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Has this happened to you?
Your analysis indicates a client will experience a shortfall in meeting their retirement goals. You lay out a series of options, like:
- Increasing the risks in their portfolio;
The client acknowledges the issue and agrees to implement some of your recommendations.
But the next time you meet, nothing has been done. The client has various excuses, but it’s clear your advice is not being taken seriously.
You have a non-compliant client.
The depth of the problem
You’re not alone.
Judging by the number of articles on why clients don’t follow your advice, the problem is widespread. One study (discussed here) found that actions didn’t match good intentions. Only 14% of those who planned to increase their savings rate did so.
Typically, the culprit is attributed to the poor communication skills of the advisor, resulting in the client having a lack of trust, or the client succumbing to behavioral biases (often overconfidence and confirmation bias) and feeling overwhelmed.
Based on my research, advisors are being unfairly blamed for these issues.
The problem is the client’s brain and our lack of understanding of how it functions.
Temporal discounting
Temporal discounting is a cognitive bias where we value immediate over future rewards. This tendency manifests in behaviors like opting for a smaller sum of money now instead of a more considerable sum in the future or choosing immediate pleasure (like eating junk food) over long-term benefits (like maintaining a healthy weight).
The concept is rooted in behavioral economics, neuroscience, and psychology. It’s a critical factor affecting decision-making in many aspects of our lives, including finance.
Our brain and temporal discounting
The neuroscience of temporal discounting involves the interplay between two brain regions: the prefrontal cortex and the limbic system. The prefrontal cortex is associated with planning, decision-making, and moderating social behavior, while the limbic system is associated with emotions and rewards.
When facing a decision involving temporal discounting, your prefrontal cortex evaluates long-term outcomes. However, the limbic system often advocates for immediate gratification. The balance (or imbalance) between these two systems influences our choices.
Dopamine, a neurotransmitter linked with pleasure and reward, also plays a crucial role. The release of dopamine reinforces the behavior that led to the reward, making us more likely to repeat the behavior in the future.
Impact of temporal discounting
Here’s how temporal discounting impacts retirement planning, often to the detriment of long-term financial health.
Lack of savings
The immediate satisfaction of spending money now often supersedes the future benefit of retirement savings. This leads to a more challenging financial situation later in life.
Risky investment choices
The desire for quick returns can make risky investments seem more appealing, which may not align with an appropriate risk tolerance for long-term retirement planning.
Delayed decision-making
Because planning for retirement doesn’t offer immediate gratification, it's easy to procrastinate. Delaying these decisions can significantly impact the compounding growth of retirement savings.
Overcome temporal discounting
The first step in overcoming non-compliant behavior is considering whether its cause is temporal discounting. If it is, here are some suggestions for overcoming it.
Cultivate a more future-oriented mindset
Encourage clients to focus on the long-term benefits of saving and investing wisely.
Ask the client questions like, "What do you see yourself doing in retirement?" or "What kind of lifestyle do you want in retirement?" By painting a picture of their future selves, clients can better understand the importance of making intelligent investment decisions today that will benefit them in the future.
Use commitment devices
Commitment devices are strategies that bind clients to a course of action that they might not choose but will benefit them in the long run.
An example would be setting up automatic transfers to a retirement account, which "locks in" savings, making it less likely that they'll spend that money immediately.
Use advanced financial tools
One tool financial advisors can use to mitigate the effects of temporal discounting is target-date funds. The seamless rebalancing of these funds can help alleviate some of the stress and decision-making involved in long-term financial planning.
Advisors can use financial planning software that includes interactive tools to help clients visualize the long-term impact of their decisions. Some software provides retirement planning calculators that show how much clients need to save each month to achieve their desired retirement income.
By providing clients with a tangible goal, you can help them overcome the temptation to prioritize short-term spending over long-term financial security.
Final thoughts
Understanding and overcoming temporal discounting is a crucial aspect of long-term financial planning. Harness the power of neuroscience and psychology to help your clients reach their long-term planning goals.
Dan trains executives and employees in the lessons based on the research in his latest book, Ask: How to Relate to Anyone. His digital marketing firm, makes extensive use of artificial intelligence to help advisors increase their SEO rankings and improve their marketing and helps advisors integrate AI into their practices.
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