One of the most important responsibilities a financial advisor has is to guide clients through a process of understanding the types of decisions they should be making, and then empowering them with the knowledge and ability to make informed choices.
Whenever a person is faced with a choice, they experience cognitive strain. This strain is beneficial as it can focus attention and is requisite in the learning process. Brain power is limited, however. Too much cognitive strain will increase stress, limit learning and reduce decision making abilities. Just like a muscle, the brain can become overworked, overloaded and fatigued. Providing too much information and too many choices can lead to confusion and uncertainty, making it difficult to prioritize options and proceed-to-action. This state of powerlessness results in inertia – the killer of financial preparedness.
Giving the client every detail about every option is not education, nor is it empowering. It’s noise that masks the signal, i.e. the value-add information they require to take action. Furthermore, every decision requires them receiving more information. As a result, advisors need to be selective in the types and number of decisions they present to clients.
There are three rules to follow when determining whether you are presenting a client with a value-add or a value-destroying decision.
Rule 1: Don’t confuse multiple options with choice.
Let’s say you have the option of receiving a five-dollar bill, or five one dollar bills. Is there a decision to be made? Sure, you need to decide between the two options, but barring a compulsion to either maximize or limit the number of bills in your pocket, it doesn’t matter. Each option presents you with the same gain. Despite having options, you really have no choice, and the decision is a waste of mental energy.
For example, if two funds have similar expense ratios, risk, performance and ratings – both may be in the client’s best interest. Only discuss one of them. Discussing both isn’t education; it’s unnecessary noise.
When a decision can be based on a flip of a coin, where each outcome results in the same value and degree of satisfaction, there is not a true decision to be made. All choices are equal. Only present one option to the client.
Rule 2: Don’t waste time with lesser value options*
What if I offer you a choice of either $5 or $10? Unless you are claiming the money on your taxes and the extra $5 will push you into another tax bracket, or you do not feel it just to receive the additional money for some reason, there really isn’t a decision to be made. You may have options, but the choice to make is clear. Think of it like this: Why would you waste time with a client comparing and discussing two different bonds with very similar risk, maturity and features, but one has a higher yield?
If one option provides more value and satisfaction than another with no additional risk, there is no decision to be made. Present the more valuable option.
* There is a special consideration when comparing options of equal and lesser value. Humans are biased towards inaction when faced with a decision where they don’t feel in-control. A key factor to feeling in-control is having multiple options to choose from. Consequently, there are times when it makes sense to present two or three options in order to provoke action.
Rule 3: The foundation of a value-add decision is risk.
Let’s try this one. What if you are presented with two options: A) Take the guarantee of $5, or B) Take a gamble where you have a 50% chance of receiving $2 and a 50% chance of receiving $8. How about now? Is there a decision to be made?
Finally, a real decision! In this example, there is a threat of loss, or, in other words, risk. Choose option A, the sure thing, and you lose out on the potential of receiving an additional $5 from the gamble. If you go with option B, the gamble, you could lose the 3 additional dollars you’d have received had you chosen the sure thing.
Risk is not only at the center of every financial planning decision, but the planning process as a whole. For example, when someone saves for retirement, they risk present income for the potential of future income. Selecting more aggressive investments is risking certainty for gain. In each of these examples, there is something of value at stake. If something isn’t deemed valuable, there is no risk and there is no decision to be made.
Making a decision is only necessary when options presented are at risk (there is the potential for a gain or loss) and deemed valuable.
The key takeaway from all of this is to make things easy for your client. Don’t force them to think about things they don’t actually need to be thinking about. Become laser focused on what is important to them, and what will move the planning engagement forward by aiding in their financial success. Ask questions. Listen. Don’t waste brain space.
How do you empower your clients’ decision making? Let me know by going to my Facebook, LinkedIn or Twitter page, and leaving a comment under this post.
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