Learning to love your future self

It’s February, deep in the blahs of winter, and clients are behaving oddly: they’re less willing to buy risky equities and more inclined to sell higher-risk holdings.

That’s because large segments of the population “are becoming either clinically depressed or mildly more despondent,” says Lisa Kramer, professor of finance at the University of Toronto.

Her research has found that the further investors live from the equator, the greater variation there is in returns among the seasons. Advisors who can recognize these tendencies and explain them to clients can prevent those clients from making financial decisions they’ll later regret.

Kramer’s research is part of the growing study of behavioural economics applicable to investing, or behavioural finance. Richard Thaler won the Nobel Prize for economics in 2017 in part for his role in exposing the irrational behaviours that can impede sound investing strategies and retirement planning. As more apps offer the nudges that made Thaler famous, we look at how advisors can help clients overcome self-defeating tendencies.

Seasonal asset allocation

Kramer and her fellow researchers studied investor data for mutual funds in Canada, Australia and the United States. They found large seasonal movement between fund categories: to safe mutual funds in autumn and risky ones in spring. Seasonal affective disorder seemed to be influencing risk aversion in investments.

The research shows that investors make decisions that aren’t always in their best interests, Kramer says. “If you calculate rates of return from the fall through to the spring, you end up with a much greater rate of return for people who are willing to hold risk during that half of the year,” she says—on average about 6% annualized difference for gross rates of return in the U.S. market.

“Getting out of equities just at the time of year when the reward for holding equities is about to get higher isn’t a great strategy for maximizing investor returns,” she says.

Advisors should be ready to coach clients through their seasonal tendencies, she says. They can also time portfolio reviews with these behaviours in mind, offering something along the lines of: “’I realize you’re feeling this way right now, but the evidence suggests this is probably not a great time to abandon your buy-and-hold strategy,’” Kramer says. “Why don’t we sit tight—you’re likely going to feel a lot better in six months.’”

Connecting with future you

Robo-advisor Wealthsimple entered the marketplace in 2016 with an advertising campaign called “Future You.” The television spots showed clients in their 20s confronted with their future selves. One ad showed the client sliding a bar across the screen that indicated the amount she was saving; the more she put aside, the fancier the accessories her older self received.

The marketing campaign wasn’t based on any particular research, the company says, but it addresses a central problem in retirement planning: a lack of identification with our future selves.

“It’s just really difficult to picture ourselves in the future and tangibly anticipate what our physical and practical needs will be,” Kramer says.

The future self is an “amorphous concept,” she says, and most people don’t like to think about aging.

Hal Hershfield, associate professor of marketing at UCLA, has done extensive research on “temporal discounting,” or prioritizing present needs over future ones. By measuring brain activity, Hershfield and colleagues demonstrated that imagining a version of oneself 10 years into the future evoked brain patterns similar to those of imagining a stranger (famous actors, for the purposes of the experiment).

“To those estranged from their future selves, saving is like a choice between spending money today or giving it to a stranger years from now,” Hershfield wrote in a 2011 paper in the Journal of Marketing Research.

Vivid imagery is one way to address the challenge. Hershfield found that showing college students pictures of themselves digitally altered to look older was effective: those who saw aged versions of themselves said they would put more than twice as much money into a retirement account than those shown images of their current selves.

One experiment used a sliding bar indicating allocations from a hypothetical paycheque made to a retirement account, with an older self smiling or frowning in response—much like the accessorized “Future You” from the Wealthsimple ad.

While Hershfield noted the technological barriers for financial advisors to incorporate the method at the time of his research, self-aging images are widely available now in apps such as Snapchat. Advisors could be using these tools today by getting clients to consider an aged image of themselves while discussing retirement planning. Merrill Lynch responded to Hershfield’s study back in 2012 by developing an online “Face Retirement” tool to age clients using a photo.

And you don’t even need technology. Hypothetical exercises such as composing a letter to a future self could also be effective. One experiment even showed that people were more likely to delay rewards when they were shown a photograph of an unknown elderly person and asked to write a day-in-the-life narrative.

The power of ritual

BEworks, a Toronto-based management consulting firm that applies behavioural economic methods to business clients, has been looking at the power of ritual in financial planning. Part of their research builds on the connection to a future self.

CEO Kelly Peters recommends having clients write a letter from their future selves about how they want to spend their retirement. The ritual could take place every Jan. 1, and the letter should be sealed in an envelope and placed in a dedicated box that’s kept visible on a shelf.

The best rituals have multiple steps and details to make them more believable, she says, and those steps should be repeated. Performing them at a specific time is also more effective.

“You’re embedding real financial planning behaviour in what seems like this fun little series of steps,” she says. The box “becomes a visual reminder of the commitment. Not only do we have the benefit of the planning that occurred in that moment, we were able to nudge people into doing something that they wouldn’t otherwise do,” namely thinking about their finances and documenting that thinking.

The firm is looking for an investment firm to partner with to test the effect of incorporating rituals into saving.

Peters pointed to other research from Harvard Business School that suggested rituals could help overcome grief from financial loss. An experiment involved participants with the opportunity to win $200. One group was instructed to write out how they were feeling on a piece of paper, sprinkle the paper with salt, tear it up and count to 10. The other group didn’t perform the ritual.

When all participants were told they would not be receiving $200, those who had performed the ritual were less upset about losing out. The feeling of being in control provided by the ritual reduced feelings of loss—regardless of how participants felt about the ritual itself.

Lisa Kramer’s research on seasonal asset allocation also contains a lesson for marketing mutual funds and other investment products: dollars might be wasted advertising riskier categories in the fall, Kramer says, when there is little appetite for them. Those efforts should be reallocated to the spring, when investors are more inclined to consider riskier equities, and fall advertising should be for safer options.

Tangible benefits

Peters also describes a project BEworks did in 2014 with Kenyan telecom company M-PESA to encourage saving through its partner, the MBAO Pension Plan. They tried four methods to encourage deposits:

• sending customers a text message, framed as coming from their children, reminding them to save for the child’s future;
• matching customers’ deposits at rates of 10% or 20%;
• matching savings at 10% or 20% in anticipation of a customer making a given deposit, and taking that amount away at week’s end if the customer didn’t save (appealing to what behavioural economists call loss aversion);
• giving customers a gold-painted coin divided into sections for each week of the experiment. They’d scratch off a section each time they made a deposit.

The coin, the size of a poker chip, was by far the most effective method: the average savings amount per person was nearly twice as much as the next most popular, which was Method 3. The researchers, Dan Ariely and Merve Akbas from Duke University, hypothesized that the coin’s tangibility made it work.

“Money’s just gotten so abstract. You can’t see savings,” Peters says. Whereas in the past people could demonstrate their savings in the form of land or livestock, now it’s more common to demonstrate wealth by spending it.

Peters says the coin’s success could also have to do with the element of ritual. Scratching a section of the coin every time customers saved made it a conscious, rewarded act rather than something abstract and automated.

Here come the apps

Abstract and automated saving is becoming more common as financial apps gain in popularity.

Andy Mitchell, managing director and head of asset management distribution at SEI Investments Canada, recalls a time when his firm’s American advisors would unfold a purpose-built game board in their offices and have clients move dozens of pieces around it. The exercise was to help them understand and articulate their investing goals.

“Imagine that process from a conversational perspective,” Mitchell says. “How much of a game changer that is, versus ‘The S&P/TSX is up 5% this year and I’m only up four-and-a-half, and why is that the case? My neighbour’s doing six.’”

The physical boards have been replaced with an app, but the same principles apply. Now, clients and their advisors talk through goals, which they can then drag and drop into SEI’s goals software.

To help clients visualize their goals, each client has progress-to-goal reporting that shows them exactly where they are on a 20- or 30-year retirement horizon. It’s all about demonstrating to clients that staying invested pays off, and helping them to stay calm during downturns or volatility, Mitchell says.

More investment companies are seeing the benefits of apps and automation.

Wealthsimple, which as a robo-advisor doesn’t speak to clients in person, uses tech to encourage saving. For instance, the firm launched a TFSA tracker when it noticed customers often forgot about the space they had remaining in those accounts. Lump sum deposits to TFSAs have since increased 48%, says chief investment officer Dave Nugent.

On the bank side, RBC launched its NOMI service last August, offering personalized service based on customer behaviour. The NOMI Insights digital assistant offers information about a customer’s spending trends, while NOMI Find & Save uses machine learning to find money in a customer’s account and automatically move it to a savings account.

More apps are coming with similar offerings, says a report from Mintel Comperemedia, “mirroring recent changes in the healthcare, self-help and diet industries” (think step-tracking apps that nudge you to move every few hours). These do-it-yourself financial wellness tools will make use of behavioural finance research and artificial intelligence.

The report said 77% of Canadian consumers who have used a mobile money management app say they like it.

Rather than threaten old-fashioned financial planning, such apps can augment the experience. Advisors can participate in configuring an app’s saving and spending goals, thereby outsourcing any planned manual nudges (e.g., monthly email reminders) to the technology instead.

Advisors can also learn from the disciplined way apps use data. In Wealthsimple’s app, for instance, if a customer opens an RESP, demonstrating they have children, they may find links to information about wills or life insurance that a parent may also want. Advisors can replicate this behaviour by creating files of articles and fact sheets organized by life event, and sharing these resources with clients as they hit milestones. Further, advisors can think of every meeting, email and phone call as a chance to build up more knowledge about a client and provide more personalized advice.

When it comes to saving, there are a multitude of forces working against following a plan. Educating clients about apps and rituals can extend an advisor’s influence beyond the face-to-face meeting.

A little nudge will do

Richard Thaler, the 2017 Nobel winner widely considered to be the founder of behavioural economics, took on present bias (or temporal discounting) by changing the “choice architecture” for retirement savings. His “Save More Tomorrow” plan included automatic enrollment in employers’ defined contribution pension plans, as well as automatic escalation of the savings rate.

Increases to an employee’s savings rate were linked to pay raises, thus addressing loss aversion—the tendency to measure losses as larger than gains. “Your take-home pay never goes down but your nest egg is nicely building,” University of Toronto’s Lisa Kramer says. At the first company to take up the plan, Thaler wrote in a 2013 paper, employees who joined quadrupled their savings rate from 3.5% to 13.6% in under four years.