Why do professional investors talk about behavioral finance more than they apply its insights to achieve more rational decision making?
- “Want to” goals are more achievable than “have to” goals: Meaning matters.
- Structure your life to avoid having to make self-control decisions in the first place by learning better habits: Choice architecture matters.
- Some people are less prone to temptation because they are conscientious - a personality trait that can also be influenced by genetics: Genetics might matter.
About Direct Change
Hillman’s words help explain why seamlessly switching from a problematic to a desired behavior is impossible. A lasting and more conscious form of change requires rewriting our narrative identity by adapting our mental immune system.
Narrative Identity and Mental Immune System
“Narrative identity” is the unwritten, unspoken, and usually unconscious story that defines who we are, what we do, and why we do it. It operates as a template for our actions. To rewrite our narrative, we have to intervene in our mental immune system, which like our physical immune system, has a self-protective function: to guard us from the psychological trauma and danger that sudden change can bring.
This can also keep us from making positive changes. Our mental immune system is often rooted in unexamined beliefs. Therefore, rewriting our narrative begins with instilling a more conscious set of beliefs.
Personal change goals can be adaptive, according to Ronald Heifetz’s distinction between “technical” and “adaptive” challenges. These require a shift in mindset, not just behavior.
Framework for Change
Empowerment is central to creating a framework for change based on the science of the brain. Empowerment requires that we redirect our attention to change how the brain functions. This is what the literature calls neuroplasticity. When we consciously shift our attention, we help facilitate self-directed neuroplasticity.
Conclusion
To empower more rational decision making, we should avoid sludges in favor of choice architecture-embedded nudges and intuition-driven heuristics. Aligned choice architecture minimizes the need for willpower.
Reflecting on our heuristics-driven narrative function is key element of the choice architecture to support desired behavior, as it can minimize the prohibiting effects of contradicting beliefs that compose our mental immune system.
Panthera Discovery 2
The less personal the variable to be optimized in an investment process, the lower the resistance.
We found that when optimizing an investment process, the degree of organizational resistance to change depends on the optimization goal. Minimizing fees, re-allocating to exchange-traded funds (ETFs), and re-negotiating transaction fees with brokers tend not to trigger much resistance. As a general rule, professional investors acknowledge the advantages and follow the recommendations. They are equally willing to optimize tax structures or implement regulatory changes.
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The diagram above shows how increased organizational resistance can relate to asset allocation-related topics. With respect to subject-specific input on methodologies, resistance is low where professional investors are academically or professionally socialized and increases as this input moves beyond their academic or professional socialization.
For example, a CIO trained in modern portfolio theory (MPT) who applies the mean-variance optimization, will likely offer little resistance to a proposal to use minimum-variance optimization. That same CIO will likely be much more resistant if asked to switch from correlation-based risk management to causality-based risk management.
Resistance usually peaks when the investment process variable relates directly to the individual, such as when it involves optimizing a daily work routine, configuring the team roles, or reducing the knowing-doing gap.
