By Chris Hanson
Last month, The Wicked Smart Investor sat down with a complete stranger and educated him on an investment philosophy supported by oodles of Nobel Prize winning academic research. He quickly invested. And if you believe this tall tale, you probably think you can actually park a car in Harvard Yard. It just doesn’t work that way. Frequently, the prospective client’s facial expression reads “If you know so much about investing, why aren’t you a multi-millionaire?”
Sometimes they even ask this question aloud.
Don’t you just love the stereotypical directness of Bostonians? If you do, keep reading this article because I’m about to get extremely candid. First of all, there is competition everywhere in the investment business. Also, despite pretenses, many people simply don’t have money to invest. Those two factors shrink the target market dramatically.
But the biggest hurdle I face as an investment advisor is that facts simply don’t change people’s minds. If I’m asking someone to change their long-held, but erroneous, beliefs about investing, it’s certainly an uphill battle. People believe what they want to believe.
I bet you have used that phrase before.
Harvard economist J.K. Galbraith explained things much more eloquently. He wrote: “Faced with a choice between changing one’s mind and proving there is no need to do so, almost everyone gets busy with the proof.”
It is hard to admit we’re wrong; it is only human to stubbornly cling to our beliefs despite being confronted with evidence to the contrary. Behavioral economists, the scholarly type who study the effect of our hardwired human behaviors on our investment decisions, call this confirmation bias. This psychological phenomenon is very dangerous; it frequently leads to poor investment decisions. The existence of confirmation bias is also supported by a mountain of Nobel Prize winning academic research. It is all available at no cost on the internet or at your public library.
The sad thing is that many people will not review this research because planning for your financial future is a yucky, scary thing. So maybe they invest in CDs for their retirement 20 years from now, purchase high cost annuities for the guarantee, or hire a planner far too eager to tell them what they want to hear. Others may turn to their friends and family and ask for advice. This could be a good thing, as long as these people actually know what they are talking about.
The recommendations of friends and family are also the best way to defeat confirmation bias. Imagine this scenario: Dear old Uncle Joe has been a constant in your life. He changed your diapers and gave you tons of birthday presents. Maybe you don’t completely agree with all of his political opinions but you have a permanent soft spot for Uncle Joe. You also know that Uncle lives a comfortable retirement despite modest earnings throughout his career. So, when you ask him for financial advice and he directs you to his financial planner, you will likely hire that planner.
The reason for your decision is a well-researched, hardwired psychological phenomenon: human’s herd mentality. As humans are social animals, our desire to be loved by others trumps just about everything else. Herd mentality explains teenage peer pressure, religious cults and book clubs. Life is much easier when you stick with the crowd; hardcore contrarians are frequently ostracized.
I utilize herd mentality to build my business. When I am referred by an existing client, I most likely get that business. Client referrals take time, that’s why I am still working on my first million.