Not long ago a bank teller and I got into a conversation about hair. She asked me: What can I do to have nice hair? Mine is falling out and it’s thin. I told her make sure to eat enough protein and vitamins, giving her examples of some foods she could eat. Then she asked me isn’t there some treatment I could do instead? Her question led me down the shampoo aisle at the nearest large store to count how many hair products were available. There were products for frizzy hair, colored hair, long hair, blond hair, products to increase volume, and products for shine. I lost count at 351. Then I reflected on human nature because I have encountered her viewpoint in the past. A close relative has told me that in his old age he’s OK with getting a medical condition as long as medical care can fix it. Healthy lifestyle? Why bother?
The question to ask here is: Has prevention gone out of style?
What does the above have to do with personal financial management? Has Cindy gone off on the wildest of goose chases? Stick with me and you will see.
Just like the shampoo aisle the amount and types of financial products has multiplied exponentially in the past decade. Whether this is in response to demand or whether it is companies trying to make money, is a chicken and egg discussion for another time. There are GMWB, ETFs, LTC insurance etc. How has the amount and complexity of financial products affected consumer behavior? Has the proliferation helped them reach financial independence? How do consumers react to increased choices? Studies have shown that in the tangible product space increased number of choices decreased actual purchases.
Behavioral finance can give us some clues as to whether consumers will benefit.
When a new product is launched it is highly promoted and many times it becomes popular, at least for awhile. Consumers want to check it out. This is in part what causes stock market movement. But not many people have stopped to ask why do we want new things? Well of course in part attraction and curiosity. Advertising has primed society to be automatic consumers. Digging deeper though, people would be hard pressed to understand that they assume the new thing is better simply because it is new.
In one week in January I took note of the price of gas. It was at least 3 different prices in the space of 7 days, enough to make you dizzy, or turn you into a gas buying gambler. These price movements have no precedent in recent history.
Those institutions that can influence the stock market have access to much more information than in the past and have the new information more quickly. As in the product space the belief is that the readily obtainable new information is BETTER information strictly because it is new. This belief is what is driving market volatility. Behavioral finance has labeled this availability bias, the belief that that NEW easily obtainable information equals BETTER.
Coupled with this availability bias is how people gather information to support the viewpoint they hold. The tendency is to give more validity and attention to information that supports your present viewpoint and to ignore information that refutes it. This is called confirmation bias. So let’s look at an example of this in action in relation to financial products.
A client asked me to advise him on an offer of life insurance on his mortgage from his bank. I explained how banks can conduct post claims analysis, especially on people with pre existing conditions which both he and his wife have. I told him there have been cases in Ontario and Alberta where the bank has refused to pay the death benefit even when sued. In this client’s mind, the offer of life insurance has legitimacy because it coming from the bank, and the offer is also available. Contrast that to my advice which is based on lesser known less easily obtained facts. I could sense both his availability and confirmation bias reflected in his voice. that he doubted the validity of what I was saying.
I was also recently asked to compare RRSPs and TFSAs. The client in his late twenties was leaning towards the TFSA as being more favorable, figuring there would be less taxes upon withdrawal. His conclusion was based on two assumptions 1) that he would use TFSA as a retirement plan, saving faithfully 2) that the TFSA would till be government sanctioned as a tax free vehicle at a point in the far future, (remember income trusts?). For the record, I support TFSAs but in the proper context of an overall financial plan.
Anytime a person needs to make a decision financial or otherwise he or she needs to be aware and able to understand what filters they have in their mind to process information. This will enable them to be open minded and ask themselves am I making the best decision for my future, financial or otherwise? Or do I want a quick fix product so I don’t have to have financial discipline and good financial habits? Unfortunately I have seen cases where people unwittingly thwart their financial future by using information only to support their own ideas or making emotional decisions. My role is to help you avoid those pitfalls.
Gorr, Gary How to Improve Returns. Advisor’s Edge Report. October 2011
Gorr, Gary First Impressions are Often Wrong. Advisor’s Edge Report December 2011.