Cognitive Bias and How to Combat It with Clients

Cognitive Bias and How to Combat It with Clients

It’s a commonplace observation among financial advisors: psychology training isn’t necessary to understand clients, but it sure couldn’t hurt.

Educating customers, sometimes a frustrating affair, is basic to our brief.  Grasping the workings of cognitive bias – perhaps you remember it from college years – can boost your understanding of clients and better your ability to serve them.

The Dunning-Kruger Effect: sounds dire, but you meet it every day. The theory describes the cognitive bias under which a person who knows little about a subject thinks they know a great deal. The nuggets they grasp gain exaggerated value and the missing bits are just that – and what they hold may be fools gold. A little knowledge is indeed a dangerous thing.

Most of our clients, at least in the first stages of our careers, tend not to know much about investing. Some trust us to provide expert opinions, while others know best, their confidence bolstered by the myriad financial principles and market facets they know little to nothing about. 

Don’t take it personally: they don’t seek to insult your professional competence. Remain calm and begin carefully educating your client. In the end, they’ll be glad you spoke up, and you may relish their look of dawning surprise when they realize just how much there is to know, which they didn’t.

Expect Optimism Bias to rear its head from time to time. It’s the can’t-happen-to-me phenomenon: portfolio implosions happen to other people. For these clients, risk tolerance and market volatility are subjects of little interest. It’s a tough bias to crack.

Deal with it by introducing the concept in objective terms; provide a few case studies of how it wreaks havoc (hopefully from someone else’s practice, rather than your own). Once they understand the phenomenon itself, self-correction, gently guided by your sheparding, should awaken their interest in the inherent dangers of investing.

For more information, please read:
Understanding Cognitive Bias | Wealth Management

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