Taking An Unfiltered View of the Investment World
In the early 1970s, psychologists Amos Tversky and Daniel Kahneman researched heuristics—the simplified, efficient rules that underlie how humans make intuitive judgments. Because people are not always able to obtain all the information they need to make the best possible decision, heuristics allow the brain to make the best of limited information.
Heuristics usually take the form of automatic, intuitive judgments, but they can also be used as deliberate mental shortcuts. For example, heuristics enable us to make faster decisions when presented with complex problems by allowing the brain to focus on one aspect of the problem while ignoring others.
This innate tendency to remove decision-making “clutter” keeps the brain from being overburdened, but it can lead to systematic deviations from logic, probability and rational choice. Errors, known as "cognitive biases," can affect decision-making in important situations like valuing a house or making an investment decision.
The findings of Tversky and Kahneman set in motion the Heuristics and Biases Research Program, which studies how people make real-world decisions and the conditions under which those judgments are unreliable. This research challenges the idea that human beings are rational actors.
In my mind, heuristics involve people hearing what they want to hear and ignoring or dismissing what does not fit into the rules they have established for filtering the world. I am fairly certain that every one of us has experienced or manifested this behavioral phenomenon. What can we do as advisors to influence the rules our clients have established for themselves—especially when those rules have been detrimental to their wealth?
The solution may be found in revisiting the outcomes of our clients’ past investment decisions, looking for specific examples of when things went well (and why) and when things went poorly (and why). Then review with the client the decision points they employed in making those past decisions. Identifying these client biases and rules—without divulging the actual rules required for making successful wealth management decisions—is crucial. We must learn their rules before we can understand how to frame our solutions.
I often see advisors trying to immediately overlay their own rules onto a client, without any regard for the rules those clients currently believe in. This is like using the rules or heuristics associated with a FOX News viewer to try to persuade an MSNBC viewer of the validity of the Fox opinion. It won’t work.
This does not mean we have to compromise our own well-grounded wealth management concepts. Rather, it is often necessary to find rules that the client believes in that are consistent with our own in order to connect that client with other, more rational investment principals.