The Elephant in the Room: How the Financial Industry’s Shunning of Emotions Fails Its Clients

Behavioral economics can and should reframe how we look at our interaction with money, as well as the business of financial advice.

I don’t think professor Richard Thaler is going to return my calls anymore. Sure, he was gracious enough to give me an interview after his most recent book, Misbehaving, a surprisingly readable history of the field of behavioral economics, was published. But now that he’s won a Nobel Prize, something tells me I’m not on the list for the celebration party.

(Although, if that party hasn’t happened yet, professor, I humbly accept your invitation!)

But I’m still celebrating anyway, because Thaler is a hero of mine and I believe that the realm of behavioral economics–and behavioral science more broadly–can and should reframe the way we look at our interaction with money, personally and institutionally, as well as the business of financial advice.

Behavioral Economics In Action

Of course, even if you’re meeting Thaler for the first time, his work likely has already played a role in your life in one or more of the following ways:

• Historically, your 401(k) (or equivalent) retirement savings plan has been “opt-in,” meaning you proactively had to make the choice–among many others–to do what we all know is a good idea (save for the future). But our collective penchant for undervaluing that which we can’t enjoy for many years to come led most of us to default to inaction. Thanks largely to Thaler and Cass Sunstein’s observations in the book Nudge, more and more companies are moving to an “opt-out” election, automatically enrolling new employees in the plan with a modest annual contribution.
• Better yet, many auto-election clauses gradually increase an employee’s savings election annually. Because most receive some form of cost-of-living pay increase in concert with the auto-election bump, more people are saving more money without even feeling it!
• Additional enhancements, like a Qualified Default Investment Alternative (QDIA), help ensure that these “invisible” contributions are automatically invested in an intelligently balanced portfolio or fund instead of the historical default, cash, which ensures a negative real rate return.
• Some credit card awards now automatically deposit your “points” in an investment account while some apps, like acorns.com, “round up” your electronic purchases and throw the loose virtual change in a surprisingly sophisticated piggy bank.

No, you’re not likely to unknowingly pave your way to financial independence, but thanks to the work of professor Thaler and others, many are getting a great head start without making a single decision.

What is most shocking to me, however, is the lack of application–or the downright misapplication–of behavioral economics in the financial services industry.

Misusing Behavioral Economics

What, exactly, is being missed or misapplied?

Well, if I had to summarize the entirety of what we’ve learned from behavioral economics, finance and the scientific findings that apply to managing money, it would be the following gross oversimplification of the seminal work from Thaler’s predecessor, Daniel Kahneman, in his book Thinking, Fast and Slow:

1. The brain’s “operating system” for processing information is actually two systems–“System 1 is fast, intuitive, and emotional; System 2 is slower, more deliberative, and more logical,” he writes.

2. Confoundingly, most of our financial (and other) decisions are made with System 1, not System 2.

Even though we may prefer to access the deliberative, logical, quantitative processor in our brain when making financial choices, the science suggests that we’re still using the intuitive and emotional part of our brain to reach those decisions. Let’s say it’s broken down 80/20 into System 1/System 2, emotional/logical, qualitative/quantitative.

However, the financial planning process more often taught and most often practiced is almost entirely System 2–even though the science suggests they’re basically two different neurological languages, and that we struggle to solve a System 2 dilemma with System 1 logic.

(Perhaps this is the reason that more than 80% of the recommendations made by financial planners are not implemented?)

The Elephant (and the Rider) in the Room

This reality is the proverbial elephant in the room, and that’s a perfect analogy because the metaphor that has helped us comprehend Systems 1 and 2 is, indeed, the loveable pachyderm.  Author Jonathan Haidt ascribed System 1 with qualities represented by the elephant, while suggesting System 2 may be characterized by the elephant’s rider.

(I asked professor Thaler a couple years back if he thought this was a fitting and proportionate analogy, and he said it was.)

But a friend reminded me recently that another interesting phenomenon is taking place concurrently. That is, as financial advisors and institutions have been exposed to the science, they’ve been quick to (erroneously) conclude that they are the rational rider and their clients are the emotionally wayward elephant!

Nevermind for a moment that the financial services industry at large has proven its own self-preservative instinct has for too long overwhelmed its nagging feeling that it should put its clients ahead of itself. But to the degree the industry has acknowledged the apparent elephant/rider conundrum, it has chosen to presume that the elephant is a big, stupid animal to be locked outside while the rider reflects self-importantly over a fine, single-malt Scotch at a mahogany board-room table.

“7 Behavioral Biases that May Hurt Your Investments,” “5 Biases that Hurt Investment Returns” and “Investors 10 Most Common Behavioral Biases” are just a few of the first-page search engine results that berate the elephant for its illogical tendencies and seem to encourage the rider to abandon his only form of transportation.

But that’s where we’re reminded half-truths are often the best lies. It certainly is true that we’re prone to all the biases illuminated by the field of behavioral economics. It’s also true that some of these biases lead to poor financial decisions.

Emotions Aren’t the Problem and May Be the Solution

But those who choose to demonize the elephant and elevate the rider do so at their own peril, because it’s also true that:

1. System 1–the elephant–can’t be suppressed. It’s impossible. When the elephant and rider are in conflict, the elephant wins. Period.

2. The elephant is the primary source of our passion, vision and resolve. It can be enlisted to help us accomplish our financial goals.

Those of us who’ve been financial advisors for any length of time know this. If you ask a room of 100 advisors with at least five years of experience how many of them have had a client cry in their office, likely every hand will go up.

We’ve known intuitively for years that personal finance is more personal than it is finance, but Kahneman, Thaler and others have proven it a scientific fact. Others, like Chip and Dan Heath, have helped explain that, perhaps surprisingly, “the Elephant also has enormous strengths and that the Rider has crippling weaknesses.”

In their book, Switch, they continue, “To make progress toward a goal…requires the energy and drive of the Elephant. And this strength is the mirror image of the Rider’s great weakness: spinning his wheels.”

Is that not what we see in personal finance, where financial improvement is one of the top-three failed resolutions every New Year? A lot of wheel spinning? An abundance of talk and an absence of action? A lot of money being made by a financial industry that fails to usher willing clients with means to a beneficial end?

Life Planning and Elephant Training

There is a small niche within the true financial planning profession, which is itself a stunning minority of the broader financial product-pitching machine, dedicated to elephant training. Known by monikers such as “financial life planning” or simply “life planning,” the pioneer in this field is George Kinder.

I recently had the privilege of joining Kinder for his two-day intro course and five-day immersive, experiential advisory training, and I’d coarsely summarize these as intensive training in recognizing, understanding and then enlisting emotions, primarily through compassionate, yet strategic, empathy.

An example of something I learned? When that client (or friend, or family member, or anybody you don’t hate) is overcome with emotion and begins to tear up, you should not–I repeat, not–give them a tissue or (in most cases, but especially with clients) even place your hand on their shoulder.

Why? Because it signals to them that you’re uncomfortable with their emotional expression and want them to stop. We’ve learned that emotions function much like waves that rise, peak and crest, and that we should never avert our eyes–even as a pensive client naturally will–so that when the swell subsides, our appreciative, compassionate, unmoving gaze signals it was totally normal (even welcome) for them to experience that in our presence.

(Then, by all means, give them a stinking tissue!)

And that was just the answer to a common, but isolated, question. In a larger sense, the Kinder Institute has honed this art to a science, giving advisors a deliberate five-step process, and even more importantly (to me), a method for guiding any and every meeting toward the most productive exchange possible.

But Kinder has been influencing the financial planning community for more than 30 years and has trained Kinderites in more than 30 countries. He’s been joined by other respected industry voices, like our five-day co-trainers, Ed Jacobson, Ph.D., and Louis Vollebregt. Others have taken up the torch with their own unique life planning manifestations, such as the late Dick Wagner, Carol Anderson, Rick Kahler, Drs. Ted and Brad Klontz, Susan Bradley, Michael Kay, Mitch Anthony and others.

Every bit of their wisdom that I’ve consumed over the past 15 years has been additive, and I’ve seen financial advisory practices transformed by bolstering their qualitative skills–their elephant training.

Financial Planning Done Right

So, why is it still a niche? Why don’t we see any huge financial firms adopting it? Why don’t we see the Certified Financial Planner™ Board of Standards adding a substantive element of qualitative training to the educational requirements for newly minted CFP® practitioners?

I can only conclude that, in general, the profit motive is still a stronger force within the financial services industry than the desire to put a client’s interest ahead of the firm’s.

But hopefully, with yet another Nobel Prize being handed to a behavioral economist, the qualitative-planning, life-planning, elephant-training movement will continue to grow. And as the growing profession of financial planning begins to separate itself from the sales engine of the larger industry, this is vitally important because life planning isn’t so much a niche or specialty–it’s simply financial planning done right.

This commentary originally appeared November 15 on Forbes.com

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