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Exclusive Interview: Vic Ricciardi Says “Status Quo” Bias Thwarts Broader Acceptance of Behavioral Finance

Exclusive Interview: Vic Ricciardi Says “Status Quo” Bias Thwarts Broader Acceptance of Behavioral Finance
January 23
00:06 2019

If you’re an investment professional, chances are you’ve heard of Victor Ricciardi. He is an Assistant Professor of Financial Management at Goucher College where he teaches undergraduate courses in personal financial planning, financial management, investments, behavioral finance, and the psychology of money. He has co-edited two major research books Investor Behavior and Financial Behavior that contain contributions from nearly 100 separate authors. These books focus on educating financial professionals and their clients about various biases we all exhibit and how to overcome them. He has made more than 125 media appearances to discuss the finding in these two books. is proud to now be on that list.

FN: Vic, it’s traditional that our exclusive interview subjects open by telling us a little bit about their background – the stuff that’s too interesting to make it in the bio. What were the life changing events you have encountered on the road to studying behavioral finance?
Ricciardi: My professional career began as a mutual fund accountant. I have a very strong background in mutual funds, modern portfolio theory, and various financial products. The first few years of my career I was responsible for the accounting valuation of investment portfolios for Wall Street firms namely determining the Net Asset Value of mutual funds on a daily basis. Learning about behavioral finance has changed me over the last 20 years. In my 20s, I traded too much, used margin, and lost a ton of money. I didn’t know then I suffered from various investment biases because all my early course work was in traditional (standard) finance such as rationality, modern portfolio theory, and efficient markets. The process of understanding the behavioral finance saved my investment portfolio – I am now a true advocate of behavioral finance. Most recently, I completed graduate level coursework in the emerging field of financial therapy; this new area of expertise is helping me train my students and financial planners to understand various approaches regarding financial coaching.

FN: Briefly relay the history of behavioral finance. Trace its early origins and how it filled a void left by the then generally accepted investment theories.
Ricciardi: The general field of academic finance known as traditional (standard) finance started in the 1950s and 1960s. It was highly quantitative in nature. In those early years, traditional finance, through the 1980s into the 1990s, was based on rationality and classical decision making. Researchers in psychology in the 1970s began to perform more experiments that were money-related, such as gambling experiments, (with probability). Those researchers demonstrated that individuals weren’t rational. Subjects in these experiments made judgments based on “bounded rationality.” In other words, they would make judgments that were not essentially irrational all the time, but which led to decisions that were satisfactory. In the 1980s, this small group of researchers in psychology began to work with a small number of behavioral economists along with finance professors who then in the early 1990s started to take the ideas from psychological experiments and apply them in the investment theories of academic finance.

FN: Modern Portfolio Theory (one of those aforementioned “generally accepted investment theories”) experienced a number of anomalies that finance professors tried in vain to correct them. Can you explain a couple of the more notable examples of these anomalies?
Ricciardi: The January effect is one major anomaly in which, abnormal stock market price increases (i.e., above average returns) occur year after year in the month of January. Another major anomaly is known as the small firm effect is based on the notion that smaller firms (stocks) tend to earn above average returns when compared to larger companies (stocks). If markets were truly efficient these patterns or trends should disappear and not repeat themselves.

FN: These examples were labeled “anomalies” merely because they failed to live up to the expectations of the Efficient Market Hypothesis. The concept of efficient markets, so elegantly displayed in the statistical mathematics of Modern Portfolio Theory (“MPT”), were predicated on the presumption of “The Rational Man.” Behavioral finance, on the other hand, presumes humans behave in (albeit often predictable) irrational ways – sometimes making decisions contrary to their best interests. What was the initial reaction to the “old school” finance professors who embraced MPT when behavioral finance first appeared? How do they react today?
Ricciardi: The initial reaction among most standard finance professors was a great deal of resistance and distaste of behavioral finance. This is an understandable and a rational response by the proponents of the rational school (traditional finance) since their beliefs and viewpoints are being challenged. Thousands of finance professors have based their entire careers including teaching and research agendas on the notion of traditional finance theories and concepts. Unfortunately, even today there is a very slow acceptance of behavioral finance. Most business schools in the United States only cover a very small portion of their business curriculum in behavioral finance. I have taught one of the first behavioral finance courses at the undergraduate level of over 15 years. A major tenet of behavioral finance is known as status quo bias in which, individuals suffer from high levels of inertia and are highly resistant to change. In my assessment, many of the standard finance professors suffer from status quo bias since they do not want to consider or learn about the new ideas in academic finance. The biggest supporters of behavioral finance are the financial planning industry since these professionals have to deal with actual clients that suffer from many of the biases identified within the behavioral finance research.

FN: A fiduciary duty requires doing what’s in the best interest of the beneficiary. When beneficiaries have the authority to make their own decisions (e.g., selecting investments in a 401k), we can naturally assume there’s a good chance they will make the kinds of mistakes identified by behavioral finance. Do you think it’s fair for the plan fiduciary to be held liable for these poor decisions? What can a plan fiduciary do to reduce the likelihood of poor decision making on the part of plan participants?
Ricciardi: I do not believe it is an issue of fairness on the part of the fiduciary since this individual is voluntary accepting this role on the part of the beneficiary. In addition, this is a major foundation of agent-principal issues in our everyday lives with all types of different relationships whether they are business or non-business related. If there is a major concern for individual suffering a financial loss as a fiduciary than take out professional liability insurance. The important aspect of this relationship is the behavioral finance dimension. There has to be a balance of expected responsibility between both the fiduciary and the beneficiary. An important aspect of this process is developing a balance between trust and control in the fiduciary-beneficiary relationship. Beneficiaries who place too much trust in fiduciaries or overly delegate control about decisions can have poor investment outcomes. On the other hand, beneficiaries who have a lack of trust or are overly controlling are unlikely to listen to the advice of a fiduciaries. Fiduciaries need to work with beneficiaries to develop a balanced relationship of trust and control that is based on strong communication, transparent guidelines, and thorough organizational processes.

FN: What do you see as the most likely behavioral finance mistake 401k plan sponsors are making right now? How can they avoid it?
Ricciardi: Within a group setting, the most detrimental behavioral finance mistake is the notion of groupthink. Since fiduciaries are potentially liable on an individual bias; they look to the consensus of other group members to justify and support the final group decision. This groupthink effect also takes place when committees examine data from peer group institutions and then make a decision based on what other organizations are making in their same peer groups. For example, if a majority on other similar institutions have automatic enrollment for 401k plans, then group members will sometimes exhibit herd behavior. That means they’ll follow the decisions of similar organizations by adopting automatic enrollment for their retirement plans as well. In my consulting work, I help investment and retirement committees institute policies to prevent groupthink. One major approach is to have a committee member play the role of a contrarian by taking an opposite view by collecting data and reasons why automatic enrollment for retirement plans might have negative consequences for employees. This ensures the group will consider both the advantages and disadvantages of all policy decisions.

FN: What do you see as the most likely behavioral finance mistake 401k plan participants are making right now? How can they avoid it?
Ricciardi: Retirement savers or retirees tend to suffer from inertia (status quo bias) by defaulting to the same decision or accepting the present situation. For example, most employees fail to monitor their retirement accounts on a continual basis. The vast majority of participants do not monitor the performance of their investments, fail to double check asset allocation decisions, and do not implement rebalancing techniques. Retirement savers need to motivate themselves to ensure they become active participants within the retirement planning process. Remember to nudge yourself by meeting with a financial planner or retirement plan sponsor on a yearly basis to ensure you are on track to meet your retirement financial goals, contributions, diversification strategies, allocation decisions, and risk tolerance profile.

FN: What do you see as the most likely behavioral finance mistake financial professionals are making right now? How can they avoid it?
Ricciardi: Financial professionals have a tendency to be overconfident about their skills, expertise, and knowledge. Overconfident financial experts believe they can influence the final outcome of a judgment based on superior attributes when compared to the average financial professional. Many financial professionals possess the conviction they are above average in their aptitude, overall decisions, and ability. In order to overcome this bias, financial professionals should have strong communication with clients to ensure they are meeting their best financial advice. In addition, financial professionals should work in teams and have other financial experts review their overall financial advice and recommendations to clients to help avoid overconfident behavior. 

FN: One of the biggest issues in retirement saving is, well, saving. People tend to save too little and start saving too late. Automatic enrollment provisions arose from the “framing” aspect of behavioral finance (where participation in 401k plans shifted from an “opt-in” decision to an “opt-out”) and took advantage of the behavioral tendency to maintain the status quo. Do you see similar possibilities in newer research that suggest policies plan sponsors can adopt that would further encourage more and earlier savings?
Ricciardi: Before plan sponsors consider implementing new ideas for improving savings based on behavioral finance research, there are still problems then need to be addressed with automatic enrollment. The initial data demonstrates that more employees are now saving for retirement because of automatic enrollment. However, whether this trend maintain itself over the long-term is a major concern. This is especially true for younger workers in their 20s that switch employers several times earlier in their careers. The data shows many of them will cash in their 401k plans early; thus, eliminating the benefit of automatic enrollment. Automatic enrollment policies need to be combined with investor education and meetings with a financial planner to truly improve the financial well-being of employees. Personal finance policies need to treat the entire financial patient and not just one aspect of poor financial literacy such as retirement planning. Automatic enrollment is a wonderful starting point; however, much of American society still needs improved education about all aspects of personal finance issues and the financial planning process.

FN: Speaking about earlier savings, and changing our focus away from corporate retirement plans to individual retirement plans, some parents (especially those who own their own businesses) have created “Child IRA” accounts for their children (see for more details). By immersing younger children in the savings and investing reality of owning their own IRA, how might it better prepare them to avoid the kinds of behavioral SNAFUs identified in your book Financial Behavior?
Ricciardi: The emerging research in financial therapy demonstrates the importance of how our experience with money during the childhood and teenage years will influence individuals for the rest of their adulthood. For instance, negative events with money during our early years create money flashpoints that establish money beliefs that will last with us during our lifetimes. Therefore, if individuals have flashpoints and money beliefs that are negative in their early years this will result in money disorders such as hoarding and compulsive buying in the most severe cases. On the other hand, positive experiences such as learning to save and invest during our childhood years should result in more positive financial behaviors in adulthood. For myself, my dad Vito encouraged me to invest in the stock market at age 12; this taught me to become a saver/investor for my entire life and this also was a major reason why I become a finance professor.

FN: We’ve seen some “dramatic” swings in the market the past view months. While this volatility isn’t necessarily unusual, it does evoke memories of bubbles bursting in years past. Investment bubbles, though seemingly random, happen with surprising regularity. In what ways does research in behavioral finance reveal the causes and life cycles of such bubbles? How can we use techniques derived from behavioral finance to more quickly identify and avoid the onset of these bubbles?
Ricciardi: In the book Financial Behavior, I wrote a chapter on the “The Psychology of Speculation” that reveals the individual biases and group psychology investors experience during a bubble and after a bubble bursts. By understanding these behavioral finance biases investors can learn to avoid the traps and opportunities bubbles present investors. My recommendation is to apply the slogan “buy on fear and sell on greed” and most investors’ do the opposite: they “buy high and sell low.” Two fundamental ways to remove the influence of bubbles and their aftermath for investors is to utilize dollar cost averaging and portfolio rebalancing. Both of these approaches remove the emotional aspects of greed and fear associated with the cycles of bubbles. In addition, tune out the overly negative and positive aspects of financial news that is driven by social media and other news sources.

FN: What message do you feel is important to leave our readers with and why is it important?
Ricciardi: With all my expertise and education, several years ago, I realized the most basic tools in finance should be applied to create wealth. These include topics such as investing for the long-term, developing a financial plan, understanding the different aspects of comprehensive financial planning, applying the principles of time value of money, dollar-cost averaging, mutual funds, diversification, asset allocation, risk tolerance, rebalancing your investment portfolio, and meeting with a financial planner on a yearly basis. If most people were educated with basic proficiency about these subject matter topics; we would all have better financial well-being and emotional health.

FN: Vic… Wow! You presented a boatload of important ideas and practical suggestions. Each one is worth exploring in greater depth. Thank you very much for taking the time to answer our questions. Our readers are no doubt wiser for the experience (and some will certainly be looking closer at your books!).

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Christopher Carosa, CTFA

Christopher Carosa, CTFA

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