Dan Ariely, the James B. Duke Professor of Psychology and Behavioral Economics at Duke University, set out to remind the 300 investment professionals at this year’s European Investment Conference of two simple facts:
- Human beings make irrational decisions in all areas of our lives, including finance.
- The concept of fairness, of earned reward — that someone has exerted effort, time, and energy in our service and therefore earned the payment we are providing them — can be just as important to us as the results they deliver. And sometimes more so.
The first of these points is widely accepted yet frequently confined to our subconscious as we view the world through our preferred lenses. To highlight the often considerable conflict between our emotions and objective thinking, Ariely engaged the audience in a series of straw polls on everyday events and scenarios. In one anecdotal survey, some of the senior professionals in the crowd revealed that they were more comfortable admitting to having texted while driving in the last year than having left a restroom without washing their hands. A potentially fatal action, it seems, is more palatable or less shameful than poor personal hygiene.
Turning to our perception of fair value and the factors that influence our pursuit of it, Ariely challenged members of the audience to consider the lengths they would go to save £10 on a £20 purchase. For such a 50% saving, many indicated they would be willing to walk further down the high street or wait additional time before making the purchase. Yet when considering the option of a £10 saving on a £1,000 purchase, their responses were far more muted. Apparently, if we’re willing to spend £1,000, £10 makes little difference. The fact that the reduced saving relative to the spend in the second scenario elicits a less favorable perception is a classic case of irrational thinking, according to Ariely. “After all,” he said, “your bank account doesn’t care where the saving came from, and £10 is £10.”
Moving to the second and perhaps more important topic of fairness and the sense of earned reward, Ariely again referred to everyday scenarios to remind investors of the simple yet powerful factors that influence their clients’ perception of fair reward and the value of the service they are receiving — with returns being just part of the equation. Citing a recent conversation with a locksmith, Ariely recalled that when the locksmith began practicing his trade, he would often struggle to find the fault, break the customer’s lock completely, replace it, and take up an hour or more of their day in the process. Now far more experienced, he can resolve most issues in well under an hour, with minimal disruption to the customer. Yet while customers once paid his high fees gladly and often tipped, he no longer receives tips at all and frequently finds himself confronted by clients who are unhappy with the fees he charges for what they see as a task that only took him a few minutes to complete. When paying for a service, Ariely said, efficient skills are harder to place a value on than the knowledge that someone has toiled on our behalf.
This, Ariely said, is a crucial lesson for the investment profession. When clients cannot see and may not understand the intricacies of the service they are buying, it is essential that investment professionals take the time to connect on a human level, understand the client’s key drivers, and provide written and personal feedback that explains clearly the steps taken (and not taken) and the thought process behind them in pursuit of the mandate. While this may seem counterintuitive to investors, Ariely was quick to point out that many professions already undertake such efforts very successfully and, indeed, use them to build their service culture. Consider management consultants who undertake a project for a client and deliver reports running hundreds of pages long when half a dozen may have sufficed to deliver the most pertinent information. On receiving the document, the client can not only view the findings and recommendations, but get a strong sense through the format of the document of the time invested, work completed, and effort deployed on their behalf.
As the investment profession seeks to demonstrate true social value after the financial crisis, Ariely does not advocate cumbersome reporting, nor does he underplay the significance of ingrained habits in our society that lead us to compare results against benchmarks. But as people continue to behave irrationally and have a longing to feel justly served, Ariely said that investment professionals need to truly engage their clients with hard facts about the emotions on which their mandate was built and honest insights into the resulting investment strategies. It is on this foundation that investment professionals can construct a valued service culture.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.
Photo credit: Paul White