CFP 101 - Unit 2: Behavioral Finance, Client and Planner Profiles, Communication, and Counseling Principles

Strategic management approach

A client's goals and values drive the client-planner relationship. Conducting a SWOT analysis (identifying strengths, weaknesses, obstacles, and threats) is done early in the financial planning process. Here, the financial planner serves as a consultant.

context

A client's profile is largely influenced by context, which includes past history or any conditions that presently exist. These conditions are affected by cultural influences, religious preferences, individual family circumstances (including biological and non-traditional), as well as individuals' ages and where they are in their life cycles

What is Mental accounting?

Also known as "money jar mentality", this concept involves the tendency of individuals to put their money into separate "accounts" (or "money jars") based on the function of these accounts. For example, amounts of money may be earmarked separately for savings, debt reduction, and a future vacation. In this case, money being set aside for a vacation while carrying a considerable amount of debt is, in general, poor money management.

values

Attitudes and beliefs for which a person feels strongly are considered values; they represent what he believes to be right.

Psychoanalytic approach.

Based on the use of psychoanalytic theory such as Freudian or Gestalt theory, this approach is not widely used by planners. Few studies have been done to address its usefulness.

What is Behavioral finance?

Behavioral finance is a relatively new field of study which relates behavioral and cognitive psychology to financial planning and economics in an attempt to understand why people often act irrationally during the financial decision-making process

Financial counseling

Financial counseling is a process that helps clients change their poor financial behavior through education and guidance.

Perception

Perception involves the ways people become aware of things, people, events, or ideas.

Beliefs

are a type of attitude because they reveal the understanding of some aspect of a person's life.

Lower voice pitches

are usually interpreted as conveying confidence

Interpersonal communication

communicating one-on-one, is important when estab- lishing relationships with clients, communicating and implementing recommendations, and throughout the financial planning process. Mastering interpersonal communication skills involves understanding differences when communicating across generations, cultures, and genders, and will ensure that the listener understands and responds effectively to the communicator. Effective interpersonal communication involves the understanding and application of oral and non-verbal skills when interacting with clients.

leading responses

guide the client to give more detail, making a "meeting of the minds" more likely.

Loss aversion theory

involves clients valuing gains and losses differently and as a result will make decisions based on perceived gains rather than perceived losses.

Body language

involves facial expressions, eye contact, gestures, and body posture and actually impacts how clients receive messages more than any other type of communication. Facial expressions communicate emotions such as interest, agreement, excitement, fear, surprise, or contempt. Eye contact can indicate attention, interest, and engagement between planners and clients. Conversely, failure to make eye contact may be interpreted as disinterested, distracted, or discourteous.

Voice tone

is the inflection of voice or emphasis on certain words. It shows attitude, whether it is humor, anger, sincerity, or sarcasm.

higher voice pitches

project uncertainty

Attitudes

reflect a person's opinions, values and wants

Auditory learning style

retain information by hearing or speaking

Visual learning style

tend to respond to visual objects, such as graphs, charts, pictures, and reading information.

Risk perception

the client's assessment of the magnitude of the risks being traded off

Risk capacity

the degree to which a client's financial resources can cushion risks

Which of the following statements regarding learning styles is(are) CORRECT? 1. Financial planning for an auditory learning client would be most effective if the financial plan- ner has frequent informative discussions. 2. A printed outline of the financial planning process would be most effective with the client who has a kinesthetic learning style. 3. Many changes in facial expression indicate that a prospective client most likely has a visual learning style. 4. A client with a kinesthetic learning style often enjoys participating in sports. A. 1 only B. 1 and 2 C. 1, 3, and 4 D. 2, 3, and 4

C. Clients with a visual learning style benefit most from printed outlines of the financial plan- ning process. These clients also communicate through facial expressions. Those with auditory learn- ing styles understand best through verbal communication. Kinesthetic learners enjoy participating in physical activities.

Economic and resource approach

Clients are assumed to be rational and will change to the most favorable behavior if given the appropriate counseling. In this approach, the financial planner is the agent of change. The focus is on obtaining and analyzing quantitative data, such as cash flow, assets, and debt.

Classical economics approach.

Clients choose among alternatives based on objectively defined cost-benefit and risk-return tradeoffs. The belief in this approach is that increasing financial resources or reducing financial expenditures results in improved financial outcomes.

Cognitive-behavioral approach

Clients' attitudes, beliefs, and values influence their behavior. Planners use this approach attempt to substitute negative beliefs that lead to poor financial decisions with positive attitudes, which should result in better financial results.

Which of the following statements is(are) CORRECT? 1. Values reflect a person's opinions, values, and wants. 2. Beliefs are a type of attitude because they reveal a person's understanding of some aspect of his life. 3. A client's context can be affected by his cultural influences, religious preferences, and individual family circumstances. 4. A planner should recognize his own attitudes, values, biases, and behaviors and be certain they do not impact recommendations made to clients. A. 4 only B. 3 and 4 C. 1, 2, and 3 D. 2, 3, and 4

D. Attitudes, not values, reflect a person's opinions, values, and wants. Values are attitudes and beliefs for which a person feels strongly; they represent what he believes to be right. The other statements are correct.

What is Prospect theory?

Investors generally fear losses much more than they value gains. Accordingly, they will most often choose the smaller of two potential gains if it avoids a sure loss. For example, if Investment A has certain return of 5%, and Investment B has a 75% probability of returning 8% but a 25% of returning 2%, people will tend to choose Investment A.

Judgment

Judgment involves making conclusions about what has been perceived.

How do Kinesthetic learning clients express themselves?

Kinesthetic learning clients often express themselves through body language. These clients tend to enjoy physical activities.

Active listening

Planners should practice active listening by paying full attention to what the client is saying and responding by paraphrasing the client's comments.

How do Visual learning clients express themselves ?

Visual learning clients will express themselves through facial expressions and often have interests such as movies and spectator sports

Which of the following statements regarding counseling theory is(are) CORRECT? 1. The cognitive-behavioral approach to financial counseling asserts that clients' attitudes, beliefs, and values influence their behavior. 2. Financial counseling is a process in which the planner helps a client change poor financial behavior by making recommendations to improve financial status. 3. Planners that use the economic and resource approach assume that clients are rational and will change to the most favorable behavior if given the appropriate counseling. 4. In the classical economics approach to financial counseling, it is believed that improved financial outcomes can result from increased financial resources or reduced financial expenditures. A. 3 only B. 1 and 4 C. 1, 2, and 4 D. 1, 3, and 4

D. The cognitive-behavioral approach to financial counseling believes that clients' behaviors are influenced by their attitudes, beliefs, and values. Financial counseling is a process that helps clients change their poor financial behavior through education and guidance, Making recommen- dations to improve clients' financial statuses is not part of financial counseling. Rational clients are assumed when using financial counseling's economic and resource approach. The belief in the clas- sical economics approach to financial counseling is that increasing financial resources or reducing financial expenditures results in improved financial outcomes.

Emma is meeting with Ethan to review the recommendations he has made in her financial plan. During their discussion, Emma explains to Ethan her concern about not having enough money saved for retirement if she follows his recommendations. Meanwhile, Ethan is thinking about a call he received earlier in the day about minor issues his child is having in school. After a minute or so, he realizes he did not hear everything Emma has said to him. He would like to wrap up his meeting with Emma so he can call his son's teacher. What is the most appropriate action Ethan should take? A. He should now try to pay some attention and call Emma later for clarification of anything he missed. B. He should ask Emma closed-ended questions to understand her concerns, attempting to end the meeting as quickly as possible. C. He should tell Emma he will adjust his retirement recommendations based on what he's already heard and end the meeting. D. He should apologize to Emma for being distracted and ask her to begin again, this time paying full attention to what she is saying.

D. The financial planner has the responsibility to engage in effective communication. Ethan was not actively listening to what Emma was saying. Even though he was distracted only for a min- ute or so, Emma may have said something significant during that time. Asking closed-ended ques- tions or trying to act on what he's already heard is not in the client's best interest and would not be considered effective communication

John has a strong feeling about a particular investment's future performance. He is constantly seek- ing information to validate his belief that this investment will greatly appreciate. However, he is dismissing any information which is contradictory to his stance. This is an example of which of the following? A Framing effect B Prospect theory C Anchoring effect D Confirmation bias

D. This scenario is an example of the confirmation bias which states that investors tend to look for information that supports their previously established decisions and beliefs.

What is Overconfidence?

Overconfident investors often believe they can control random events merely by acquiring more knowledge, and consider their abilities to be much better than they actually are. They take credit for any financial decisions that have positive results. Conversely, external influences are responsible for any negative outcomes. For example, an investor makes the decision on her own to invest in a risky stock because she feels she is qualified to make that decision without professional advice. If the stock performs well, the investor takes the credit. However, if the stock price drops, she blames the economy.

What is Confirmation bias?

People tend to pay more attention to information that supports their preconceived opinions and poorly made decisions, while disregarding accurate, unsup- portive information. This helps explain why investors tend to hold onto stock falling in value far too long before selling.

What is Framing effect?

This concept asserts that people are given a frame of reference, a set of beliefs or values, which they use to interpret facts or conditions as they make deci- sions. Under this theory, people will generally choose what they perceive is positive versus negative, winning versus losing, or getting something of high value versus low. For example, when offered a set amount of cash or a Rolex watch, most choose the cash. However, when offered a Rolex watch, cash, or an watch of lesser quality, more people will choose the Rolex because it is now considered more valuable in light of the watch of lesser quality.

What is Anchoring?

This concept involves individuals making irrational decisions based on information that should have no influence on the decisions at hand. Anchoring is especially risky when people know little about the product being purchased, the service being delivered, or the investment being mad

What is Herd Mentality?

This is the tendency of individuals to follow the actions of a larger group, whether rational or not. If people were making this decision individually, each person would not necessarily make the same decision. People who follow the herd often believe that the large group knows something they do not and believe the herd, because so many people are part of it, the herd could not be wrong. Social pressure may also cause individuals to fol- low the herd in an attempt to conform to and be accepted by the large group.

Myers-Briggs assessment

This type of assessment evaluates personalities based whether the individual is: ■ introverted or extroverted; ■ driven by senses or intuition; ■ influenced by thinking or feeling; or ■ apt to perceive or judge

three major types of learning styles

Visual, Auditory, Kinesthetic

Risk tolerance

the tradeoffs that clients are willing to make between potential risks and rewards

Kinesthetic learning style

understand concepts better using a hands-on approach. For example, writing goals and objectives with bullet points as they are formulated engages clients with this type of learning style.

emotional intelligence

which includes the ability to recognize emotional expressions in oneself and the client

How do auditory learning styles express themselves ?

words and often enjoy music and conversation.