How to Incorporate Behavioral Finance Theory into a Planning Practice

Journal of Financial Planning: March 2015


Margaret (Peggy) Doviak, Ph.D., CFP®, is founder of D.M. Wealth Management Inc., a financial planning and portfolio management firm in Norman, Oklahoma. She is an associate graduate professor for the College for Financial Planning and an advocate for the CFP Board Women’s Initiative.

Anytime we are exposed to a new theory, it feels strange and unfamiliar. When we are then asked to implement something about that theory into our business, it becomes overwhelming. The field of behavioral finance is still cutting-edge, but most financial planners who read current literature are familiar with it, at least conceptually. However, asking those planners to do something concrete with it in their practice creates a very different scenario.

As part of a “Psychology of Money” course that I teach for the College for Financial Planning, we study behavioral finance strategies and look for ways to successfully include them in a typical financial planning firm. This paper provides a summary of my students’ major concerns about adding behavioral finance components to their financial planning practices. It then offers strategies we have created to overcome them. The issues faced by my students are honest and thoughtful and must be resolved when broadening a practice from only exterior, traditional finance to also include behavioral finance.

Do I Know Enough?

“I don’t feel like I know enough about behavioral finance to use it in my practice.”

Many of my students are already planners with years of experience. Some of them are already CFP® practitioners. Further, most of them take my class, which is an elective, because they have heard of behavioral finance and want to learn more about it. However, at the beginning of the class, most of the students had done nothing in their practices to specifically account for the ways their clients are not rational. Most of them, instead, just express frustration at the times when they know they gave good advice and the client wouldn’t take it. I offer my students several strategies for better understanding and implementing behavioral finance in their practices.

First, study the subject and read in the field. There are many great books written about behavioral finance. I particularly enjoy Thinking, Fast and Slow by Daniel Kahneman and Facilitating Financial Health by Brad Klontz, Rick Kahler, and Ted Klontz. You don’t need to have a perfect understanding of some of the statistics and math that underlie parts of the theory to understand the topics enough to use them in your practice.

From the readings, choose specific exercises or topics that you find especially interesting. Talk to family, friends, and colleagues about the biases you have discovered and how you think they apply to financial planning. If you find a formal exercise in both of the books I am recommending, have friends complete it. For example, they might write down their earliest money memories or try to complete complex mathematics and physical activity at the same time. Ask the participants for unbridled analysis of the process. What worked? What did they enjoy? What didn’t work? What didn’t they enjoy? Do they feel they learned something about themselves? Then, turn the lens on yourself. What was easy for you to explain? What was difficult? Where did you feel uncomfortable? Continue working with the exercises and concepts with colleagues until you feel as though the process is a success for you and your “clients.” Remember that you should not try any new exercises or activities with actual clients until you are very comfortable with them. 

Once you feel confident enough to use the exercises and activities with your clients, begin to implement them with clients whom you believe will be most receptive. Explain to them that you are trying to implement different kinds of questions to help them better reach their financial goals, manage risk, and create effective portfolios. Few clients will resist when that is your goal. Tell clients you chose them specifically to help you implement these changes in your practice, and once they have completed the exercise, have them offer feedback in the same ways you requested it from your friends. Of course, if the client shows any hesitation, let it go. The goal is to make you a more effective financial planner, not lose clients!

Just because you use behavioral finance techniques with some of your clients doesn’t mean you have to implement them with all of your clients. Some clients may not be receptive, and you may not want to try anything with them. Just the knowledge you have gained in your study will give you better insight into these clients. You could even ask an occasional behavioral finance question to see if something you are noticing is accurate. The more I study and work with behavioral finance exercises, the more I weave the concepts into nearly every client meeting, even if the client doesn’t see it directly.

Some planners never reach a comfort level with behavioral finance techniques. Those planners would be better served to stay on the quantitative, exterior side and provide excellent, holistic traditional finance-based planning. We need good financial planners to offset the salesmen and fear mongers. If behavioral finance doesn’t work for you, once you’ve given it a try, then don’t use it.

How Do I Organize?

“Okay, I’ve read the material. I feel like I’m memorizing a laundry list of behavioral finance biases and errors in judgment. How do I keep them organized?”

One component of behavioral finance examines investor errors in judgment and biases that impact their behavior by making them not logical or rational. Some of them appear to be very similar, particularly when studied in a book. New students often find the number of biases overwhelming, especially when they are given the material over a relatively short period of time, like an eight- or 16-week course. The study of the biases can feel like a memorized list, much like being told to memorize the periodic table in chemistry or the presidents of the United States. Students often express dismay when they become confused with the nuances between the biases, and they can’t exactly determine into which bias a specific investor behavior falls. I offer the students several strategies to help with this.

The possibly least scholarly and still most effective strategy is not to worry too much about it. Simply recognizing that the client is falling into a logical fallacy is a major accomplishment. When you can see that your client is acting out of emotion, you can try to discover the underlying cause of that emotion. For example, if a client who has been risk averse suddenly wants to seek additional risk, you need to try to discover why. Once that information can be processed, then you and the client can work together to decide whether the behavior should be avoided or the risk tolerance profile should be adjusted. Sometimes, changes in a client’s life can bring about true changes in risk tolerance. It’s always a risk to assume a client is simply behaving irrationally and dismiss their requests without additional data gathering.

When determining the kind of bias becomes important, drill down to the major categories. For instance, cognitive biases or simple errors in logic are easier to correct than belief biases, where the bias is more pervasive in the client’s life. Understanding the complexity of the bias and how committed a client is to the belief can help the planner create more effective planning strategies.

Studying the specific biases and categorizing them is still a useful exercise, even when it feels like memorization. As planners, we are also subject to behavioral finance errors and biases. We will tend to discount our own biases if we aren’t forced to give them sufficient study. The more we can become aware of the types of errors we tend to make, the more we can try to engage critical thinking, especially in those areas, when we are working with our clients. This focus on overcoming personal biases is similar to disclosing conflicts of interest. Even though our behavioral finance biases aren’t conscious, ethical decisions, they can still cause us to give biased advice.

Do I Have the Time?

“Addressing behavioral finance issues with clients takes time. I don’t have any more time to add to client meetings.”

Time management is a challenge for all of us. Meeting with clients and managing the outcomes from these meetings fills much of our time, and anything left involves staff meetings, administration, compliance, or marketing. When my students are overwhelmed with the concept of adding yet something else to a client meeting, I am sympathetic. However, we have developed a few strategies that make it easier.

First, it takes more time to explain behavioral finance to existing clients than it does to add it to the new client onboarding process. Many of us have an initial “meet and greet” meeting where we explain our philosophy, talk about the clients’ needs, and mutually decide if the relationship is a good fit. It is easier to include behavioral finance analysis at this time because the schedule is more fluid.

If your compliance firm allows it, send a letter, email, or other mass announcement to your clients (or selected clients) discussing the value you believe behavioral finance conversations will add to your planning process. This avoids the need for a totally cold introduction to the topic in a client meeting.

Some activities are questionnaires or other projects that the client can complete at home. The client could return them to you before the next meeting so that you could have read the documents and have some areas for discussion.

Committing to this kind of planning may take more time. You likely will have to decide whether or not you believe it adds sufficient value to your practice to justify the time. Personally, I believe that most financial plans that are well written and not implemented by the client have fallen apart at the behavioral finance level. The planner has overlooked, underestimated, or simply not been informed about something in the client’s life that is causing them to act irrationally.

Is It Too Touchy-Feely?

“I don’t like things that are touchy-feely!”

In every class, at least one person has the nerve to say what I know other students are thinking. They are quantitative, and they don’t like dealing with qualitative, non-rational human behavior. It is unnerving to ask clients personal questions. Inevitably, they provide answers that are also personal. Sometimes, the planner knows how to respond, and sometimes, the situation is outside the planner’s area of expertise. 

Most importantly here, I tell students to know when they are past their area of skill. There is a major difference in learning that clients’ financial beliefs stem from childhood role models (a very common phenomenon) to learning that it occurred in an abusive relationship endured as a child. You may need to redirect the conversation.

Keep the conversation focused on how the client’s belief or bias is affecting the current planning and investing situation. The more you keep the conversation on your role in the client’s life, focusing on money-based activities, the less likely the client is to evolve into a place you do not want to go.

Try to find a money coach, money therapist, psychologist, or other professional who is trained to work with people and their money psychology. Interview this practitioner to be sure they have a philosophy you professionally respect. Get creative. Maybe you could give this person office space one day a week. Perhaps you can work together with each other’s clients if the clients support the idea. Again, clear everything you are considering with your compliance department. Although it may sound intimidating to add a money coach to your practice, your clients won’t find it as strange if it is organic to your practice. In today’s world, we all have coaches for something. A money coach is just someone else on the team.

Whether you choose to deal with your clients’ behavioral finance biases and errors in judgment, they will still have them. Ignoring them may limit the effectiveness of your planning strategies; however, remember the earlier point. We need outstanding comprehensive planners, whether they follow behavioral finance principles or not, to advance our profession. 

Applying behavioral finance principles to a financial planning practice can be daunting. My students and I spend considerable time discussing, resolving, and modifying ideas and practices through our weekly online discussions. The strategies provided in this article are not comprehensive, and everything won’t work in every practice. However, they provide a place to begin to make the theoretical world of behavioral finance practical and usable.

General Financial Planning Principles