If you’re a financial professional handling client finances, then at some level, you’ll be helping your clients to make financial decisions.
And the profession has numerous regulations to try and ensure that those financial decisions are aligned with client interests, with their risk tolerance and stated objectives, and thus produce the best outcomes for the client.
And while that’s all well and good, it assumes that good advice, in the regulated sense, will lead to good outcomes. Intuitively that makes sense to us. Bad advice usually leads to bad outcomes, so good advice should lead to good outcomes. But in order for that to happen, the advice needs to be processed by a good decision-making process and the client needs to be in a good physiological state.
This raises a key question: what do we know about the financial decision-making process? And, more importantly, for each client, what do we need know about their financial decision-making process?
Human decision making
What we know about human decision making is that it’s not usually a rational, utility optimising process. Behavioural economists have conclusively proved that our decision-making is riddled with biases, contradictions and flawed logic.
Financial decisions are even more prone to this because money evokes such strong emotional responses. But behavioural economics only focuses on generic flaws, which are common across most of us because they have the same evolutionary roots. We all suffer from hindsight bias, recency bias and loss aversion. So, we can think of these as general cognitive biases.
When it comes to understanding a client’s financial decision-making process, what really matters is not these general cognitive biases, but whether clients have any unique money beliefs that lead them to making bad or sub-optimal financial decisions.
We can think of those as cognitive distortions. Cognitive distortions are biased perspectives that we take on ourselves and the world around us. They are flawed thoughts and beliefs that we unknowingly create and reinforce over time. We all have cognitive biases, and we all have cognitive distortions. Favouring information that confirms our existing beliefs is a cognitive bias, and we all have that; believing that it is hard to be rich and happy is a cognitive distortion, and not everyone believes that.
Why this matters is because its beliefs that drive behaviour
A client’s money beliefs drive how they spend, save and invest. These are beliefs about themselves, about money, and about money and themselves. A financial decision-making process that contains significant cognitive distortions will produce sub-optimal results, no matter how good the advice.
These cognitive distortions manifest themselves itself in many ways – overspending, underspending, refusal to plan for wealth transfer, difficulty in discussing money. And I’d like to emphasise that there is no judgement about these beliefs or distortions. They may lead to ‘bad’ outcomes, but most beliefs are subconscious.
If we want to understand a client’s money beliefs, we need to know where money beliefs come from. Our beliefs about ourselves and money develop in childhood and are based on messaging by the people around us and the broader cultural environment.
The messages can be explicit – money doesn’t grow on trees – or indirect. Indirect messaging comes from the behaviour of people around us, and is at the core of how we build an understanding of how the world works. Children mainly copy what we do, not what we say. We translate these messages into stories and these stories drive our beliefs. Everyone is unique and, more often than not, siblings growing up in the same environment will have different money beliefs and money patterns, sometimes radically different.
So, if financial decision making is driven by money beliefs and money beliefs come from childhood messaging, how do we explore what those beliefs are?
We ask.
We ask clients to tell us their money stories
We can ask directly – what did you learn about money growing up? What is important to you about money? what messages did you get about money when you were young? We can ask indirectly – could you please share your story with me?
And we listen and ask follow-up questions.
Sounds simple, but of course it’s not that easy. However, it is a skill that can be mastered with training and practice. It sits at the heart of building trust and people like to tell their stories, even about money.
If you’re in the business of helping clients to make financial decisions, then knowing how they make financial decisions should be at the heart of your relationship. If you don’t know that, then there will always be a limit to how much you can achieve together. When good advice meets flawed beliefs, the beliefs always win out.