Finding Normal: The Next Generation in Behavioral Finance

Journal of Financial Planning: August 2020

 

In neighborhoods throughout the country, you can find little free libraries designed for people to take a book or leave a book.

In the time of coronavirus, Meir Statman, Ph.D., saw his neighbor put up a little free food pantry that included free face masks for anyone who needed them. This is normal behavior, Statman said in a webinar from the CFA Institute titled “Behavioral Finance in the Time of COVID-19,” (access a recording of it at cfainstitute.org).

“Normal people are compassionate people,” Statman said.

Traditional behavioral finance seems to describe people as irrational, “bumbling idiots,” according to Statman, but they’re not. Echoing the overarching message of his book, Behavioral Finance: The Second Generation, Statman said that people are normal—compassionate, rational— mostly normal smart, and normal knowledgeable, but oftentimes they lean toward normal stupid and normal ignorant. The good news is, since people are generally intelligent, we can increase the ratio of smart to stupid and knowledgeable to ignorant.

“Once you understand and accept that people are normal, you can see how many doors it really opens,” he said.

The “second generation” of behavioral finance, as defined by Statman, acknowledges the full range of clients’ “normal” wants and distinguishes those from cognitive and emotional errors.

“People’s normal wants underlie answers to important questions of finance, including saving and spending, portfolio construction, asset pricing, and market efficiency,” Statman said.

To check if clients have normal wants, Statman suggests asking the following questions: Do you want to avoid poverty? Do you want prospects for riches? Do you want to nurture your children? Do you want high social status? Do you want to stay true to your values?

Normal people want three things from financial services: utilitarian benefits (what does this do for my finances), expressive benefits (what does this say about me to me and others), and emotional benefits (how does it make me feel).

Statman emphasized the importance of framing questions correctly and recommends using analogies to do so.