This is the 3rd installment in a series of essays about the darker side of the investment advice industry.
(To see part 1 of this series, click here.)
(To see part 2 of this series, click here.)
Behavioral influence
In teaching the principles of behavioral economics over the years, I’ve often been asked by new students whether the investment industry might be using it as a form of manipulation and control. That may sound a little paranoid, but I think there is something to it.
We now know from many years of study, that people are prone to making behavioral mistakes when it comes to managing their finances. Over-reliance on mental shortcuts instead of using critical thinking skills; myopic loss aversion that causes panic selling at the worst times; recency bias that causes investors to place too much importance on recent events, while ignoring historical patterns.
Behavioral manipulation
For twenty years now, economists and psychologists have been working to identify the behavioral mistakes that cost investors so dearly. Initially, the goal was to educate and enlighten, so that we might do better. But human nature being what it is, it looks like the ones who have gained the most are the marketers, advertisers, and sellers of financial advice and services. While there’s nothing wrong with a seller trying to influence a prospective buyer, influence can sometimes cross the line and become manipulation.
There is a key difference between influence and manipulation. They both involve “producing an effect in another person without apparent exertion of force.” But manipulation is defined as “having control over others by having the ability to influence their behavior (emotions) and their actions so things can go in the manipulator’s favor” and “to control or play upon by artful, unfair, or insidious means especially to one’s own advantage.”
Manipulators in the advice business tend to zero in on a few key aspects of human behavior – the emotions of fear and greed, and the nearly universal desire to be liked and admired by others.
Compared to manipulation, influence has a more subtle character that takes into consideration others’ needs and desires. Influence takes many forms, but it’s characterized by strong rapport, clear and seemingly logical communication, and an awareness of the weaknesses (often called “hot buttons”) of others.
Examples
Some examples of behavioral tendencies that get investors into trouble include things such as reciprocation, loss aversion, social proof, and the desire to be part of the “in crowd.” These are some of the psychological phenomena that explain consumer behavior, and why we are so quick to abandon the sales resistance we may have had at the beginning of the sales process.
Take reciprocation for example. In a sales situation, I do something nice for you, and its human nature for you to want to reciprocate – return the favor. A great example is the offer you get in the mail for a free dinner, for you and your spouse, at an upscale restaurant not far from where you live. All you have to do is sit through a brief presentation about how to retire with more money. You might think that very few people would agree to listen to a sales pitch from a stranger, but you would be wrong.
These mailers are successful because people love free meals at nice restaurants. But even more importantly, the sales pitch at dinner is very successful, because people want to reciprocate for the free meal they just enjoyed. They don’t consciously decide to reciprocate, they just do it instinctively.
The other influence techniques I mentioned earlier work in similar ways, and on various human emotions and behavioral tendencies. At this point you might be wondering what’s so bad about a sales professional using sales techniques to make a sale? The answer lies in what’s at stake.
The stakes are high
We have rules and regulations that require financial professionals to conduct themselves professionally, and to always place the client’s interests ahead of their own. If we were talking about overpaying for a vacation or a new car, that would be one thing. But we’re talking about your entire life savings, and the cost of bad advice can be devastating.
Do some financial professionals use behavioral economics to manipulate us into agreeing to things that might not be in our best interest? Of course they do. But in my experience, investors can be taught how to recognize the signs of manipulation and effectively defend against them.
The truth is that there is no such thing as a perfect “mind control” tool (with the exception of extreme brainwashing techniques) that can make another person do something that is unacceptable to his or her personal beliefs or values.
Coming up
Next week in part 4 of this “Take Advantage” series, I’m going to cover the most common investment scams in use today. I’ll briefly describe each one, explain how to recognize them, and what steps you can take to avoid falling for them.