Financial Planning Competency Handbook, 2nd Edition

CHAPTER 82 Applications of Behavioral Economics in Personal Financial Planning

Swarn Chatterjee, PhD

University of Georgia

Joseph W. Goetz, PhD

University of Georgia

INTRODUCTION

Behavioral finance has applications in furthering financial planners’ knowledge bases around money psychology to more effectively address maladaptive financial beliefs and decisions of clients, as well as their own biases. In contrast to traditional finance theory, which assumes that individuals are rational, most financial planners assume that individuals often fail to make the rational financial decisions that lead to expected utility maximization, and that planners play an important role in this regard. Financial planners also recognize that clients are strongly influenced by cognitive biases, emotional factors, and their past experiences with money within various social systems. Thus, this chapter examines the applications of key concepts of behavioral finance within the context of the financial planning process. Knowledge of recent research that provides insight on investor behavior and some key financial innovations based on behavioral finance are discussed.

THE FINANCIAL DECISION-MAKING PROCESS

The process of financial planning involves interaction between advisors and their clients. Scholars of behavioral finance define this type of communication structure within the context of a client-planner relationship as a two-mind system that involves two levels of decision making.¹ Benartzi (2013) ...