Financial advisors know the difficulty of getting clients to do the right things. Clients often fail to diversify portfolios, rebalance out-of-whack allocations or discuss inheritance plans with adult children. These behaviors undermine long-term outcomes.
Fortunately, new research in the field of behavioral economics sheds light on conversations that can help clients avoid the minefields that cost them money and strengthen relationships in the process. These conversations tap into the power of default behavior, the things that happen if the client does nothing to alter pre-existing decisions. Popularized in the book Nudge: Improving Decisions about Health, Wealth and Happiness by Richard Thaler and Cass Sunstein, defaults can get clients on the right track and keep them there.
Five words can put the right default behavior in place: “Unless you tell me differently.”
Research on the power of defaults
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It is important to differentiate between a “nudge” and a “shove.” A nudge is a suggestion, while a shove is mandated activity that provides no option to change. An example of a “shove” is withholding of taxes. To ensure that tax payers are not faced with large tax bills, the IRS mandates that taxes are paid over the course of the year, without any alternative.
While they’ve become popularized lately, defaults are not new; early examples are negative-option programs such as Book of the Month Club, founded in 1926, where books were mailed to members each month unless they returned a card indicating that they no longer wanted to receive the offering
Additional research on how defaults encourage desirable behavior:
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In his TED Talk, Duke economist Dan Ariely describes his research on organ donation rates among European countries. There are extremes between what on the face would be similar countries – Denmark at 4% vs. Belgium at 98%. Germany at 12% vs. Austria at a remarkable 100%.
The difference is opt-in as opposed to opt-out. In high-organ-donation rate countries people are signed up to donate organs unless they opt out. In low-organ-donation-rate countries people are not signed up unless they opt in.
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In What Advisors Can Learn from Bernie Madoff, I described different approaches used by hotels to encourage guests to reuse towels and bed linens. After experimentation with a variety of different approaches, the one that has proven to work best was reusing linens unless guests took action. Here’s a typical message used by Hilton hotels:
If you are staying with us more than one night, we will launder your linens upon request. To have your linens changed today, please leave this card on your pillow. As always, linens are automatically changed after every guest checkout.
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The University of Chicago's Richard Thaler is a pioneer in the field of behavioral economics. In A Simple Strategy to Triple Client Savings Rates, I outlined how Thaler initiated experiments that entailed two changes that dramatically increased savings rates in 401K plans. First the default contribution rate was increased from 3% to 6%; employees could always reduce the savings rate, but if they did nothing 6% of their savings went into their savings. And second, when they did the paperwork for their 401K contributions employees were given information on a Save More Tomorrow Plan in which half of future salary increases would be automatically allocated to savings. Even if they signed up for this, employees could change that commitment at any time.
Approximately 80% of employees signed up for the Save More Tomorrow Plan and fewer than 10% reduced their automatic savings rates from 6% or opted out of the decision to direct half of future salary increases to increase savings. This is evidence of the strong power of the right default activity - and given these results today many 401 K plans offer employees the ability to direct a large portion of future salary increases to savings.
Applying defaults to client conversations
Some advisors are already incorporating defaults into their conversations with clients. Some examples of the things that advisors are already saying that you could adapt for your own situation:
Rebalancing portfolios:
As we’ve discussed, maintaining the right allocation to stocks, bonds and cash is essential to controlling portfolio risk on the way to achieving your long-term goals. When we conduct our annual reviews, unless you tell me otherwise, I will take action to rebalance your portfolio to ensure that it stays within your target allocation.
Scheduling review meetings with new clients:
Something that I’ve learned is important to get our relationship off to a good start is to schedule a short coffee after 90 days to talk about how things are going. We can do this here at my office or I can meet you close to your office or home, but as a matter of course I schedule a 30-minute update with every new client 90 days after we begin working together. Can we schedule that coffee right now?
Diversifying portfolios:
Research shows that the most successful investors are very disciplined about diversifying their portfolios. That means diversifying the stocks you own across regions, countries and industries and diversifying your bond holdings also. Unless you tell me otherwise, diversification of holdings will be at the core of all the recommendations I’ll be making when we sit down to discuss your portfolios.
Addressing questions:
While I am always available to take your questions, in the normal course for any questions and administrative issues you should call my assistant Philip. Philip will be completely on top of your situation and will be in the best position to resolve any issues.
Conversations with client accountants:
In working with successful business owners like you, I have learned that to minimize your tax exposure it is essential that I communicate with your accountant. Unless you tell me otherwise, I would like to reach out to your accountant and tell him or her that you have given me permission for us to talk about your investments. That way we can ensure that there is clear communication and that you pay the lowest tax possible.
Conversations with adult children
Research shows that the most successful families have clear communication about their finances; the less ambiguity and uncertainty, the better. For every client with adult children, I suggest that we meet to talk about the parents’ financial situation. Some clients have told me that they were a bit uncertain going in, but in every case clients told me afterwards that they were glad we’d had the conversation with their kids. Unless you tell me otherwise, in the next while I will suggest that we schedule a time for the three of us to sit down with your adult children to review your financial situation.
To learn more about structuring default activity in your practice, read this New York Times article: The Default Choice, So Hard to Resist.
Dan Richards conducts programs to help advisors gain and retain clients and is an award winning faculty member in the MBA program at the University of Toronto. To see more of his written commentaries, go to www.danrichards.com or here for his videos.
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