Knowledge is power. Understanding
your clients can help you minimize the
impact of their subconscious thoughts.
By Nicholas Arreola, Ph.D.
Psychology has infiltrated the field of financial advice and does not appear to be stopping its influ- ence any time soon. This makes sense. With the popularity of outsourcing money management on
the rise, many financial advisors are finding that their most
valuable offering is the management of client behavior.
Every advisor seems to have his or her own story that
underscores this point. The client temptations always vary —
reaching into a 401(k) too soon, taking on unnecessary debt,
dipping into savings, etc., but the image that advisors create is
always the same: taking off their businessperson hat and playing the role of a psychologist.
These advisors would be the first to acknowledge a lack of
formal training in psychology, but knew, most likely through
professional intuition, that they had to do something. They
needed to prevent their client from behaving in a way that would
have a potentially profound negative impact on attaining their
financial goals, even if it meant losing them as a client.
Two Systems at Work
In his book, Thinking, Fast and Slow, Daniel Kahneman, a mod-
ern-day psychologist who’s known for winning a Nobel Prize in
economics for his work studying judgment and decision making,
presents a framework for how the mind works, which he and his
colleagues have labeled System 1 and System 2 thinking. System
1 thinking is described as automatic, intuitive, and emotional,
whereas System 2 thinking is deliberative, effortful, and logical.
This framework for how people think implies one of the
best arguments for having a financial advisor — to protect clients from the impulses of System 1, which is error-prone and
sacrifices accuracy for speed and gratification.
Over the last several decades, researchers have identified a
number of systematically occurring errors in human thought,
which are referred to as cognitive biases. You’ve no doubt
witnessed someone succumb to one or more cognitive biases,
ie. a disappointed gambler walks away empty-handed from
the blackjack table, or a novice basketball player confidently
shoots, but misses, a free throw. These two scenarios represent
the gambler’s fallacy, an incorrect belief that a series of losses
will decrease the chance of losing in the future (or vice versa),
and overconfidence bias, an exaggerated belief in one’s abilities.
Have you caught yourself engaging in one of the these
biases? Naturally, we humans are not designed to catch ourselves engaging in biases — the exception being when they are
brought to our attention. We are simply too limited in our span
of attention and consciousness.
Even System 2, the effortful and logical counterpart, is
not much help in preventing cognitive biases since System 2