Behavioral Finance, or “Befi,” made famous in the DC world by UCLA professor Shlomo Benartzi, may be one of the most overused and least understood terms in our industry. Professionals from Sibson Consulting, a division of Segal, provide a basic and easy-to-understand guide to Befi, including practical examples.
Sometimes it’s hard for trained investment professionals to understand how people can make such bad financial decisions, such as not saving up to the match, for example. Irrationality and inertia, which can be caused by complexity aversion, are the biggest culprits. Understanding the cause and finding ways to use Befi to overcome them can be effective ways to improve outcomes while showing plan sponsors how decisions that are small, relatively inexpensive or even free can make a difference.
Sibson reviews some simple ways to help participants make better planning decisions through choice architecture, or the science of how choices are communicated. Terms like heuristics, cognitive bias, hyperbolic discounting, complexity aversion and clue seeking are defined, with examples of how they can lead to bad decisions in 401(k) plans. A quick read, and worthwhile.
