Traditional economic and financial theories assume we will always make fully rational decisions. This is the basis for Modern Portfolio Theory, the Efficient Market Hypothesis, the Capital Asset Pricing Model, and even Black-Scholes. However, you and I know the truth, which is that people—whether individually or as a group—seldom make fully rational decisions. What this means is that all of the sales approaches that act as if the consumer is Economic Man (Homo Economicus) often fail because we are really Homo Sapiens. The problem is that as regular people we let biases and emotions get in the way. There are 111 triggers that can set up a mix of 28 different biases—any of which can fog our decisions. We can’t do anything about group decisions, but often we can do something to help the person across from us make better financial decisions by removing the fog. However, some fogs are thicker than others.
Question: Did the North American Free Trade Agreement (NAFTA) result in a loss of American jobs, yes or no? Your inclination is probably to say yes, but the reality is that workforce data shows more U.S. jobs were created than lost due to NAFTA. Answering “yes” to the question is a result of availability bias, where we base our decision on the most vivid data, our emotions having been stirred, oftentimes, by the most recently publicized data. It is a difficult bias to counter. Usually the best solution is to acknowledge it and wire around it, such as: “I hear you; by buying this insurance policy you are helping to preserve American jobs.”
We can prevent fogs by using correct framing. An example of correct framing would be asking whether a potential insured would rather his family receive 50 cafe lattes or a check for $100,000 if he died, rather than asking if he can afford a $200 life insurance premium. Another framing example would be to ask a fixed index annuity prospect whether she’d be interested in how to potentially earn the equivalent of 10 years’ certificate of deposit interest in a single year, rather than saying that this annuity is linked to a stock market index but the most you can earn is 4 percent.
A bias to be aware of is representativeness, which means assuming what applies to one thing will apply to another. Here’s what I mean. Survey after survey finds most people want a retirement vehicle with an income that is guaranteed not to go down and will last as long as they live. The same surveys find many of these people say they would not buy an annuity (which is what they just described they wanted). The problem is that they typically are basing this on an assumption that with all annuities the insurance company keeps your money if you die. A way around this bias is to introduce new decision points by saying your financial instrument has those guarantees but that you keep control and can get any remaining cash value at any time (guaranteed lifetime withdrawal benefit). Now, when you say your solution is an annuity, the person will have additional information and will have to reevaluate his opinion on annuities.
It isn’t practical to learn each of the 111 triggers and 28 different biases that affect decision making, but it is important to understand that the prospect across from you is not Homo Economicus and to be aware that there are other forces at work as you present the rational reasons for him to decide in favor of your solution.
