Understanding Client Behavior Rational or Irrational?

Abstract

This chapter examines the rational and irrational decisions made by people based on the concept of bounded rationality, examining how bounded rationality can be used to study financial decision making of households. Cognitive mistakes happen when costs are decoupled from consumption in people's minds. Many telecommunications companies, health clubs, and other service providers tend to take advantage of this bias by offering customers a much higher flat fee for an amount of service that a consumer is unlikely to be able to fully consumer. People try to make rational decisions within the limitations of their cognitive abilities and biases. Humans are ecologically rational because they made optimized decisions within the constraints of their information-processing abilities. Good financial planners often practice these virtues as part of the comprehensive financial planning process by educating their clients about the risks and returns of securities and asset classes, sharing their own experience in the markets, and by periodically reviewing the financial situations of their clients.

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