One of the biggest roadblocks standing in the way of financial success is our own human nature. The problem has been exacerbated further by an industry that has failed to adapt to serve the needs of its clients even as we learn more about why people make the decisions that they do. In the 1980’s, an economist by the name of Richard Thaler created a new model for how people make financial decisions. As a keen observer of human behavior, Thaler wanted to have a greater understanding for how people make their financial decisions so that we could better explain stock market movement, which at times is completely irrational. Inspired by the works of Amos Tversky and Daniel Kahneman, Thaler’s ultimate goal was to answer the question “why” people make the financial decisions that they do. Today, behavioral finance goes beyond just understanding stock market movement and goes further into areas including financial planning, tax planning, savings, retirement and more.
So why is this important? A more importantly why is this important for you? For decades now the financial services industry has ignored what is likely the most important consideration in working with individual clients, “is this the most appropriate strategy based on the individual needs of the client AND will they act on the advice being given.”
In many boardrooms across the country, decisions are being made for individual investors based on the masses with little thought towards customization for the individual. To some degree this is understandable as the financial industry is dominated by giant companies with millions of clients which forces them to focus on strategies and solutions that can be built to that scale efficiently. The problem is not in the product manufacturing as having scale can definitely be an advantage when it comes to areas including cost. No, the problem lies in distribution and how those products are being recommended.
This mentality becomes far more problematic when you go beyond investing into areas including general financial planning and discussion around financial goals, strategies to achieve them and so on. When companies mass manufacture “individual and customized” plans it can leave investors with a false sense of comfort for a short period of time before they realize that their plan failed to consider their own behavioral biases.
Take for example a simple retirement plan which shows that in order for our client to retire they must save $10,000 per year and earn an average annual rate of return of 5%. Simple enough but this plan is only considering one aspect of this client’s needs and has not evaluated their past behavioral decisions which include that the client is currently sitting on $40,000 of credit card debt, is notorious for running up debt even after debt consolidation and elimination strategies have been implemented and often bails their children out of tight spots on a regular basis. Any part of that sound familiar? Don’t worry, you’re not alone.
The point I am making is that there is more to implementing successful financial planning strategies than just the numbers and the text book answers. I often tell clients that what could be the best investment for one client might be the worst for another. Some investors can be comfortable with high volatility, others cannot, and their stress will force them to sell at the wrong time. Some investors are excellent savers by nature, others need to have their money taken away from them. Understanding the individual’s behavioral patterns and customizing the solution based on their own personality is critical to ensuring that they will buy into the recommendations for the long term. Mass production can be great but does nothing if the investor can’t stick to the plan being laid out for them.
- Grant White, CIM, CFP®
Grant White is an award-winning Portfolio Manager/Investment Advisor at Endeavour Wealth Management with Industrial Alliance Securities Inc. Together with his partners he provides comprehensive wealth management planning for business owners, professionals and individual families.
This information has been prepared by Grant White who is a Portfolio Manager for Industrial Alliance Securities Inc. (iA Securities) and does not necessarily reflect the opinion of iA Securities. The information contained in this newsletter comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any of the securities mentioned. The information contained herein may not apply to all types of investors. The Portfolio Manager can open accounts only in the provinces in which they are registered.