Thursday, April 5, 2018

Informed Financial Choices

Morgan Housel wrote a thoughtful article titled How to Talk to People About Money that I highly recommend reading. He makes the case that not everyone’s financial goal is to get richer. Many people just want to maximize the chances they can keep living the way they’re living.

He likens financial advice to medical advice where doctors lay out your options clearly and let you decide what medical intervention you want. Just as people want a say in their medical treatment, they want a say in their goals when investing their money. Financial advisors are trained to examine their clients’ risk tolerance and other factors, but a better model may be to lay out the possible outcomes of different investment approaches and let people decide for themselves what they want.

There is an important caveat here, though. In medicine, there is the concept of informed consent. Doctors need to explain medical procedures and the possible outcomes to their patients in a way they can understand. If financial advisors are going to lay out choices for their clients, they need to explain the probabilities of various outcomes in a way their clients can understand. This is a challenge.

For example, an advisor might tell a 60-year old woman that her nest egg could buy an annuity that pays $2500 per month for the rest of her life. If she seeks safety, she might like the sound of this. What she might not understand is that 3% inflation would leave her with only $1384 per month buying power when she’s 80. If those two decades include 5 years of 10% inflation, then her buying power drops to $996 per month at age 80. She might not like this so much if she is properly informed.

In principle, I agree that financial advisors should not make all investment choices for their clients, just as doctors shouldn’t make all medical choices for their patients. However, I think financial advisors have a tough job in getting informed consent. It’s very difficult to get people to understand the range of possible long-term outcomes from different investment approaches. And just doing what people say they want is very different from helping them make informed choices.

2 comments:

  1. The concept of Informed Consent in the Financial World seems quite foreign when dealing with some institutions. I have a distrust of the industry that makes me not trust what I am told by Financial Folks, so I guess I am like the crazy Anti-Vaccination folks with the Medical World. Wow, that is an epiphany for a Thursday...

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    1. @Alan: I agree that most of the financial world seeks to have you make uninformed financial choices. But, even if an honest and competent financial advisor wanted to help you make informed financial choices, he or she would find it challenging.

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