November 13, 2013

5 Reasons Clients Make Bad Investing Decisions

Behavioral finance plays a big role in any successful client relationship

Curian never ceases to stop trying to solve problems that advisors face, and  managing client expectations is a big focus. 

“One of the things I’ve found is that advisors believe investors only focus on performance and returns,” Keith Johnson, vice president of practice management at Denver-based managed account provider Curian Capital, says. “We know from behavioral finance that’s not always the case. The level of service, combined with the level of performance is what drives expectations.”

And that, he adds, is “where advisors are missing the boat.”

Behavioral finance is something he “loves,” he says, because it tells us so much about how investors form expectations. The tenets of behavioral finance that are particularity relevant in forming clients' often-mistaken expectations are:

1) Anchoring — Investors set arbitrary reasons for continuing to hold a stock, even as the price tanks. “They’ll hold onto X, even if there is no good reason to hold onto X,” Johnson explains.

2) Too many choices, too many voices — With choices, investors and advisors have to have a clear direction of what to do. With voices, the listen to friends, co-workers, relatives and of course the media, the latter of which have an outsize influence on decision-making. “Everyone seems to have an uncle in the business,” he quips.

3) Runaway expectations — Clients tend to overemphasize recent trends, which often are not the best way to analyze investments. “They have to be taught to really examine the fundamentals of any investment.”

4). Fear of regret — People hate to be wrong, especially when they perceive everyone else to be right, so they’ll jump in on an investment trend for that reason, which results in them buying at the wrong time and selling at the wrong time.

5). Fear of loss — Studies show that people feel the sting of a loss twice as much as the euphoria of a gain. That’s why portfolio protection is now paramount, Johnson says.

"It’s incredibly important for advisors to carefully frame questions in a way to focus more on discovering client expectations, and even before that, they need to ensure they actually ask questions," he concludes. "Too often advisors are so focused on getting their own point across, they sometimes fail to listen.”

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Check out 2 Best Practices for Managing Client Expectations on ThinkAdvisor.

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