is some food for thought. What if you could earn an additional tax credit by deferring at least 10% of salary or not having a loan against your 401(k)? What if an employer gave one additional vacation day per year if a company-wide goal of participation and contribution was reached? Ultimately, the system can work, but we need to continue to innovate and provide fresh ideas.

Click here to read more on John Bogle’s comments.

Classic Indexes Are Hurting Retirees

Personal Benchmark InvestingEngrained in most retirees is that as the markets go, so do their savings—up markets are good, down markets are bad. It’s not that it’s inherently wrong to think that way, it’s just that there’s a better way of looking at your savings in action. Historical benchmarks do a disservice to investors at indicating how successful they can be in creating real purchasing power.

Chuck Widger, Executive Chairman of Brinker Capital, was brought on to TheStreet.com, a leading financial news website, to discuss this new line of thought, and how the industry needs to redefine its value proposition.

Check it out here: Classic Indexes Are Hurting Retirees

*Please note that references to specific holdings in the video are for illustrative purposes only and not necessarily owned by Brinker Capital.

Question Framing and its Role in Retirement Planning

Sue BerginSue Bergin

Many advisors attribute their success to their ability to listen and to ask the right questions.  Knowing the questions to ask, and when and how to ask them, are at the heart of the retirement planning and relationship building process.

When helping a client prepare for retirement, for example, you probably ask clients when they plan to retire and how long they think they are going to live.  You may not have realized this, but the way the question is framed impacts the answer.

John W. Payne of Duke University, recently found that people would give significantly different answers about their longevity depending upon how the question is asked.

questionsPayne’s study participants gave themselves a 55% chance of living beyond age 85.  When the question was framed differently, their answers were far more pessimistic.  Study participants gave themselves a 68% chance of dying by the age 85, which translates to only 32% chance of living to age 85.[1]

In her Harvard Business Review Blog, “How to Frame a Question for Maximum Impact,” Melissa Reffoni suggests that we think about the metaphor behind the concept of question framing.

A frame focuses attention on the painting it surrounds. Different frames draw out different aspects of the work. Putting a painting in a red frame brings out the red in the work; putting the same painting in a blue frame brings out the blue. How someone frames an issue influences how others see it and focuses their attention on particular aspects of it.”[2]

By framing the question in the, “what age will you live to” context, you bring clarity to the retirement planning task.  Their attention is focused on life post-work, not when they are going to die.


The Brinker Barometer: Absolute Return Strategies On The Rise

Each quarter, we conduct a survey among financial advisors to gauge their confidence and sentiment regarding the economy, retirement savings, investing and market performance.  In our most recent Brinker Barometer, we asked respondents to reflect on key financial issues, including their clients’ retirement readiness, investing and the nation’s debt problems.

Click here for the official press release

Below is an infographic that sums up the results of the latest Brinker Barometer survey:

Brinker_Barometer_Q4_2012

Surviving the Middle

Sue BerginSue Bergin

One of the dynamics advisors face with many clients in the retirement planning process is a loss of interest or focus.  During initial meetings, clients seem gung-ho to organize their financial lives organized and plan for the future.  They eagerly meet with their advisors and gather any documents or paperwork the advisor needs to initiate the process.

After about the second meeting, suddenly things slow down.

Sometimes they even grind to a halt.

The same phenomenon occurs with other tasks that people view as chores.  After all, who hadn’t looked around a driveway littered with everything that formerly inhabited the garage and wondered why they got involved in the project in the first place?

A research team at Northwestern University’s Kellogg School recently proved that there is such a thing as a “stuck in the middle” phenomenon.

Study participants had to read and find the errors in nine essays.  The first time they read essays, they found an average of .122 errors per second.  The next time they only .092 spotted errors per second.  Their accuracy was the best on the third and final try.  They found .124 errors per second in the third set, which they knew would be their last.

What this study demonstrates is that people are motivated at the beginning of the chore, and at the end – because it is almost over.  The middle is the attention vortex.

Keep this in mind when you structure your process.  If possible, front and back-end load the tasks that you need the client to complete – like filling out fact finders and locating documents.  Also, let your clients know when they are nearing the end of the planning process (and entering the active monitoring stage), so you both can benefit from extra burst of energy.