Using behavioral science in a financial-planning practice

By understanding influences on clients’ decision-making, CPA financial planners can work with them better and operate a practice more effectively, Michael E. Kitces highlighted in a presentation at the AICPA & CIMA ENGAGE conference in June about how to use behavioral finance in a financial-planning practice.

Books and articles on behavioral finance tend to discuss “the crazy things that clients sometimes do and not a lot about what we, as practitioners, are supposed to actually do about it,” said Kitces, an author, speaker, and head of planning strategy at Buckingham Wealth Partners.

Behavioral finance is a field focusing on the sometimes irrational ways people make financial decisions and how to improve their decision-making.

In his ENGAGE presentation, “Applying Behavioral Finance in Your Financial Planning Practice,” Kitces discussed some ideas for financial-planning practices to consider.

Shorten client meetings

One study that Kitces summarized — that at first glance might seem unrelated to financial planning — suggests that overly lengthy client meetings can hinder clients’ ability to arrive at a decision.

The researchers found, in another context, that a criminal parole board was more likely to grant parole if the parole hearing was held first thing in the morning rather than at 11 a.m. after other hearings. Why? By 11 a.m., the strain and effort of the morning’s previous hearings had caused the parole board members to become mentally drained, hindering their ability to make deliberate decisions, Kitces said.

Kitces explained that, in behavioral finance terms, the weary parole board members tended to revert to “system 1” thinking, which is impulsive and instinctual, rather than “system 2” thinking, which is slow and rational. The impulsive and instinctual approach was more likely to result in the denial of parole.

An implication of this study, Kitces observed, is that after a 1½-hour meeting with a financial adviser, clients may think, “My brain is freaking tired. You ain’t getting no decision from me at this point.”

Focus client decisions

For similar reasons, Kitces suggested that advisers should be careful not to overwhelm clients with the number of decisions they must make simultaneously, because this can impede decision-making too. Instead, after a broader discussion, consider focusing on achieving one or two goals at a time, he recommended.

Another worthwhile technique, Kitces observed, is to have clients write down their priorities and set a written deadline for achieving them. This may help spur them to complete the tasks, because people are wired to feel socially obligated to follow through on written commitments, he said.

Understand the effects of fee structures

Kitces also discussed “choice architecture,” which examines how the framing of choices influences people’s decisions.

The difference between opting in versus opting out is especially important and has implications for financial planners’ fee structures, Kitces noted. In one medical study, researchers found that when individuals filled out forms asking if they were willing to be an organ donor (e.g., to have donor status listed on their driver’s license), most people didn’t have the mental bandwidth to make this consequential decision.

Kitces explained that most people think, “I’ve got other things to deal with; my brain is tired,” and leave the box unchecked. Thus, they default to becoming organ donors if the form requires them to check a box to opt out.

Financial planners designing their fee structures should consider this insight into people’s natural tendency towards inertia, he stressed.

In some financial-planning fee models, clients keep paying for the services unless they opt out, meaning the default option is to continue using the services. In contrast, with hourly billing, clients must make a fresh opt-in decision each time they have a new financial question to ask the adviser for which they’ll be billed. The easiest choice is to forgo asking the question, saying, “I’m just going to not deal with it right now,” Kitces said. Advisers should at least be aware of this behavioral difference.

A related notion applies to business decisions about whether to bundle services together, Kitces noted. For instance, if a firm strongly prefers working with highly motivated clients (and isn’t worried about having enough of them), it might consider charging for a service separately. Clients who overcome inertia to make an affirmative choice to spend money on the service will be more likely to follow through with it, compared to those who receive it bundled in, he said.

Humanize online interactions

Another study Kitces shared demonstrates the benefits of personalizing online interactions with clients and prospective clients.

The study found that radiologists “just seem to literally do a better job” of reading an X-ray when a photo of the patient was attached to it, Kitces explained, because “the virtual patient was humanized.” In fact, they suddenly made five times as many potentially life-saving “incidental findings,” such as identifying a possible cancerous growth in an X-ray taken for unrelated reasons, he said.

Taking a cue from this study, Kitces said, his former firm began asking clients for permission to take a headshot photo when they were in the office and put it in their customer relationship management (CRM) record. That way, all members of the team, including back-office employees who might not meet with clients at all, weren’t “just looking at a bunch of numbers in the CRM,” Kitces explained. The photos humanized the clients.

In addition, Kitces said, his former firm began posting one-to-two-minute videos of its advisers introducing themselves. Using videos rather than merely photos led to a rise in website-driven inquiries from potential clients, who “bonded with and picked their adviser” from the short video introductions, Kitces said. The videos humanized the advisers and led to an increase in business, he indicated.

In sum, behavioral science can be a powerful tool for working with clients more effectively and operating a financial-planning practice better. But, Kitces stressed, “Please use ‘The Force’ for good and not for evil.”

Michael E. Kitces discussed these and other ideas in his ENGAGE presentation “Applying Behavioral Finance in Your Financial Planning Practice.” A video recording of it is available to those who bought an all-access pass to AICPA & CIMA ENGAGE 2024.

For more practice tips, listen to the AICPA PFP Section podcast episode “Digging Deeper With Your Clients, Part 1 of 3.”

— Dave Strausfeld, J.D., is a JofA senior editor. To comment on this article or to suggest an idea for another article, contact him at David.Strausfeld@aicpa-cima.com.