From the March 2009 issue of Boomer Market Advisor • Subscribe!

March 1, 2009

Behavioral economics, your boomer clients - and you

Little surprise; we're our own worst enemy. An oft-repeated (and startling) statistic from research firm Dalbar Inc. found that while the S&P 500 returned 12.2 percent in the roughly 20 years from 1984 through 2002, the average equity mutual fund investor earned a paltry 2.6 percent.

Market timing, performance chasing - blame what you will. But if the investing public behaves this badly in an unprecedented bull market, well ... you can only imagine the havoc they'll reap in the current bear market.

"One of the assumptions economists make is that individuals are fully rational," explains Dr. Daniel Kahneman, a psychology professor at Princeton University. "If you want an easy introduction to behavioral economics, it's economics without making the assumption that [investors] are fully rational or that they have perfect self-control."

Kahneman knows of what he speaks. After identifying the concept with partner Amos Tversky in a landmark 1979 paper, he continued to develop it over the next 20 years. Kahneman was eventually awarded the Nobel Prize in economics, specifically for his work with behavioral economics. Even more significantly, as a psychologist, he was the first non-economist to be awarded the prize, reinforcing the link between the two disciplines.

So after a Nobel Prize did the attendant publicity and hype mean advisors and their boomer clients finally got the message? We teamed with Matt Thornhill and The Boomer Project to find out.

Calm, cool rational decision making (and an awareness of debilitating investing biases) is what's needed now more than ever. How are you handling the current crisis? What are you telling your boomer clients? What moves are they making, both positive and negative, to ensure their plans for retirement don't disappear as easily as their investment returns? Thornhill surveyed readers to answer these questions - and much, much more.

"Readers tell us the current economy is having a profound impact on the finances of their baby boomer clients," says Thornhill (again, little surprise). "Readers report that boomers are feeling the impact, have suffered significant losses, and are modifying their behavior because of current conditions. Despite the panic, however, most contend that their boomer clients may have short-term pessimism about the economy, but all agree that boomers remain unfailingly optimistic about the longer term future."

Good to know. It's our job to ensure the optimism holds in the weeks and months (years?) ahead. Here are the results.

1. Behavioral economics is a concept my clients:

Behavioral Economics 1

We're pleased to see that 68 percent of respondents said their clients have at least heard of the concept. Still, with only 5 percent fully understanding the tenets of behavioral economics - prospect theory, loss aversion, mental accounting and overconfidence - and more than a third having never heard of it, it's clear there's still a long way to go in saving clients from themselves. We hope (and suspect) that it's been explained to some in that last third of respondents, only under a different name.

2. How would you describe the attitude or mindset of your typical baby boomer client?

Behavioral Economics 2

Can't blame them for the negative vibes. Thornhill reports that two in five readers say their boomer clients' portfolios have lost 30 percent or more. Nearly half say their clients have lost 10 percent to 39 percent. Only one in seven say their clients' losses average less than 10 percent. The dangers of retiring in a down-market are well-documented. Losses sustained in the initial years can kill a portfolio, from which a client most likely will never recover. With the best being a 10-percent loss, we know we have our work cut out for us.

3. How often are you using a "stay the course" message with your clients?

  • Not at all -- 4%
  • Sometimes -- 34%
  • Often -- 62%

With daily headlines of fixed income retirees losing dividend income because of yet another bank insolvency, stay the course is an increasingly tough message to sell. Reasonable and prudent modifications to the boomer portfolio are necessary, to be sure. But as we previously noted, if boomers kill their returns due to emotional and irrational decision-making in up-markets, we can only imagine what will happen in the current down-market. If your clients are properly diversified, it's the best you can hope for. If you feel market timing and performance chasing are better alternatives, we wish you the best of luck.

4. In the past six months I have:

Behavioral Economics 3

What does all this mean? Opportunity (and a big one at that). As author and industry speaker Mitch Anthony recently said, "It's the greatest bear market for gaining new clients." Sticking to the fundamentals with a prudent eye on the portfolio will do right by your boomer clients, which means they'll do right by you in the form of referrals and wallet share. John Rafal, president of Connecticut-based Essex Financial Services, told us in our December 2008 issue, "At the end of the day, we're working hard, but we feel we'll be aptly rewarded with new clients. In the past three months, we've lost three, but probably gained 60."

No reason you can't as well.

5. What percentage of your clients are moving to some sort of guaranteed insurance product?

Behavioral Economics 4

Too many boomer advisors still do not like annuities - plain and simple. The compensation structure too often doesn't fit with their business model, and pricing and suitability issues continue to reign. Couple this with the fact that so many living benefits are now "in the money,"

and carriers are rethinking their guaranteed product strategies altogether. None-the-less, the downside protection/ upside potential for the use of annuities (when appropriate) is playing out before our eyes. As any good wholesaler will tell you, it gives investors the confidence they need to jump back in to the market. And confidence is something in short supply of late.

6. My "stay the course" message to clients is:

  • Resonating -- 38%
  • Accepted with skepticism -- 56%
  • Rejected -- 2%
  • No longer applies -- 4%

More than 90 percent of respondents said clients are - at the very least - accepting the message, albeit with skepticism. Fine; boomers are a skeptical bunch, far more than previous generations, so we won't hold it against them. If skepticism is the worst you're hearing from clients, you're doing fine. They'll thank you for it when we come out of this (and we will come out of this) and probably recommend you to others for the cool and decisive advice you offered.

7. What is the most common piece of advice you find yourself repeating to your baby boomer clients today?

Behavioral Economics 5

See the previous answer. All five responses are tenants of financial planning since before anyone can remember. It might be "different" this time, but the strategies for dealing with it are not. More than anything else, context is required and a longer-term, macro view of the crisis will do more to calm boomer clients than anything else. To be sure, erratic responses to short-term fluctuations won't do any better. No, there's not much time left for boomer "re-accumulation" (we shudder at the term) but let's ensure our clients don't make a bad situation worse.

8. How would you describe the typical allocation of your baby boomer client's assets?

Behavioral Economics 6

We're surprised at this one, but it's consistent with your stay the course message. More than two-thirds of respondents report a heavier emphasis in equities, despite the fact that bonds are now posting equity-like returns. Good to know, which means they're well-positioned for the recovery. The only red flag is that boomer clients haven't bothered to reallocate at all. Again, we're not necessarily calling for a complete portfolio revamp, but prudent monitoring of the portfolio is just as much of a responsibility for clients as advisors, especially now. If you're clients haven't come to see you, you've got more problems than you know.

9. The proportion of your typical baby boomer client's assets now in cash and cash equivalents is:

Behavioral Economics 7

Only 13 percent of respondents have 40 percent or more in cash (OK, 40 percent's a significant number, but again, context). Sitting on a mountain of cash if you're a company? Good. Sitting on a mountain of cash if you're an investor? Not so good. But with the unprecedented nature of what's happening, we won't second-guess your advice to clients. We're just wary of where that leaves their market position for the recovery, and no doubt believe it's something you're closely monitoring.

10. How concerned are your typical baby boomer clients about the current economic environment?

  • 5 (Very concerned) -- 43%
  • 4 -- 45%
  • 3 -- 12%
  • 2 -- 0%
  • 1 (Not at all concerned) -- 0%

Top two numbers = 88%
Mean = 4.3

Questions No. 10 and No. 11 suggest that readers don't have the same level of concern over the current economic environment as do their clients, according to Thornhill - which could be a good thing - they've seen it all and know the economy will rebound. Or, are our readers by nature more optimistic? Communication and attitude (obviously) are key. If you're optimistic about the future, be sure the message is getting through to your clients. Clich?, we know, but a positive attitude will go a long way in seeing them through it.

11. How concerned are you about the current economic environment?

  • 5 (Very concerned) -- 22%
  • 4 -- 33%
  • 3 -- 32%
  • 2 -- 12%
  • 1 (Not at all concerned) -- 1%

Top two numbers = 55%
Mean = 3.6

As motivational speaker and industry expert Mark Zinder notes, the fact that you can cut through the noise (and there's lots of it) is your value proposition to your clients. If the Fed cuts interest rates, can you explain how they, specifically, will be affected? Do you go to government and forecasting Web sites to read reports directly, so you can get an advanced peak before it hits the morning papers? If digesting, understanding and reiterating current events is something that helps you sleep at night, make sure your clients are getting it as well.

12. I think the economic recovery will become apparent in:

Behavioral Economics 8

It's 2010 by a slight margin. Not what we want to hear, but not all that surprised. Preparing for the worst and hoping for the best is certainly sound advice. The timeline fits if the downturn began with the September 2008 Wall Street collapse, but we'll stick with the National Bureau of Economic Research's original December 2007 point of origin. We also suggest you re-read our interview with Putnam Investment head Bob Reynolds from"10 questions for ..." in our January 2009 issue. Putnam's research found downturns typically last an average of 14 months. If we been in it now for that long, a recovery might occur (as Reynolds believes) much sooner than most people think. Optimistic? Yeah, but we'll take it.

13. When the recovery does occur, the economy will:

  • Come roaring back -- 9%
  • Be characterized by slow and steady growth -- 71%
  • Not return to previous levels in the foreseeable future -- 19%

If you really do believe it's different this time (and honestly, how could you not), then the fundamental restructuring of our financial system will take time, to say the least. One economist compared it to Russia after the fall of the Soviet Union. We won't go that far, but hopes for a wave of economic resurgence are dim. Slow and steady are the order of the day; two words that - implemented sooner - could have saved us from much of the pain we now feel.

14. How are your baby boomer clients responding to the current economic situation?

  • Changing their budget or spending habits -- 84%
  • Delaying retirement -- 71%
  • Decreasing their systematic withdrawals -- 36%
  • Decreasing or ending charitable contributions -- 30%
  • Looking for part-time or full-time work -- 25%
  • OTHER: Examples include looking for more conservative/stable investments, not making any changes, showing signs of panic/stress -- 12%

Boomers are the ultimate consumers, so we know the first response to question No. 14 has to hurt. We were initially skeptical, and wondered if they were really changing their behavior. But one look at the consumer discretionary sector confirms the view. A simple formula; less coming in means less to spend. Increase income or decrease consumption. Not a whole lot of room to maneuver of the former, so it will have to be the latter. The second response, delaying retirement, is a no-brainer, if nothing more than for the reasons outlined in question No. 2.

15. How optimistic are your baby boomer clients about the future economic situation?

Behavioral Economics 9

Readers weren't kidding when they voted for 2010 and beyond in question No. 12. Beyond by at least five years. Given Japan's lost decade in the 1990s, and the similar moves our government is making in response to the crisis, it isn't at all unrealistic to believe 2014 is the best we can hope for. Not that it's something we personally believe ... we're just saying. And clearly it is something readers believe. You're the experts (as much as we'd really like to discount this last one).

16. If the Dow dropped 700 points in one day, what would you counsel your clients to do?

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It isn't exactly landing a plane in the Hudson, but we should all be proud of your response to question No. 16. If we can't be consistent with TARP funds or government policy, at least we can be consistent with our answers to this survey. Stay-the-course once again resonates, and our reader base is calm and collected enough to know not to panic. Our readers average 17 years of advisory experience, so you've seen it before (granted, not to this extent). It's a twist on the old adage, but relevant; what goes down must come up. It hasn't resonated a whole lot lately, but give it time.

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