Behavioral Finance in Action Psychological challenges in the financial advisor/ client relationship, and strategies to solve them Part 4 Regaining and Maintaining Trust: Competence + Empathy By Shlomo Benartzi, Ph.D. Professor, UCLA Anderson School of Management, Chief Behavioral Economist, Allianz Global Investors Center for Behavioral Finance
Regaining and Maintaining Trust: Competence + Empathy Investor paralysis is just one important consequence of the recent financial crisis. A second, related corollary is its impact on the bond of trust that exists between financial advisors and their clients. The Nobel laureate economist Kenneth Arrow is often quoted as saying, Virtually every commercial transaction has within itself an element of trust (Arrow, 1972). This is especially true of the financial advisor/client relationship (Guiso et al., 2008). A July 2010 Gallup Poll ranks financial institutions 11 th out of 16 institutions in the United States in terms of public trust. Only television news, Labor, Big Business, HMOs and Congress score lower, in that order. According to the Chicago Booth/Kellogg School Financial Trust Index, at the beginning of 2009 only 34 percent of Americans expressed trust in financial institutions. Financial advisors are often tarred by the same brush and many now face clients whose confidence in them has been undermined. The bruised psychological state of investors has been likened to the feelings of betrayal following the discovery of a partner s affair. Just as in repairing such a relationship, regaining trust with clients in the aftermath of the financial crisis requires humility, patience and hard work. Regaining trust is a top priority for financial advisors, even if their strategies did not lead directly to clients losses (Gounaris and Prout, 2009). 1 Noah Goldstein is a member of the Academic Advisory Board of the Allianz Global Investors Center for Behavioral Finance. As financial advisors know very well, their client relationships have two components: the technical and the personal. Active demonstrations of professional competence and personal empathy have been identified as key to building and maintaining trust, notes Noah Goldstein, 1 of the UCLA Anderson School of Management (see Gärling et al., 2009). The following BeFi-in-Action strategies are applicable not just to regaining trust in current circumstances, but also to maintaining trust in the ongoing financial advisor/client relationship. Some of these strategies might at first seem commonplace, but we add a unique angle on them, often backed up by social science research. Active demonstrations of professional competence and personal empathy have been identified as key to building and maintaining trust. Noah Goldstein, UCLA Anderson School of Management Behavioral Finance in Action 1
Demonstrating Competence Clients understand that financial advisors are professionals with a demonstrated level of competence. Nevertheless, research shows that clients perception of their financial advisors competence can, and should, be constantly bolstered in many ways. Some of these actions seem basic and perhaps obvious, while others are even counterintuitive. Many financial advisors know intuitively that acknowledging shortcomings engenders trust in their client. And social science research shows this to be the correct thing to do (Lee et al., 2004). Moreover, a 2010 Golin/Harris survey revealed that the most effective action a company can take to restore broken trust is to be open and honest. The same holds true for individuals. Honesty resonates strongly, and enhances trust. Less intuitively obvious is that admitting luck has the same effect. We will start with this suggested action. Admit luck. When performance meets or exceeds expectations it is only human nature to want to take full credit. However, according to social science research, it is unwise to do so. Warren Buffett shows himself to be a student of psychology in understanding this. In Berkshire Hathaway Inc. s annual report for 2006, Buffett said the following: all that said, a confession about our 2006 gain is in order. Our most important business, insurance, benefited from a large dose of luck. Mother Nature, bless her heart, went on vacation. After hammering us with hurricanes in 2004 and 2005 she just vanished. Last year the red ink from this activity turned black, very black. Why would Buffett do that, rather than claim all the credit for himself? Just as admitting shortcomings triggers a willingness to trust by the intuitive mind, so too does admitting that luck has played a part in a favorable outcome (Williams et al., 1993). In Buffett s case, he went on to claim credit for the successes in the rest of Berkshire Hathaway s portfolio. No doubt the shareholders were nodding in agreement. Talk about the downside before presenting the upside. As we all know, nothing is perfect in this world, except perhaps Mom s apple pie. In the world of financial products and strategies, however, potential pluses (high returns) usually come with potential minuses (high risk). Of course, financial advisors already understand the necessity of offering a balanced presentation of benefits and risks. Research, however, shows that the sequence in which the Behavioral Finance in Action 2
downside and upside are presented is crucial to how the whole is perceived. In this case, clients will be more trusting of positive claims about a product or service if the positive claims are preceded by one or two negative claims. These are known to social scientists as two-sided messages (Bohner et al., 2003). By talking about the downside first, the financial advisor is displaying honesty that elicits a greater willingness in the listener to trust what is then said about the upside. Note that this does not mean that the very first thing you say about the product needs to be negative. Ideally, you could mention one positive argument for the product, followed by a potential downside, followed immediately by the strongest argument for the product. The reason for this narrative structure is that social science research shows that people are more likely to remember the first and last things you say about something (Atkinson and Shiffrin, 1968). Display evidence of competence. Here s a story of a physicians practice that struggled with the common problem of patient non-compliance with exercise therapy designed to speed recuperation. No amount of explaining to patients the importance of the exercises made for a significant improvement in compliance. The physicians assistants engaged a consultant to find a solution. On visiting the practice s offices, the consultant noticed that there were no professional credentials to be seen. The consultant advised the physicians assistants to prominently display all relevant certificates and diplomas. Patient compliance immediately leapt by more than 20 percent (Goldstein, 2011). This dramatically improved outcome is hardly rational. If asked, the patients would have surely acknowledged that they knew the physicians assistants would not be able to practice without the required certification. Yet when these credentials were clearly visible, patients compliance soared. From a psychological perspective, this improved outcome was not a matter of patients reflective minds thinking, Hm, look at all those diplomas. These people must really know what they are doing. I had better do as they tell me. Rather, making evidence of competence salient in the professional environment triggered an unconscious response in the intuitive mind, in this case in a positive direction. If you don t do so already, know that displaying professional credentials is not a sin of ostentation. Rather, it helps your clients more readily see who you are, professionally, and what you have achieved. Displaying professional credentials is not a sin of ostentation. Rather, it helps your clients more readily see who you are, professionally, and what you have achieved. Shlomo Benartzi, UCLA Anderson School of Management Behavioral Finance in Action 3
Exhibiting Empathy Most financial advisors know very well that there is more to the advisor/client relationship than just shaping an investment portfolio: there is the human side of the relationship, too. Those financial advisors who place great value on this aspect of their interaction with clients should know that their intuition to do so is strongly supported by research. This research shows that paying genuine attention to the human element in business transactions improves all bottom-line measures (Pfeffer, 1998). Putting value on the human side of business has been described as relational intelligence (Saccone, 2009). In the context of regaining and maintaining trust, therefore, exhibiting empathy with a client is not just being nice : it is good business practice. And most financial advisors know that exhibiting individualized care to their clients is an integral part of the way they need to work, in order to serve their clients most effectively. Here are a few actions around exhibiting empathy that may be less obvious. Have frequent contact with clients, especially in difficult times. As we all know, maintaining relationships requires frequent interactions. When those contacts are made are, however, even more important. Financial advisors find talking with clients during prosperous times to be easy, and even rewarding, notes Goldstein. But clients need contact with their financial advisors most urgently during difficult economic times, when they are facing uncertainty and worry. These difficult times offer an opportunity to strengthen the relationship. Good financial advisors push aside the inclination to avoid contact at these times, and call their clients more frequently than before, thus providing emotional support. They are regarded not only as competent, but also as trustworthy. Their example is worth emulating. Allay embarrassment. Have you ever asked a client, Is there anything about our strategy you don t understand? It is a perfectly valid, and very professional, question because it comes from a desire to ensure that the financial advisor/client relationship is on a sound footing. After all, no financial advisor wants a client to be going along with a strategy that he/she doesn t fully grasp. However, the wording of the question might not elicit the truth. Many people don t like to admit ignorance. A client might not understand everything, but will nevertheless answer, No, there isn t, rather than face that embarrassment. A slightly different wording of the same question, such as Is there anything about our strategy that I can clarify? allows the client to admit ignorance without it being so labeled. The same goal is achieved. Seek feedback. Seeking feedback from clients is a standard part of the financial advisor/client relationship. But, once again, this is especially important in challenging economic times. A financial advisor might therefore ask, Is there anything I can do to improve my service to you in this difficult climate? This is a win-win question, for several reasons. To begin with, the financial advisor is showing concern to be doing better for his/her client. If the answer is Yes, then an opportunity has been opened to improve the professional relationship. If the answer is No, then the financial advisor can be content with what he/she is offering. At the same time, something psychologically quite interesting happens in the client s mind. Behavioral Finance in Action 4
By publicly stating that the financial advisor is providing excellent service, that notion is reinforced in the client s mind, as described by the theory of self-perception. This theory says that people s attitudes and beliefs may be shaped by observing their actions (in this case, by making a particular statement). The theory is counterintuitive, because it would seem more natural if actions were shaped by beliefs (Bem, 1972). Financial advisors find talking with clients during prosperous times to be easy, and even rewarding. But clients need contact with their financial advisors most urgently during difficult economic times, when they are facing uncertainty and worry. Noah Goldstein, UCLA Anderson School of Management Regaining and Maintaining Trust BeFi-in-Action: Competence 1. Admit luck. 2. Precede the greatest upside of a product with a potential downside. 3. Display evidence of competence. Empathy 1. Have frequent contact with clients, especially in difficult times. 2. Allay embarrassment. 3. Seek feedback, especially in difficult times. Behavioral Finance in Action 5
References Kenneth Arrow, Gifts and Exchanges, Philosophy and Public Affairs, vol 1, pp 343 362 (1972). R.C. Atkinson and R.M. Shiffrin, Human Memory: A proposed system and its control processes, in K.W. Spence and J.T. Spence, Psychology of Learning and Motivation, II, Academic Press, pp 89 195 (1968). Kathleen Gounaris and Maurice Prout, Repairing Relationships and Restoring Trust: Behavioral Finance and the Economic Crisis, Journal of Finance Service Professionals, July 2009, pp 75 84. Luigi Guiso et al., Trusting the Stock Market, Journal of Finance, vol 63, issue 6, pp 2557 2600 (2008). D. J. Bem, Self-Perception Theory. In L. Berkowitz (Ed.), Advances in Experimental Social Psychology (Vol. 6, pp 1 62). New York: Academic Press (1972). F. Lee et al., Mea Culpa: Predicting stock prices from organizational attributions, Personality and Social Psychology Bulletin, vol 30, pp 1636 1649 (2004). G. Bohner et al., When Small Means Comfortable, Journal of Consumer Psychology, vol 13, pp 454 463 (2003). Jeffery Pfeffer, The Human Equation: Building profits by putting people first, Harvard Business Press, 1998. Gallup Poll, Congress Ranks Last in Confidence in Institutions, July 2010. Tommy Gärling et al., Psychology, Financial Decision Making, and Financial Crises, Psychological Science in the Public Interest, vol 10, no. 1, pp 1 47 (2009). Noah Goldstein, 2011, personal communication. Steve Saccone, Relational Intelligence: How leaders can expand their influence through a new way of being smart, Jossey-Bass (2009). K.D. Williams et al., The Effects of Stealing Thunder in Criminal and Civil Trials, Law and Human Behavior, vol 17, pp 597 609 (1993). Behavioral Finance in Action 6
About the Author The Behavioral Finance in Action series was written by Shlomo Benartzi, Ph.D., Professor, UCLA Anderson School of Management, and Chief Behavioral Economist of the Allianz Global Investors Center for Behavioral Finance. Professor Benartzi is a leading authority on behavioral finance with a special interest in personal finance and participant behavior in defined contribution plans. He received his Ph.D. from Cornell University s Johnson Graduate School of Management, and he is currently co-chair of the Behavioral Decision-Making Group at The Anderson School at UCLA. Professor Benartzi is also co-founder of the Behavioral Finance Forum (www.behavioralfinanceforum.com), a collective of 40 prominent academics and 40 major financial institutions from around the globe. The Forum helps consumers make better financial decisions by fostering collaborative research efforts between academics and industry leaders. Professor Benartzi s most significant research contribution is the development of Save More Tomorrow (SMarT), a behavioral prescription designed to help employees increase their savings rates gradually over time. Along with Richard Thaler of the University of Chicago, he was recognized by Money as one of 2004 s Class Acts for SMarT s success increasing savings rates in one plan from 3.5% to 13.6%. The SMarT program is now offered by approximately half of the large retirement plans in the U.S. and a growing number of plans in Australia and the U.K. Professor Benartzi has supplemented his academic research with practical experience, serving on the advisory boards of the Alaska State Pension, Fuller and Thaler Asset Management, Guggenheim Partners, Morningstar and the U.S. Department of Labor. Behavioral Finance in Action 7
Acknowledgements We would like to thank the following experts in behavioral finance for their input to the intellectual content of the Behavioral Finance in Action series. Each of them is a member or past member of the Academic Advisory Board of the Allianz Global Investors Center for Behavioral Finance. Richard H. Thaler The University of Chicago Booth School of Business Ralph and Dorothy Keller Distinguished Service Professor of Behavioral Science and Economics http://www.chicagobooth.edu/faculty/bio. aspx?person_id=12825835520 Daniel G. Goldstein Yahoo Research, Research Scientist London Business School, Assistant Professor of Marketing http://www.dangoldstein.com/ http://www.london.edu/facultyandresearch/ faculty/search. do?uid=dgoldstein Nicholas Barberis Yale School of Management Stephen & Camille Schramm Professor of Finance http://www.som.yale.edu/faculty/ncb25/ Noah Goldstein UCLA Anderson School of Management Assistant Professor of Human Resources and Organizational Behavior http://www.anderson.ucla.edu/x20524.xml Kent Daniel Graduate School of Business, Columbia University Professor of Finance http://www.columbia.edu/~kd2371/ John Payne Duke University, The Fuqua School of Business, Joseph J. Ruvane, Jr. Professor of Business Administration Director, Center for Decision Studies, Fuqua School of Business http://faculty.fuqua.duke.edu/~jpayne/bio/ We would also like to thank the financial advisors who provided feedback on the Behavioral Finance in Action series. And we welcome further comments from our readers. Email us at contactus@allianzbefi.com. Behavioral Finance in Action 8
The Allianz Global Investors Center for Behavioral Finance is committed to empowering clients to make better financial decisions by offering them actionable insights and practical tools. We developed Behavioral Finance in Action to present potential solutions to some of the key challenges financial advisors are facing. We consider this a work in progress. Our goal is to build on what we ve begun, to improve and expand upon the contents. We can do this most effectively in partnership with you. We therefore invite you to give us your feedback. To do so, please email contactus@allianzbefi.com. befi.allianzgi.com Allianz Global Investors is the asset management arm of Allianz SE. The Center for Behavioral Finance is sponsored by Allianz Global Investors Capital and Allianz Global Investors Distributors LLC. The principles and strategies suggested do not constitute legal advice and do not address the legal issues associated with implementing any recommendations, or associated with establishing or amending employee benefit plans. There are many legal and other considerations plan sponsors and plan fiduciaries should consider prior to adopting any of the recommendations herein, and legal counsel should be consulted to ensure compliance with the law. Any adoption of these general recommendations must be considered in light of the particular facts and circumstances of each retirement plan and its participants, and the authors of the program and Allianz Global Investors provide no advice regarding, and are not responsible for, implementation of these concepts by any particular plan. AGI-2012-05-29-3926 Behavioral Finance in Action