In this week's episode of the Financial Planning Podcast, one of behavioral finance's founding fathers explains why financial advisors who embrace their role as "wellbeing advisors" have the power to transform the business.
But Statman's passion for understanding why people think and behave the way they do really started when he was just a child. Today, he dedicates his time to figuring out what investors want, and to how advisors can help them get it.
The key, he said, is happiness. But understanding what makes people happy is easier said than done, and requires a dismantling of the walls that have long stood between client and advisor.
During his conversation with FP Podcast host and lead editorial producer Justin L. Mack, Statman talks about the common mistakes advisors make when talking to clients; what the next evolution of behavioral finance will look like; and why rational investors can still make some really stupid decisions.
Listen to the new episode — as well as all future and past episodes — by subscribing to the FP Podcast on
Transcript:
Justin L. Mack: (
Good morning, good afternoon and good evening. Welcome to the Financial Planning Podcast. I'm your host Justin L. Mack, wealthtech editor with Financial Planning. And on this week's edition of the FP Pod, we're going to be continuing a conversation about behavioral finance that started in the real life and digital pages of Financial Planning with our guest this week, Meir Statman of Santa Clara University, aka a founding father of behavioral finance. Meir, thank you so much for joining us on the show this week.
Meir Statman: (
Well, thank you, Justin. I'm happy to be with you. And you are praising me too much, but it is fine.
Justin L. Mack: (
And that's all right. We like to make sure everyone's feeling good and comfortable here on the FP Pod. And for all the listeners, Meir is a behavioral fi expert and the Glenn Klimek Professor of Finance at Santa Clara University's Leavey School of Business. His research focus is understanding how investors and managers make financial decisions, and how those decisions are reflected in financial markets. His most recent book on the topic, "Behavioral Finance: The Second Generation," is published by the CFA Institute Research Foundation. And as mentioned earlier, he shared some of his expertise with FP not too long ago in a story from Managing Editor Lynnley Browning that examines why behavioral fi is top of mind for wealth managers. If you haven't yet, be sure to go check that out. And Meir, I'd love to kick off the conversation this week by talking about your presence in the space. And really going back to how long you've been doing this kind of work and what drew you to it in the first place. Because as we discussed, it's a really big topic and a big top of mind focus for wealth managers and advisors now. But when you first got into it, when was that and why'd you do it?
Meir Statman: (
Well, formally into behavioral finance, it was the very early 1980s. But growing up I, like everybody else, was interested in what makes people tick. Why is it that people behave that way? And when I went into economics, that was my point. Let me make sense of how people behave in economics and financial decisions. And so it was only in the early 1980s that I came across the work of Kahneman and Tversky. And suddenly it all began to make sense. And from that I have learned a lot and I've taught some.
Justin L. Mack: (
Definitely. And I love that focus … just wanting to understand what makes people tick. I mean, it speaks to my heart as a journalist. One of the things I got into this business was just (the) interesting people. Learning about people. I feel spoiled. My job is to talk to interesting strangers, find out the coolest thing they have to say and then share that with other strangers who might be interested in it. So that very human element of understanding folks on a deeper level is something I definitely relate to. And I think that's awesome that you get to do that every day for work. So switching gears a bit on the topic of advisors and financial services like Lynnley's story pointed out, let's set some stakes a bit. Why is behavioral fi so top of mind for wealth managers right now?
Meir Statman: (
Well, it is top of mind because it is at the center of their work. I think of financial advisors as wellbeing advisors. Financial advisors are more than wealth managers. They are wellbeing managers. They are in the business of helping people find wellbeing. Happiness, as we often call it. And there are many parts of behavioral finance that are helping them do just that. And now it is really important to note that we academics in behavioral finance have learned from advisors at least as much as they've learned from us. We learn from those experiences. So if I go briefly through the stages of behavioral finance and the stages of my development in behavioral finance, I started my studies at the Hebrew University of Jerusalem in the mid '60s. And I studied economics and statistics.
Meir Statman: (
And the models in economics were about people who are rational. Computer-like rational, interested only in maximizing wealth. The first generation of behavioral finance, the one that I was part of at the very beginning of the 1980s, described people as irrational. It really found all of those cognitive errors that we know and said, look at those people who are pretty stupid (and) irrational. How can we help them maximize their wealth without falling into those pitfalls of those cognitive and emotional errors? The stage where I am at — and I think academics should be at and financial advisors are at — is really the second generation of behavioral finance, where we describe people not as rational or irrational. But rather as normal. People like me, like you, like the people who are listening to us, are people who are generally normal-smart and normal- knowledgeable. But sometimes (they are) normal-stupid and normal-ignorant. But the the nice thing is that we are intelligent people and we can learn and we can increase the ratio of smart to stupid and knowledgeable to ignorant.
Justin L. Mack: (
Definitely. And I'm all about increasing that ratio of smart over stupid. But I love that kind of breakdown. Give me an example of a normal-stupid decision that someone might make with their finances as an investor. Something that an advisor might grapple with. Because I think that is probably more common than we realize. Doing something that might not make the best sense, but we're still gung-ho about it. So what is an example of that normal-stupid or normal- irrational that we want less of?
Meir Statman: (
Well, for example, people tend to extrapolate sometimes from the most recent events. We refer to it sometimes as recency error. And sometimes from what is very vivid. And so if the market is going down, then people tend to extrapolate and think that this is the direction of the market and it will continue to go down. And fear. Fear is, again, a very useful emotion. But it can be exaggerated. And so they say, wow, the world is coming to an end. Inflation. COVID. War. And the rest of that. The advisors are subject to the same cognitive errors and the same emotions. But advisors are people who have moved from being normal-ignorant to normal- knowledgeable. They can carry their clients with them and sort of explain that markets go up and markets go down. What happened in the past probably has nothing to do with what is going to happen in the future. Sit tight rather than dump all the stocks in your portfolio.
Justin L. Mack: (
Something you mentioned earlier, and it kind of hits right on what you said, the evolution of the advisor going to that knowledgeable person that can help a client through those decisions. Those emotionally driven decisions. Those decisions driven by what we just saw in the news or on our phone a second ago. And it kind of speaks to that financial advisor … that advisor portion of it almost taking center stage over the finances when it comes to working with a client. Understanding what motivates them from a very personal level, instead of the pocket level, is probably going to be something that's very valuable now. Especially as clients have more options for advisors. It's easier to find potential financial advice. So a client finding someone that speaks to them on a personal level, I imagine it gives those advisors an edge. The reason I ask is, I'm just wondering how advisors have managed to leverage this research and behavioral fi to grow their business after that evolution from first generation to second generation?. How are advisors using behavioral fi to grow the business?
Meir Statman: (
So behavioral finance, or rather advisors, don't always think about the part that they do. They try to figure out, what is it that people really want? What do their clients want? And (they try) to figure out what is going to increase their wellbeing. They don't think about it as being part of behavioral finance. But it is really central to behavioral finance, especially to that second generation of behavioral finance. So that is really what is important. For example, one of the things I say is it is better to give with a warm hand than with a cold one. Americans have … many of them have this odd attitude that if they give money to their children, and I'm talking about people who are really wealthy enough to hire financial advisors, they're going to spoil them. They're not going to look for a vocation and all of that.
Meir Statman: (
That is heartless nonsense. You know, young people need money when they are young. When they're in their 20s. When they're beginning their lives and careers, where they're getting married and so on. This is the time to give money. Now, I'm not talking about giving the last dime of parents to the kids. But I'm talking about people who have millions and just thinking that it's a good idea to impose some poverty on their kids to get them to move off the couch. So advisors have to kind of figure out what it is that makes people happy. If you are an advisor and you told me that I can afford to take a trip, a cruise around the world, I would say, "sure I can!" But it will not take me more than two days before I jump overboard.
Meir Statman: (
So you have to kind of figure out, what is it that makes people happy? And for some people it is a Mercedes-Benz. I would never buy a Mercedes-Benz. It's presumptuous to me. But now when I go on long flights, I buy tickets in the business class section and I pay through the nose for them because I'm sufficiently old and sufficiently well-off to have that comfort. And that is what is increasing my wellbeing. And so having this kind of conversation … open conversation with clients to figure out what will increase their wellbeing is central. And I think that, again, good advisors know that. They don't have to listen to me to know that.
Justin L. Mack: (
And in your opinion, what's one of the most understood concepts in behavioral finance, whether it be by folks doing the research or the wealth management or financial services industry that can benefit from the research? What do people get wrong or don't quite have nailed down when they talk about this topic?
Meir Statman: (
So for academics, the part that they don't get is that what matters is what people want. So before you jump to accuse people of making errors, find out if this really is an error. For example, if you see people buying a lottery ticket, maybe it's not an error. Maybe the hope (they've had) for an entire week before they find that they've lost their dollar again is worth it. You know, after all, we pay more than a dollar to see a movie. This is also a fiction. But I would say one other thing that is common to advisors and to academics is really to judge by outcome. What I mean is that everything that goes wrong must be because a decision was wrong, as if there's no such thing as randomness and luck. You can see that in the proverbs … the early bird catches the worm. So jump first. But then you say, look, before you jump. Wait a minute. Don't jump.
Meir Statman: (
I think that in the last count there were something (like) 200 cognitive errors. But most of them are really kind of errors by hindsight. And so you have to really figure out that sometimes, there are smart decisions that have poor outcomes, and stupid decisions that have good outcomes. Generally good decisions bring good outcomes, but not always. And so don't jump to call something an error. You have to be careful. You know, you look at what the Fed does. And in hindsight, they should have started taking care of inflation earlier. And then people say, "well those people are idiots. They know nothing." Well, they were not chosen to be at the Fed because they are ignorant and stupid. But sometimes, you just make the best decision based on what you know now and then. And then it does not work out. But generally making good decisions is the best way to go.
Justin L. Mack: (
Fantastic. And with that, we're gonna take a quick break and enjoy a word from our sponsors. But when we return, we'll have more with Meir Statman, talking about behavioral finance and closing out with some FP Podcast good vibes. Stay locked. We'll be right back after this break.
And welcome back to the Financial Planning Podcast. I'm your host, Justin Mack, and we are diving back into our conversation this week with behavioral finance expert Meir Statman of Santa Clara University. Now Meir, before the break, we talked about really learning what makes people happy being so central to behavioral fi. And I think, you know, when joy or happiness is at the core of something, that probably makes people motivated to get into it. So for advisors who want to find that source of happiness and deepen their relationships and their businesses with their clients, how should advisors talk to clients? And where do they slip up from time to time when they are trying to figure out what that source of happiness might be?
Meir Statman: (
So, you know, happiness is a very fuzzy concept. But if you think about it, wellbeing has many domains. And of course, money (and) finances is one. But also health and family and friends and religion and on to other things. Work, of course, is central. And so I think that financial advisors should touch on all of them. Now, finances really underlie all of them. Even religion. You cannot practice without some money. I'm not just talking about tithing. I'm just talking about driving to church or synagogue. I'm talking about all the things that go with it. You have to have a life. And so I think that it is important for advisors to be aware of all the domains of wellbeing and ask people questions about them and figure out what it is that makes them happy.
Meir Statman: (
God knows families make us really happy and make us really miserable. And every family has its sponsor of pain. And I think that conversations with advisors should be at least as close as conversations with close friends, where advisors know what the issues are. There are many families where the question is not whether they can afford to send their kid to Harvard. The question is that the kid doesn't want to even go to community college. So, how do you navigate kids? You know, kids are not automobiles. And it is a hard thing to do to the extent that advisors can be like good friends. It is important. In fact, a tax advisor just told me about one of his clients who is a billionaire. But he decided to leave his son just $5 million, which is a substantial amount, surely. But not for somebody who is a billionaire perhaps several times over.
Meir Statman: (
So he does that really to piss off his son to say, I kind of hate you. You know? I'm going to leave you an amount that is, you know, substantial for most people, but surely not for the son of a (billionaire) client. Now, why do that? To the extent that an advisor can, pause and say, do you really hate your son this way? Do you really not realize that when you are old and decrepit, it will be your children who are going to be the first to come help you? Not the nursing staff and all of that. What are you doing? You know, that kind of question comes in. "I'm unhappy with my work," says a client. Helping people find a vocation. Helping people find a change. I mean, we can always think about our own experiences. I was unhappy with my work in Israel after I completed my studies there. I took, objectively speaking, a major risk coming to the United States to study for the Ph.D. But I was driven. Not because I liked risk. It is because I was searching for a vocation that was going to also pay enough to sustain me and my family. These are the central issues. And again, at the center of them is this issue of wellbeing and maximizing wellbeing.
Justin L. Mack: (
Definitely. And I want to dive more into that. Having that conversation more like a close friend instead of just as a financial professional. When you talk about that example of what a client might be doing with how they're providing funds to their children, for example. And for the record, for anyone listening, if anyone wants to show me they hate me by giving me $5 million, you can shower me with that hate all day. Just wanna put that out there into the universe.
But seriously, on that topic of being able to have a real conversation like that with a client and kind of taking down some of the stuffier traditionalist walls that might have existed between client and advisor, I think I'm seeing that all over the place. And maybe the pandemic, in a way, aided that, because we're so often connecting with people by Zoom. And with that, you get a portal or a window, right, into a person's real life. Their real house. Their real office. Maybe an advisor is working from home. So some of those barriers are gonna break down no matter what. For you, how do advisors keep breaking down those barriers? How do you become a person instead of just, you know, a service to your clients? How do you practice getting better at being a real person to your clients?
Meir Statman: (
Well, you could be a better person by a self-disclosure, for example. Whatever is convenient for you. In my case, you know, our older daughter is disabled by mental illness. So I'm quite open with that as I just mentioned it to you and the listeners. And what I found is now, and my wife does superb and extensive volunteer work for NAMI, the
Meir Statman: (
I've met enough people who are very wealthy, owning businesses, and they just want their kids to be as successful as they are by making at least as much money as they do, not realizing that the fact that they are so wealthy gives their children a wonderful opportunity to choose vocations that may not pay that much. Knowing that they have that backing … the kids don't want to be entrepreneurs. The kids want to be, say, professors. The kids want to be elementary school teachers. There are social workers. There are many lines of work vocations that are going to be really satisfying. Some people cannot afford them because they don't have this financial backing, but other people have that financial backing. And it feels so good to be able to support your children and to be able to support your community. Because if you find yourself being fortunate enough that you need a financial advisor, then you should know that there are people who are much, much less fortunate and you can spare some of your wealth to help them.
Justin L. Mack: (
Absolutely. And earlier we talked about the evolution in behavioral finance, that first generation to second generation. So I'm gonna put you on the hot seat and ask you to predict a little bit. If you could predict what the next evolution might be, what do you think is next for this research topic for how financial services might use it? Speculate wildly. What do you think is coming for behavioral finance?
Meir Statman: (
Well, I think that this issue of wellbeing is still very far from being even at the beginning of its development within behavioral finance. So I'm writing, for example, a book now about that very topic. And before that I wrote the monograph that is called Wellbeing Advisors. That was published by the Journal of Wealth Management as a supplement to the journal. And so there is a lot of knowledge from sociology, for example, and anthropology as well as psychology, about, again, what makes people tick. What is it people want? So this kind of goes back to economics. How is it that you can make sense of people making financial and economic decisions, and how can you help them make better ones? So you sort of see the expansion. We had economics with its rationality. Now we next have psychology. But I'm looking at what sociology and what anthropology can do to help us expand our horizons. See more and show more.
Justin L. Mack: (
Definitely lots to keep in mind going forward. And I know a topic that we will be continuing to cover and analyze here at Financial Planning.
And as we wrap up, which has become customary here on the Financial Planning Podcast, we like to end with some good vibes. I don't know if you knew that, Meir, but tell your friends. We like to always send listeners home with something positive to hold onto as they get back into their probably way too busy days and a bunch of emails in their inboxes that they've been ignoring. So with that good vibe send off, I wanted to ask you, what do you love most about the work you do today? You mentioned earlier, even taking the risk of coming here to follow a vocation because you wanted to be a part of it … something that was truly fulfilling to you. And hearing you talk about it today, you can see the enthusiasm that you bring into your work every single day. So what do you love most about this world of research and learning how people tick?
Meir Statman: (
What I love most is the ability to make connections that sometimes other people don't see. So for example, those connections between economics and finance and sociology. How is it that people behave in communities as well? And, you know, I am very fortunate to be at my university, at Santa Clara University. Where we say, and we mean it, that we help people grow into people of competence and conscience and compassion … people for others. And at my university, the point is not to necessarily publish more and more papers in the Journal of Finance. The point is to have an impact to serve others. To serve by my scholarship. And so in debt indeed?, I am fortunate. Many years ago, an advisor said, "you know what? I've known everything you say, but I was unable to put it in words." Well, that is my job to take obvious things and put them into words.
Justin L. Mack: (
All right! Absolutely. And I know you will keep doing just that. And I want to thank you again for sharing some of those words with us this week on this edition of the Financial Planning Podcast.
And I want to thank all the listeners for listening to the Financial Planning Podcast this week. This episode was produced by Arizent with audio production by Kellie Malone. Special thanks again to our guest Meir Statman of Santa Clara University. Rate us, review us and subscribe to all of our content at www.financial-planning.com/subscribe. From financial planning, I'm Justin Mack. Thanks for listening.