Behavioural finance has profoundly reshaped the landscape of long-term financial planning. Rooted in the basic insight that human behaviour often deviates from purely rational economic models, it has enabled the development of policies and interventions that better align with real-world decision-making.
A prime example is the UK’s auto-enrolment policy, where employees are automatically enrolled in workplace pension schemes. This policy leverages behavioural insights like inertia – the tendency to stick with the default option – ensuring that more people save for retirement without needing to take active steps.
Key to such policies are behavioural insights about “present bias”, where individuals prioritise immediate gratification over future benefits, or “loss aversion”, which causes people to fear losses more than they value equivalent gains.
Auto-enrolment leverages behavioural insights like inertia – the tendency to stick with the default option
Auto-enrolment also taps into “status quo bias”, ensuring that once enrolled, individuals are less likely to opt out. These insights have underpinned a range of “nudge” strategies, which subtly guide people towards better financial choices without restricting their freedom to choose.
However, this line of thinking isn’t without its critics. Gerd Gigerenzer, a notable counterpart to Daniel Kahneman, challenges some of its foundational assumptions. Gigerenzer highlights how biases like inertia and loss aversion, often framed as errors, can serve adaptive purposes.
For example, “social proof” may be a clever way to deal with limited time and limited information. And loss aversion can act as a safeguard against excessive risk-taking. His work reminds us that these “biases” are often contextually rational, crafted by evolution to navigate a complex world.
In a conversation with Daniel Crosby in his Standard Deviation podcast, Brian Portnoy – founder of learning and development platform Shaping Wealth, which facilitates “human-first” financial advice – critiques the current state of behavioural finance as applied by the industry, referring to it as an “entertainment complex” that often fails to translate insights into actionable strategies for real people.
Advisers may over-rely on nudges without adequately addressing the underlying emotions or personal contexts driving client behaviour
Portnoy outlines that while nudging can simplify complex decisions, its application in wealth management often assumes a one-size-fits-all approach. Advisers, for instance, may over-rely on nudges without adequately addressing the underlying emotions or personal contexts driving client behaviour. Portnoy suggests that for nudging to really serve clients, it must be integrated with empathy and a deep understanding of individual needs.
Portnoy argues for a shift towards a more empathic advisory practice – what he and Meir Statman call “Behavioural Finance 2.0”. This evolution moves beyond merely identifying biases to helping clients achieve financial wellbeing by aligning their money choices with their values and wider life goals. Statman differentiates Behavioural Finance 1.0, which focuses on correcting biases, from 2.0, which respects the emotions and aspirations behind financial behaviours.
Empathy, as Portnoy notes, involves meeting clients where they are without condoning mindsets and behaviours. For example, if a client insists on paying off a mortgage instead of saving for retirement, a judgment-free conversation can help them explore the emotional comfort that drives this decision.
Similarly, if a client prefers an annuity over a flexible drawdown plan, advisers can seek to understand the client’s need for predictability and security rather than recommending the “rational” choice.
Dr Daniel Crosby’s assertion that “Wealth Isn’t About The Numbers” – the title of a chapter out of his recent The Soul of Wealth – underscores this perspective. True financial wellbeing extends beyond achieving a numeric target; it’s about integrating money with meaning.
A shift toward Behavioural Finance 2.0 means engaging clients as holistic individuals
The PERMA framework (out of Positive Psychology), which emphasises positive emotion, engagement, relationships, meaning and accomplishment, provides a valuable lens for advisers. By addressing these elements, they can help clients build lives that are not only financially secure but deeply fulfilling.
For financial advisers, a shift toward Behavioural Finance 2.0 means engaging clients as holistic individuals. A client’s objective is hardly ever “to beat inflation with investments from our portfolio” (even though, as Chris Budd’s research revealed, that’s what 95% of suitability letters most commonly state). Rather, they have emotional, social, wellbeing-oriented and lifestyle-oriented objectives next to the utilitarian ones.
Embracing this perspective (e.g. when meeting a prospect, during the fact-find or in client-review meetings) is the essence of human-centric advice and, our research from 2020 suggests, leads to higher profit-margins, more referrals and advisers that are more optimistic about the future of their business.
Dr Thomas Mathar is customer experience & insight manager at Aegon
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