What can regulators learn from behavioural finance ?

It is exciting to note that financial services industry is employing behavioral economics people. Sarah Newcomb a PhD in behavioral economics is working with Morningstar as a behavioral economist.

In her recent interview with Business Line she offers a basic primer on the field. One of the qs was What can regulators learn from BF?

For those creating policy, the important thing is to make sure that the incentives of people selling financial products must align with the incentives of people buying financial products. In the US, for instance, we are seeing regulations tighten to ensure that advisors sell products that are in the client’s best interest. If a client has a portfolio allocation that is fine to begin with, and there is a new product that the advisor is selling him, and if the only advantage of the new product is that he is paid to sell it, then you’re adding risk and transaction costs and higher fees to a portfolio that is already fine.

What about financial advisors?

One of the biggest barriers we found in behavioural science that keeps us from making good financial decisions is that we discount the future. When something is closer and immediate, we see those costs and benefits as disproportionately large as opposed to our mental picture of the costs or benefits of something in 10 years. So, we repeatedly, in academic studies, take small immediate rewards over large rewards later.

One thing that shows promise is using psychological distance to our advantage. We’ve seen that when people have a closer relationship with your future self, you make better financial decisions. One of the things you can do is age-progress your face, it puts clarity and detail in your own picture of you. It’s like a little brain hack that makes your future more real and the consequence of your saving or not saving feel more real. Another thing that financial advisors can do for clients is to get them to put a lot more detail into the mental picture of their lives in the future.

Hmm. Interesting bit..

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