“To change behavior, we have to slow down and act intentionally rather than from habit and impulse.”Henna Inam
*Click here to listen to the podcast episode for this article
The perfect plan is rendered useless in the absence of execution.
You can know the intimate details of someone’s values, hopes, dreams and fears and pair that with flawless technical advice in the form of the best financial plan and portfolio ever created.
Yet, if the advice is never implemented, none of it matters.
It’s like building a house and never moving it.
It may look good. But that’s about it.
According to this study, 70% of financial planning clients implement less than 20% of recommendations.
In other words, most clients will only implement 1 of 5 recommendations!
That’s why the job of a financial advisor and planner isn’t simply to dispense the advice, pat yourself on the back and walk away as if your job is done.
It’s to help the client follow through on your advice. Ensuring they implement and execute the items you’ve laid out that solve their problems and achieve their goals.
The reality is that getting clients to actually follow through and implement the advice you give without constant follow-up is hard (see the stat above!).
There are several possible explanations.
But, one of the most prominent culprits is a psychological phenomenon inherent within the very nature of financial advice.
The battle between the current and future self.
Here’s an example from the world of health and fitness:
When you decide it’s time to shed the love handles and become chiseled, the first thing you do is make a plan to eat healthy and work out.
In that moment, your current self is planning for your future self. How you ideally want yourself to behave at a future moment to accomplish your goals.
But when the alarm goes off in the morning and you’re supposed to knock out a workout, your current self is now the one calling the shots.
And your current self really loves feeling good in the moment. It has no desire to get out of bed.
Or when the pizza you’re not supposed to eat is sitting in your fridge late at night, your current self has no regard for the health plan made for your future self.
Here’s an example from financial advice:
You have a client that tells you they can definitely save an extra $500/month to be financially independent in 10 years.
Six months later, nothing has changed.
That’s the current self taking over. It would rather order items on Amazon than have to wait 30 years for the future self to benefit.
Research tells us the current self views the future self as nothing more than a stranger.
Or, put another way…your current self is about as interested in helping out your future self as you would be helping out your neighbor that you’ve never met.
Would you rather spend $500 on yourself or your random neighbor?
So, how can we design and deliver our advice in a way that helps counter this powerful force?
Enter the commitment device.
Introducing Commitment Devices
Here’s a quote that helps explain what exactly a commitment device is:
“Commitment devices are decisions you make with a ’cool head’ [right now] to bind yourself so that you don’t do something regrettable when you have a ‘hot head’ [in the future].” — Daniel Goldstein
Commitment devices come in many forms:
- A bank in the Philippines offered savings accounts with no access for 12 months to improve savings
- Using smaller plates/containers to eat less food
- Removing all desserts from your kitchen to avoid breaking the diet
- Making one cookie at a time instead of an entire batch to eat less
- Committing to going on walks with another person (or doing anything with another person for accountability)
- Setting your phone in another room while spending time with family to avoid being distracted
- Setting your alarm clock out of reach from your bed so you have to wake up to turn it off
They’re all decisions made in a rational state that binds your emotional self to behave the way you want them to.
Fortunately, there are several commitment devices at your disposal that you can use with clients to help the battle between their current and future selves.
Here is a toolkit of 9 different commitment devices categorized by the type of financial behavior they’re designed to improve:
- Investment Behavior
- Savings Behavior
- Spending Behavior
**Some of these may not be approved or might require approval before deploying.
Improving Investment Behavior
1) Investment Process Statements (Investment Policy Statements)
These can ultimately take on a variety of different looks, flavors, lengths, etc.
Some firms treat this as a document where you lay out your entire investment philosophy, rules-based process, risk assessments, portfolio construction approach, and so on.
But, if you’re simply looking for a way to help clients navigate through turbulent markets and ensure they don’t sell at the worst possible time…
Then, you want to capture in writing an agreed-upon plan that details exactly what your clients will do in various market conditions.
In other words, they are sitting in your office in a cool-headed, rational state to bind themselves to their ideal and desired action in the future.
A future when their life savings has declined by 30% in two months and they’re operating in a hot-headed, emotional state.
Make sure you’ve already spent time educating them on the frequency of market declines (10%, 20%, 30%, and so on). Make sure they know this is going to happen at some point in the future.
And, then walk through each decline and ask them what they want to do when the market drops 10%, 20%, 30%, 50+%.
(Important Note: To do this most effectively, don’t just use percentages. Use real dollar figures. They won’t know when the market is down ____%. But they’ll definitely know what their account is worth.)
Come to an agreed-upon action for when the market hits those numbers. You can:
- Do nothing
- Invest more
- Allow them to sell up to a predetermined amount (Obviously, this isn’t ideal but it’s better than letting them sell the whole portfolio.)
Write down the agreed-upon action and have the client sign the document. Then, let them know that to do anything different than what’s been agreed upon, it requires a revision and updated signature.
You’ve now helped the client commit to a plan in a rational state of mind that will guide their decisions when their emotional side takes over as the market plummets.
Plus, you’ve created a barrier to hasty decision-making by requiring an updated signature to do anything different.
2) Fee-Reduction Reward
This is another method to help improve the odds that clients stay invested over the long term when they encounter a plummeting market.
If you’re charging AUM fees, you can offer a “fee reduction” to reward the client for staying invested.
For example, suppose the client starts off with a 1% AUM fee. You can offer a .15% fee reduction if they stay invested and follow the plan for the first three years.
(Here’s an article from a firm that does it and calls it “Milestone Rewards.”)
That way, you’ve provided an extra barrier and incentive in an attempt to prompt the ideal behavior for long-term success.
3) Stop-Loss Orders
A stop-loss order is an order to buy or sell a specific stock once it reaches a certain price.
(I know most people don’t buy and sell individual stocks anymore, so stick with me because there’s a broader application.)
Think about the client with a stock position that has tanked in price. For example, they bought it at $100/share and it’s now worth $20/share.
But, they refuse to get rid of the position because it would require accepting the loss. Plus, there’s the hope that it will always go back up because it’s been there before.
Or, think about the client who has money on the sidelines to invest. They’ve told you they’re planning to invest the money once there’s a “buying opportunity.”
Yet, with each “buying opportunity” that passes, they come up with another excuse as to why it wasn’t the right time.
Both of these clients know what they need to do, but their emotions and biases are preventing them from pulling the trigger.
That’s where the “stop-loss order” concept comes in.
For the client who owns the stock that’s now only worth $20/share, have them tell you at what price they would feel comfortable selling both on the upside and downside.
Ask what price they think the stock can realistically reach (upside). Agree to sell at that price.
Ask how much lower they feel comfortable with it going (downside). Agree to sell at that price.
It doesn’t have to be an individual security. You can apply the same idea to help improve your client’s behavior with their portfolio.
For the client in cash waiting on a “buying opportunity”, guide them through a conversation to clarify exactly what needs to happen for them to invest.
This is going to depend on what they use to justify their lack of action.
For example, if someone is staying in cash because they want to see the market come back down to “reasonable levels”, guide them through a conversation where they tell you what a “reasonable level” looks like.
Then, put an agreement in place that once it reaches that “reasonable level”, you’re going to invest the money.
If nothing else, facilitate a conversation to have them explain and tell you exactly what they want to see happen to make them comfortable investing the money.
And, then agree to take action once that happens.
Improving Savings Behavior
4) Automation System
This has been well-documented for years now. But, it’s still one of the best examples of using a commitment device with personal finances.
The most notorious example is a 401(k), where money is automatically taken out of a paycheck and invested.
The more you automate your finances and cash flow, the less you’re relying on willpower and memory. And the less you rely on willpower and memory, the better your results.
For instance, suppose your client needs to save $1,000/month (into various accounts for various reasons).
If they have an automation system in place to route their money out of their checking account into other various accounts (that have been decided on in a rational state), it happens without allowing for any emotional interference.
In other words, if you had a client who was manually transferring $1,000/month, you run the risk that next month when they go to transfer the money, they think about all of the other things they could be doing with $1,000 and maybe only transfer $300.
Or, they don’t transfer anything!
The more cash flow you can automate, the better follow-through and results you’re going to see.
5) “Restricted” Savings Accounts
This is for someone who is prone to tapping into their savings account against their better judgment.
The idea is to keep saving. But instead of using the typical savings account, have the client save into an account that increases the friction of withdrawals.
Here are some examples of accounts that add friction to the withdrawal process for one reason or another:
- Retirement Accounts with age restrictions
- 529’s and HSA’s
- Life Insurance
**Clearly, each of these vehicles comes with trade-offs that you’ll want to discuss thoroughly with your clients.
6) Tax Withholding
You’ll often hear that having too much money withheld is an irrational decision because it’s simply an “interest-free loan” from the government.
And, while ultimately true, receiving an interest-free loan from the government is better than receiving a credit card statement with a balance!
For anyone who needs help reigning in their spending, having them withhold more money from their paycheck is a subtle way to “save” more money.
As you know, money that is withheld or deducted from a paycheck before hitting your bank account is rarely missed if you don’t ever see it.
Obviously, this isn’t going to work as well for self-employed clients and business owner clients. You’ll have to focus more on the other spending and saving devices (i.e. automation system).
Improving Spending Behavior
7) Withdrawal Policy Statement
This is the exact same concept as an Investment Policy Statement, only it’s aimed at improving spending behavior rather than investment behavior.
This has primarily been used for retired clients entering the decumulation phase of their investing lives and starting to spend and withdraw their own assets.
Here’s an example of a withdrawal policy statement from Morningstar: Retirement Policy Statement Template.
The idea is to outline the assets you have available, the amount of annual spending you plan to do, and then create a systematic approach for which account to use and how much to pull out.
It also allows for an agreed-upon strategy dictating how much money to keep in cash at all times, how to handle inflation, whether to withdraw a percentage of assets or set dollar amount, how to handle RMD’s, etc.
It could also be used to dictate how to adjust spending in various market environments. If the market is up 10%, spending increases ____. And the same goes for down markets.
Or, in the event that a spending cut is required, you can help clients identify in advance exactly where they would cut their spending.
But, it can just as effectively be used for accumulating clients with spending problems or clients whose careers and businesses have them on a trajectory where they will inevitably face “lifestyle creep” and you want to ensure their spending doesn’t rise with their income.
Have these clients commit to a plan that dictates how future increases in cash flow will be allocated.
And, just like the investment policy statement mentioned above, put it in writing and have the clients sign the document.
8) Credit Card Ceiling
Many credit cards will allow you to impose a maximum monthly amount or a “ceiling.”
If you have someone struggling to reign in their spending and they recognize the need to change and have struggled to do it, have them agree to a self-imposed ceiling amount.
Universal Commitment Device For All Behavior
9) Making Intentions Public
This method helps with any type of action the client recognizes they need to do and want to do. They just haven’t done it.
Whether it’s finally talking with their adult children about their financial situation and wishes, or the need to get their estate documents in order, or procrastinating on something like transferring their assets, publicizing your intentions creates accountability.
Making them “public” doesn’t have to be shouting them from the mountaintops. Obviously, financial information and details are typically not something we publicize.
It could be:
- Having a friend or family member hold you accountable
- Calling your adult children to tell them that you’re going to be setting up a time for everyone to get together and talk
- Telling friends and family about the goals that you’re working towards that require follow-through. You don’t have to publicize the task itself. You can publicize the goal that requires completing the task. (i.e. Tell your friends and family that you’re going to be retiring in 3 years and taking a yacht trip around the Caribbean.)
This isn’t an exhaustive list. There are certainly other methods out there that aren’t on this list (and probably even some that came to mind as you were reading through this).
Ultimately, the point is this: When you’re giving financial advice, you’ll always be dealing with the battle between the current and future self.
And, it will often be a reason why your clients have yet to follow through on your advice to help them accomplish what’s most important in their lives.
Designing and delivering advice where clients actually follow through means having ways to overcome this challenge.
That’s precisely what commitment devices are designed to do.
Commitment devices are a proven method to help the current self treat the future self as a friend rather than a stranger.
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