Professor Shlomo Benartzi is a leading authority on behavioral finance with a special interest in personal finance and participant behavior in defined contribution plans. He also serves as co-chair of UCLA Anderson's Behavioral Decision-Making Group.
Benartzi’s is perhaps best known for the development of Save More Tomorrow™ or "SMarT", a behavioral prescription designed to help employees increase their savings rates gradually over time. Along with Richard Thaler, Chicago Booth's Ralph and Dorothy Keller Distinguished Service Professor of Behavioral Science and Economics, he was recognized by Money as one of 2004’s “Class Acts” for SMarT’s success – increasing savings rates in one plan from 3.5% to 13.6%. Benartzi is also chief behavioral economist at Allianz Global Investors Center for Behavioral Finance, or BeFi.
In a recently released white paper called "Behavioral Finance In Action, Benartzi sets out to illucidate for financial advisors the psychological and emotional underpinnings of client decision making with a goal of improving that process for both parties.
In the paper, Benartzi references Nobel Laureate Daniel Kahneman's notion of "two minds" in decision making. One mind is the "intuitive mind" which makes rapid decisions easily and the other is the "reflective mind" which is "slow, analytical and requires conscious effort."
Writes Benartzi:
Classical economics held that people are rational, self-interested and have a firm grasp on self-control. Behavioral economics (and common sense) showed instead that we are not as logical as we might think, we do care about others, and we are not as disciplined as we would like to be. It is not that people are irrational in the colloquial sense, but that by the nature of how our intuitive mind works we are susceptible to mental shortcuts that lead to erroneous decisions. Our intuitive mind delivers the products of these mental shortcuts to us, and we accept them. It’s hard to help ourselves.
Benartzi says that the "core" of these powerful but erroneous intuitions is "people’s hyper-negative response to potential loss, or “loss aversion." "Simply put," Benartzi writes" "losses loom larger than equal-sized gains. Psychologically speaking, the pain of losing $100 is approximately twice as great as the pleasure of winning the same amount. For this reason, most people are prepared to enter a 50:50 gamble of losing $100 on one hand, only if the sum to be won is at least $200.
The concept of "loss aversion" might actually have an evolutionary origin: It's better to avoid danger and live than confront it and get killed. But when making financial decisions, "loss aversion" may not be to one's benefit.
For instance, people have a tendency to hold on to losing stocks too long. Selling a losing stock is extremely unpalatable because it brings the reality of loss very much to mind. On the other hand, people often sell winning stocks too soon because the act of selling a winning stock realizes a gain, and that gives us pleasure. We feel pain when we realize a loss and pleasure when we realize a gain. The mistake people are making here is one of mental accounting: instead of looking at their portfolio “as a whole” they look at each stock separately, and make decisions based on these separately perceived realities.
To read Professor Benartzi's white paper, click here.
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