Avoid the Wrong (Mental) Shortcut

Decision making is a major part of financial planning and the more advisors understand it, the better off their clients will be.

To deal with information overload and process new information, people tend to create mental shortcuts, according to Deena Katz, associate professor in the Personal Financial Planning Division at Texas Tech University. When making decisions under uncertainty, these mental shortcuts, or heuristics, can sometimes take them down the wrong path.

Understanding this tendency can help advisors guide clients toward better decisions, Katz says. “It can be helpful for advisors to know how people are going to perhaps make the wrong decision because they are taking these shortcuts.”

Representativeness is one type of a mental shortcut that could lead a client astray. Katz says mistaking a good company for a good investment is an example of this. Consider a client who reads about a successful company in the newspaper and then wants to buy stocks of the company. While it doesn’t necessarily mean investing in the stock is a good idea, the success of the company becomes tied to the stock in the client’s mind.

Unlike classical economics, behavioral finance assumes that people are not rational, but that they are indeed predictable, Katz says. Advisors can use that predictability to better serve clients. “We know they’ll make some inappropriate decisions, and knowing that we can help guide them to make better decisions,” she says.

Katz, a Financial Planning columnist, will expand further on these issues at the Women Advisors Forum in Dallas on Thursday. In her session, “Can We Talk?,” Katz will cover basic mental shortcuts, her firm’s 22 question ‘risk coaching’ questionnaire based on these shortcuts and how advisors can help recast client decisions to make them more appropriate for the client.

Other sessions on the agenda will cover additional practice management strategies including working with women in transition, succession planning and how to use complex assets for charitable giving. The conference also offers ample networking opportunities and a working lunch where attendees can pick a specific issue they’d like to discuss and collaborate on with other advisors.

The Dallas conference is the second event in this year’s Women Advisors Forum series.  Learn more about the conference and consider joining our Women Advisors Forum group. And if you are in Texas, but not registered, come on down--walk-ins are welcome.