Skip to main content

Check out our 4Q2023 Market Review and Investment Outlook for 2024

I Stock 000012062410 Small

To Nudge or Not to Nudge – What to Ask of Your Financial Advisor

Photo of author, Will Carter, JD.
Will Carter, JD
Senior Advisor

A lot has been written over the past decade about the tendency of otherwise smart and accomplished people to make what appear to be dumb decisions with their finances and other life choices. See, for instance, an earlier blog of mine, Why Smart People Make Bad Financial Decisions.

Helping people avoid mistakes is one of the most reliable ways for financial advisors to create meaningful value for clients. But there are different ways to do this; advisors can do the work for their clients, tell their clients what to do, and/or teach their clients how to know what to do.

The growing field of “behavioral finance”, anchored in Nobel-prize winning research by economist Daniel Kahneman, has produced a school of thought regarding what to do about people’s tendency to make poor financial decisions. Capably led by Cass Sunstein, a Harvard law professor who oversaw regulatory matters for the Obama administration, much of the discussion has focused on the concept of “nudging” – that is, constructing situations that encourage, but do not require, people to make financially optimizing choices.

For instance, proponents of nudging successfully have advocated for federal policy changes that allow employers to automatically enroll and invest an employee in a 401(k) plan unless that employee takes the initiative to dis-enroll or select different investments. And, the research suggests, this has produced improved rates and methods of saving for retirement.

Not surprisingly, there have been critiques of this paternalistic approach.

Most commonly, many skeptics have questioned whether we can trust sources of “nudging” (governments, businesses) to know what is best for their clients/constituents.

Others have asserted that nudging, even when indisputably for a good cause (e.g., encouraging people to donate organs by requiring people to “opt out” of such an arrangement) is intrinsically de-humanizing – that increasing the cost of people choosing “bad” behavior (e.g., cigarette taxes) robs them of the dignity and autonomy associated with the freedom to make bad choices.

I recently came across a thoughtful, detailed essay recommended by Sunstein as a sympathetic yet forceful critique of nudging. Written by Ricardo Rebonato of Oxford University, the 68-page paper provides a thorough description of the philosophical foundations of the nudging movement, which he describes as a form of “libertarian paternalism”. To view the paper, click here.

The essay culminates with a compelling strategic objection – namely, that nudging tactics are too “soft” to warrant the attention they have garnered because of their failure to address the underlying cultural, economic, and psychological factors that produce habits of poor decision-making in matters of wealth and health in the first place.

In effect, Professor Rebanato suggests that academics and policymakers are selling people short by focusing so much energy on designing ways to “work around” our bad thinking habits. Noting that our brains’ plasticity is what has caused us to develop weak thinking habits to begin with, he urges that more attention be paid to designing strategies to improve the effectiveness of our thinking.

This reminded me of much of what we offer in the financial services industry, which is full of expert help offering to do things for people (such as investing their portfolios), but with relatively less attention paid to what we can help clients do better for themselves, such as developing the disciplined moods, knowledge, and actions that provide the solid foundation of earning, spending, and investing habits that have the biggest impact on people’s financial future.

Of course, advisors should do all they can to help clients arrange their financial situation in a way that makes it easy for them to maximize the value of their tangible and intangible assets. Advisors can also, however, go beyond that and help people develop more fundamental ways of relating to their money in order to avoid weak financial decision-making in the first place.

That, however, requires a very different set of skills – skills that will allow advisors to function as effectively as a coach to teach and inspire, and as a personal trainer to make clients sweat, not just a responsive, capable expert who do what clients ask. (For more on what else to ask from your financial advisor, see a blog post I shared some time ago.)

Related Insights
I Stock 1209818907 PLM Blog

You CAN Know What You Don’t Know

Want to feel like a true Superwoman? Try checking off your household to-do list all by yourself! Take it from me, there are many valuable "life skills" that all women (married, single, divorced, widowed, or care-giver) should know, or at least become familiar with (aka, know the right questions to ask). Find out more from my lessons learned.

Read More
I Stock 823660872 JAB Blog FINAL

New U.S. Law Mandates Reporting of Beneficial Owners

Since 1990, the Financial Crimes Enforcement Network (FinCEN) has been a bureau of the U.S. Department of the Treasury. They are tasked with promoting national security and safeguarding our financial system by combatting financial crimes like money laundering and terrorist financing.

As of January 1, 2024, FinCEN has been given a new responsibility. Under the Corporate Transparency Act of 2021, FinCEN is now collecting required reports from U.S. companies that identify their beneficial owners and detail information. Is your business or entity one that is now required to report beneficial owners? Learn more.

Read More
I Stock 1475288298 copy 800px

Women Investors: Take Advantage of Financial Opportunities in Every Decade of Your Life

Women face unique financial challenges throughout their lives: the gender pay gap, taking time off work for caregiving, and having a longer life expectancy, to name a few. Each stage of life presents a different set of financial considerations and decisions — and getting them correct is important to living your "good life". Learn more.


Read More
Play