“Alarming” lessons in investor behavior

I’ve recently wondered about the popularity of behavioral finance. Does this popularity stem from its cathartic nature? Recognizing foibles in ourselves and those around us can be a healthy coping mechanism. Irrational behavior is easier to tolerate when we recognize it as part of our nature and forgive ourselves for being human.

But I hope for more. I think we can learn from behavioral finance and, more importantly, shape behavior through that learning. One lesson worth assimilating is the power of commitment devices, a behavioral concept that has great applicability for the advisor-investor relationship.

The power of commitment devices

So what are commitment devices? Here’s a description by behavioral economist Jodi Beggs:

“Commitment devices are a way to overcome the discrepancy between an individual’s short-term and long-term preferences; in other words, they are a way for self-aware people to modify their incentives or set of possible choices in order to overcome impatience or other irrational behavior.”1

Another clever name for a commitment device, which originated in the medical industry, is a Ulysses Pact (or Ulysses Contract). It’s inspired by the story of Ulysses in Homer’s Iliad. Ulysses ordered his sailors to plug their ears with beeswax and tie him to the mast of his ship so he could hear the Sirens’ song without being lured to his death.


A modern example of a Ulysses Pact is Clocky® (pictured above), a moving alarm clock invented by former MIT student Guari Nanda for an industrial design class. Clocky can help those who struggle with chain-snoozing. It’s also more relatable to normal life—and investing—than being tied to a ship’s mast. Even if you’re not a chronic oversleeper, you can likely relate to the following in some area of your life:

10:00 p.m.: Rational, “Night-Before-You” sets your alarm for a productive 5 a.m. “Gotta get that eight-mile run in. And 6° below zero won’t be so bad once I get going!” This commitment is made in a stable, rational state.

5:00 a.m. (with normal alarm clock): The shrill cry of your clock taunts you awake. Sleepy, “Morning-You” half-consciously fumbles for the snooze button. Last night’s conviction and commitment evaporates in this flustered emotional state. “Ahh…seven more minutes of slumbering paradise.” Repeat until late for work.

5:00 a.m. (with Clocky): Clocky chipperly chimes his morning greeting… then promptly rolls off your nightstand and scurries around your bedroom floor on his knobby wheels. Sleepy, “Morning-You” fumbles for the snooze button before realizing the clock is now under the bed and you’ll have to get up to shut it off. Sleepy, “Angry-You” gets up, shuts off Clocky and thinks, “Well, I’m up anyway. Might as well find my running shoes…”

Using commitment devices with clients

It’s easy to see the effectiveness of a commitment device in this scenario. It’s harder to know how to apply them in investment decision making.

Fortunately, you might be familiar with several useful commitment devices or be using some already. These include:

  • Investment policy statements
  • Written financial plans
  • Automated savings programs

Each of these can help clients overcome the occasional discrepancy between their long-term preferences – their financial goals – and their short-term preference to react to market volatility or headline news. You can use these tools to discuss and document how you and your client will work together in these moments.

And don’t be afraid to use examples like Ulysses or Clocky as you describe your role in their investing future. If you secure their explicit permission to play that role, you may be able to more effectively guide them when they’re in an emotional state. They’re more likely to remember the commitment they made to heed your advice if it’s linked to a creative and memorable explanation.

The bottom line

You can’t tie your clients to a mast to prevent them from jumping ship during choppy markets. But you can get more creative with tools like commitment devices if you better understand where their power originates.

1“Be Careful With Those Commitment Devices…” http://www.economistsdoitwithmodels.com/2009/06/17/be-careful-with-those-commitment-devices/

Clocky is a registered trademark of Gauri Nanda.

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