How Bad Financial Decisions Get Reinforced


In a previous blog, I wrote about how the brain is constantly scanning its environment to determine if there is anything unfamiliar that could pose a potential threat. When something unfamiliar is present, the brain shifts from a state of cognitive ease to one of cognitive strain. If you aren’t familiar with these concepts, I’d encourage to read this post before moving on.

This is a useful function that allows the brain to reserve its finite mental energy for times when it is truly needed. In a state of cognitive ease, you’re likely to feel safe, trusting and are more disposed to a good mood where you act on intuition. You won’t weigh options and identify the best course of action; you will just act. These are what are referred to as System 1 processes.

When something out of the norm happens that necessitates tapping your mental reserves to think, your brain shifts to a state of cognitive strain where it utilizes System 2 processes. This could be the result of something as simple as reading messy handwriting or as complex as trying to solve an unsolvable math problem. In a state of cognitive strain, people are more analytical and less trusting. Evolution built strained cognitive processes to keep an eye out for danger, creating a link between thinking and fear.

Making it safe for clients

This is an important factor for advisors to consider when stretching clients out of their comfort zone by challenging them with new information and different ways of thinking. The environment advisors create must be one of safety, where the processes of learning and applying information are reinforced, especially when making uncomfortable decisions that can be perceived as risky.    

Reinforcing the right types of client behaviors is a difficult task, because inaction or staying in one’s comfort zone, even when not in their best interest, may feel good, making these poor choices naturally reinforcing. But, retirement planning takes strain, and the ability to make tough choices. This is where advisors can help by creating focus and direction. For example, avoiding risk and making decisions based on short-term consequences, where the impact is more immediately felt, are likely to be primary influencers on behavior. Oftentimes, these behaviors are not in the long-term interest of the client. What gets reinforced, gets repeated.

There are two types of reinforcers that will influence a client’s behaviors and decisions: positive and negative reinforcement:

  • Positive reinforcement is when a person engages in a behavior with the expectation of receiving something desirable.
  • Negative reinforcement is when a person takes an action in order to avoid something undesirable.

Understanding why clients do what they do

It’s not always clear what is driving client behavior. Perhaps they are repeating a behavior as the result of past positive consequences, or they’re engaging in it for the first time out of future expectation. In addition, knowing whether a behavior was influenced by positive or negative reinforcement requires understanding why they engaged in the activity.

Let’s say you have a client who decides to save more for retirement. Does the act of saving more tell us what drove the decision? Not necessarily. We would need to better understand what took place before the decision. It could be as simple as how you, as their advisor, framed the conversation.

Perhaps you provided positively reinforcing information by discussing their projected account growth. Conversely, you might have addressed the amount monthly retirement income they stood to lose by not saving more. In the latter case, you are presenting information that frames the discussion in negatively reinforcing terms.

Which of the above scenarios do you think more likely to have influenced the client’s actions? Though both may have the same result, using negatively reinforcing framing is more likely to provoke client action. When considering the nature of cognitive ease and strain as well as the two systems model, it becomes clear why this would be the case.

Loss aversion

When you provide your client with new and unfamiliar information, or make a recommendation that differs from their desires or expectations, you are shifting them from System 1 to System 2 – a mental state that exists to assess risk. If a risk is detected, it acts. If risk isn’t detected, it saves energy and shifts back to the less thoughtful System 1 where prompt action is less likely. In other words, people are more driven to take action in order to avoid danger (something undesirable) than to seek something desirable. The potential of losing monthly income in retirement is a risky proposition, whereas investing for account growth is not.

What this tells us is that our brains are more prone to trigger behaviors as the result of avoiding undesirable and risky consequences, i.e. negative reinforcement. In fact, prospect theory, a central tenet of behavioral finance, demonstrates that the motivation to take action in order to avoid loss is twice as powerful as that which is taken to seek a gain. For example, if an investment has the potential to lose $1,000, most investors would need it to also have the potential to gain at least $2,000 for consideration.   

This aversion to loss has shifted how many financial advisors and companies communicate to their clients. For example, historical standard practice was to emphasize account balances in statements and online. Considering what has been discussed about positive and negative reinforcement as well as loss aversion, consider the behaviors reporting account values produces.

Sure, people will want to invest more when they see good results. Seeing investment gains will usually be perceived as positively reinforcing. But, if that’s the primary motivator, what are they then likely to do during down markets? Avoid the undesirable pain by reducing savings rates and securing their investments.

Compare this to what is becoming more prevalent: emphasizing the monthly retirement income gap in today’s dollars. Unless the client is on-track to meet or exceed replacing monthly income – a rarity – they are looking at how much income they stand to lose in retirement. This is an undesirable risk to be avoided, which is more likely to prompt quick action regardless of market conditions.

Positive vs. negative reinforcement

This would seem to support advisors leveraging and heavily relying on negative reinforcement in their communication. Not so fast. The problem with negative reinforcement is that its effects are temporary. Running on risk-avoiding System 2 is exhausting to the brain. It is looking for the soonest possible opportunity to go on System 1’s cognitive ease-based autopilot.

As a result, once a client feels as though they’ve averted danger, they are not likely to continue to keep taking action. Think of it this way. In which of the following scenarios are you more likely to maintain a clean home when your spouse or partner goes out of town?

  1. You clean up after yourself to avoid an argument with your spouse or partner.
  2. You keep a clean house because you feel better and less stressed in a clean environment.

Most people would be more likely to take urgent action in scenario A, but are far more likely to consistently maintain a consistently clean home on their own in option B. The lesson, here, is that negative reinforcement may influence quick action, but it’s not sustainable. Once the negative stimulus is removed, the behavior stops.

Positive reinforcement, especially when intrinsically produced, is far more likely to yield lasting behavioral change. Clients who are only taking action that betters their financial situation as a result of negative reinforcement will require the consistent application of negative reinforcement to create lasting new behaviors, i.e. advisor engagement based in negative reinforcement. The advisor will have to drive success, not the client. This is backwards. Clients should own and drive their own success.

Ultimately, both methods of reinforcement have a use. However, negative reinforcement should be used sparingly and only when necessary.

There are two general rules of thumb advisors can follow when incorporating positive and negative reinforcement into their communication.

Think of negative reinforcement like a car’s ignition and positive reinforcement like the has pedal.

  • Motivated clients are already cruising down the road. No need to ignite their motivation. Only positive reinforcement is necessary.
  • Negative reinforcement should be reserved for unmotivated clients. But, once the car is started, you don’t need to keep turning the key. Once they take action, shift to the gas pedal, i.e. positive reinforcement.

How do you positively reinforce desirable client behavior?

Matt Nelson

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