Most financial advisors know that positioning products as solutions generally increases their attractiveness.
Consider, for instance, the “70% rule” that advises people to plan on spending roughly that portion of their current income during their retirement. For most clients, this rule is appealing.
But it’s markedly less palatable when expressed in terms of the 30% of current expenses that need to be eliminated, says professor Shlomo Benartzi at the University of California – Los Angeles in a recent paper entitled Behavioral Finance In Action: Applying Behavioral Insights to the Retirement Income-Planning Process.
Even though the two concepts are mathematically identical, the paper notes, the comparison highlights how small changes to the “frames” you use can have a huge impact on your clients’ decisions.
Professor Jeffrey Brown of the University of Illinois applied this logic to creating retirement income, asking prospective retirees to opt for either a life annuity paying $650 a month or a savings account of $100,000 bearing the equivalent interest. Although both choices were actuarially balanced, half of the group was presented the annuity choice in a “consumption” frame – a monthly income of $650 for life – and half was presented the choice in an “investment” frame – a monthly return of $650 for life. When the annuity was presented in terms of monthly income, 70% chose it; only 21% chose it when the amount was expressed as a monthly return.
In a recent study entitled Framing Effects and Expected Social Security Claiming Behavior, Brown tested other framing concepts with American retirees contemplating when to apply for Social Security benefits. Brown found that framing the decision in terms of potential gains through higher-benefit payments or losses through payments not received in earlier years of retirement led to significantly different timing choices.
Retirees were divided into groups, and each group was asked to indicate when it would begin taking Social Security. The questions were framed in 10 ways. The underlying information provided to study participants – the monthly benefit they would receive at each alternative age – was unaffected; only how the information was presented was altered.
The choices included both a baseline approach that was totally value-neutral and a break-even analysis that illustrated how many years it would take later claimants to recoup the money they otherwise would have collected had they had begun at age 62, the earliest possible starting age.
The remaining approaches used combinations of three framing approaches – gains vs losses, consumption vs investment, and older vs younger claiming ages.
Although all approaches produced different results, the researchers concluded that “presentation of gains leads to later claiming than losses.” What was striking was that the break-even analysis, which “frames the decision as a risky gamble while downplaying the insurance aspects of the choice,” led participants to claim benefits at far earlier ages than did the other nine frames – 12 to 15 months earlier, in fact.
As recent changes to the Canada Pension Plan will force your clients to accept a greater reduction in indexed benefits if they start CPP earlier than age 65, you would do well to consider the manner in which you broach such issues. IE
© 2012 Investment Executive. All rights reserved.