Why cash is co much more than a number

A look at the two sides of cash, how advisors can tune into clients’ emotional perspective of this asset class, and the opportunity that this expanded understanding holds. 

The paradox of cash

Cash is simple. Cash is also complex. The paradox stems from the dual nature of cash as a medium of exchange as well as a store of value.

In its role in transactions, cash is so logical and mathematical that parents often use coins to teach addition and subtraction to their children. Cash in its role as a store of value, however, is where the complexity arises. For financial advisors, this duality has important consequences, and understanding how it affects client behavior can improve outcomes for clients and advisors alike.

Approaching wealth management with logic, many financial advisors view cash primarily in its transactional role. Even with today’s higher rates, cash is often viewed as a transitory portfolio asset that sits idle after a trade, awaiting deployment into some other investment. The goal is to keep this cash to a minimum, and there’s no emotional connection to the cash.

The emotional side of cash

In contrast, clients often think about cash differently, guided heavily by emotion. As the growing field of behavioral finance continues to reveal, a number of psychological factors and biases can influence behavior and cause people to act irrationally when it comes to money. Behavioral finance is especially helpful in understanding how clients feel about and deal with cash – including why clients don’t always share their views with their advisors. Understanding what motivates clients and drives their cash decisions may position advisors to better, more holistically serve clients, which, in turn, may lead to stronger and longer-lasting client relationships. 

Understanding clients' cash motivations

At Flourish, we’ve made several insights regarding how clients feel about their cash – and how those feelings translate into financial decisions, especially decisions that seem illogical to advisors. The following are some highlights and the behavioral finance factors that can help explain them. 

Clients often think of cash as separate from investments. As a result of the services Flourish offers and the transactions that flow through our platform, we have seen that many clients hold far more cash than their advisors think. In fact, the average Flourish Cash† household holds more than $250,000 in cash outside of their investment portfolio.

The reason clients keep their advisor in the dark about this cash stems largely from two behavioral finance concepts: mental accounting and emotion gap. Mental accounting is the tendency to allocate money for specific purposes into buckets. Many people don’t put cash into their mental bucket for investing, but rather keep it separate and “theirs” instead of handing it over to their advisor. In addition, they may not share this decision with their advisor because of the so-called emotion gap, or decision-making based on strong feelings of fear or anxiety. Clients may not want to admit that they keep a larger-than-recommended amount of cash for fear of potential judgment, either of the fact that they have the cash or the reasons why they are holding it.

Clients often recognize that it is not completely rational, but the emotional benefits – from feeling that extra cash will protect them if their investments fail, to maintaining a sense of control over their spending – take precedence. 
 
Advisor takeaway: First, assume that wealthy clients are likely to have more cash than you are aware of – even if you think clients have told you everything about their holdings. Second, create space to understand their behavior without judgment or attempts to immediately change behavior. Digging down to the root of their behavior will help you understand the client and their needs while attempting to persuade them to change their behavior by appeals to reason could be perceived as aggressive. Finally, consider how to bring cash into the conversation and offer alternative ways for clients to manage their cash that emphasizes trust and continues to position you as a support in all areas of their financial lives..
 
Cash represents security and safety. As research shows, cash increases a sense of happiness, which is primarily the result of the sense of security that it offers. The more cash one has at their disposal, the more secure they feel about their life and outlook. Researchers at the University of Cambridge, as well as at the University of Michigan, have found that one’s emotional framework surrounding money develops in early childhood, eventually shaping how people decide between alternatives that involve risk and uncertainty. This is central to prospect theory, developed by behavioral economics pioneer Daniel Kahneman, who won the Nobel Prize in economics in 2002, and his academic partner psychologist Amos Tversky. Prospect theory suggests that people are loss averse, which means they experience losses with greater pain than the joy they experience from equivalent gains. As a result, individuals are generally less inclined to take risks that could lead to a loss. When it comes to cash, clients will opt to maintain the sense of happiness and security a reserve of cash offers rather than risking loss. The amount needed to provide this sense of security varies person to person. For some, three months’ living expenses is sufficient, while others prefer to keep much higher amounts of cash liquid, just in case. 
 
Advisor takeaway: Cash should be a frequent topic of discussion and advisors should know how much cash each client wants to have easily accessible. If clients don’t have enough, high-yield cash accounts with tools such as recurring deposits can increase interest earnings while automating the savings process, an approach that makes goals easier to attain. For clients who have the amount they need to feel secure, check in to ensure that it’s earning the highest rate possible. And for clients who have more than they require emotionally, have a sensitive conversation to understand why they are holding that much cash, before discussing how it may impact their long-term goals.

Clients are resistant to changing their cash behaviors. Similar to prospect theory, status quo bias is a preference for maintaining the current situation and resisting change. The tendency toward loss aversion that makes people reluctant to take risks also fuels status quo bias. The latter phenomenon – essentially, inertia – is based on Kahneman and Tversky’s observation that people feel greater regret for bad outcomes that result from taking new actions than for bad consequences resulting from inaction. Even when offered a higher-paying alternative for their cash, for example, many people keep their money where it is. According to an analysis by The Wall Street Journal of S&P Global Market Intelligence data, savers miss out on billions each quarter by leaving their money in the five largest U.S. banks rather than moving it to the five highest-yielding savings accounts. 
 
Advisor takeaway: Since making a change in client cash behavior would require overcoming two behavioral finance hurdles – loss aversion and status quo bias – as well as a change in mental accounting, basing cash suggestions on purely dollars-and-cents considerations likely will go only so far. Advisors are more likely to find success in coming up with solutions that address emotional challenges more positively.

The challenge of client inertia is real. If you discover that your clients are holding a lot of cash, recommending that it be immediately invested, or even transferred to your custodian to purchase a money market fund – which often feels very different to clients than an account they can easily access without the involvement of their advisor – can often be met with resistance. Advisors are more likely to find success with solutions that take the emotional aspects of cash into consideration. Encouraging clients to shift their cash into an account paying a competitive rate – all while making it easy for them by prefilling applications – can ease the path to earning more, eliminating a hurdle to action by preemptively kicking off the process on behalf of clients and demonstrating how the cash can be used to help them work toward their goals.

How Flourish Cash can help

Money is rational – and also emotional. When advisors view cash as purely rational and skip out on the emotional component, then they miss out on a valuable opportunity to deepen both the level of their advice and the relationship with the client. Rather than fight the forces of behavioral finance that motivate client actions, Flourish Cash^† enables advisors to use those forces to improve client satisfaction and results by giving clients precisely what they want – safety, control, ease of accessibility and use, and judgment-free transactional autonomy in high-yielding, FDIC-insured^Ω accounts that are separate from their investments.

Cash may be complex, but for advisors and their clients, Flourish can make cash a lot less complicated.

About Flourish

Flourish builds technology that empowers financial advisors, improves financial lives and retirement outcomes, and delivers new and innovative investment options to advisors. Today, the Flourish platform is used by more than 700 wealth management firms representing more than $1.5 trillion in assets under management. Flourish is wholly-owned by MassMutual. For more information, visit www.flourish.com.