Advisors Are Really ‘Financial Physicians,’ Says Statman: Five Good Questions

"Good advisors are managers of both wealth and well-being ... [as] good physicians ...manage both health and well-being," says behavioral-finance guru Meir Statman.

Meir Statman, the Glenn Klimek Professor of Finance at the Leavey School of Business, Santa Clara University, and a visiting professor at Tilburg University in the Netherlands, is a leading expert on behavioral finance. His latest book, What Investors Really Want, has recently been published by McGraw-Hill, and he has a regular blog on the topic.

Meir Statman,  Leavey School of BusinessFor the second interview in my Five Good Question series, I spoke with him about how advisors can better manage their clients' financial health, portfolios and other matters.

Q. In your book, you note that most advisors tend to see investing as essentially utilitarian and that doing so is a mistake.  What does that mean, and why is it a mistake?

A. High returns with low risk are utilitarian benefits of investments, and some advisors focus on these. They construct for their clients retirement portfolios with asset allocations such that clients are likely to receive the highest returns for the level of risk they are willing to take.

But think of a prospect who says to an advisor, "I abhor the damage done by tobacco and want no stocks of tobacco companies in my portfolio." That prospect cares about the expressive benefits of her investments, expressing herself as a socially responsible investor, and the emotional benefits of staying true to her values.

Some advisors are inclined to say: "My role is to get you the highest returns for the level of risk with is right for you. I'll include tobacco stocks in your portfolio because they yield high returns, and you can spend these high returns on anti-smoking campaigns." It is fair to guess that this prospect would not turn into a client.

Expressive and emotional benefits extend much beyond social responsibility. Some investors want the expressive and emotional benefits of "playing" the stock market, even if trading costs diminish returns and their utilitarian benefits. Some want the status of hedge funds and private equity.

Think of the pride of investors who were offered shares of Facebook by Goldman Sachs. And some hate taxes so much that they would rather lose with tax-free investments than gain with taxable investments.

Q. You make the point that our role as advisors is to be "financial physicians."  What might that look like?

A. Advisors often describe themselves as "wealth managers," but good advisors are managers of both wealth and well-being, in that they are similar to good physicians who manage both health and well-being. 

This includes asking questions about goals and concerns, listening carefully before jumping to asset allocation, empathizing with clients who are distressed because of a disables child or impending divorce, educating about financial markets and human behavior, prescribing portfolios and other components of financial plans, and following up on treatment.

Q.You also explain that investors want education.  What are some ways that good advisors can provide education effectively?

Clients benefit from education about investments and financial markets and education about investor behavior. There are many myths about investments, such as that market timing is easy.

Advisors should counter myths by the tools of science, providing scientific evidence that market timers are more likely to hurt themselves than help themselves. There are many behavioral pitfalls, such as overconfidence.

Advisors should provide the scientific evidence about the harmful effects of overconfidence and other cognitive errors and emotions. Elements of education include face-to-face meetings, brief emails or newsletters explaining cognitive errors and emotions, and "client appreciation" events featuring experts on investments and investment behavior.

Q. You also show that investors want advice.  What do you mean by that and how is that different from what advisors typically provide?

A. Advisors always provide advice, but the focus of that advice is sometimes restricted to investments and conversations are more likely to be about what goes on at the Fed rather than what goes on in clients' lives and the lives of their families.

Yet advisors can serve clients better by focusing on their lives and the lives of their families. Such focus also promotes trust and loyalty in clients.

Q. Finally, you stress that investors want protection.  How can good advisors offer protection to their clients?

A. Good advisors can protect clients from others, explaining why they should be wary of people who offer investments which are too good to be true. And they should protect clients from themselves, explaining how fear and exuberance mislead investors and creating structures to protect investors from themselves.

For example, advisors can set a rule by which implementation of changes to portfolios are delayed by a week or month so clients can "cool off" and make better choices. 

(The photo of Meir Statman is courtesy of McGraw-Hill.)

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