Did you ever wish you had the power to truly understand the minds of your clients? To see the world through their eyes and know their concerns and anxieties? Now, thanks to research in behavioral finance, you can.
For many years, academics have studied how people make decisions, particularly financial ones. They found people are not always the rational beings hypothesized by efficient-market theorists. Instead, their decisions are sometimes affected by preferences, biases, and perspectives that are “nonrational.” Such nonrational behaviors can undermine an investor’s long-term success. At a minimum, they arouse feelings of pain and anxiety that can make investing an unpleasant experience. They can also cause investors to take actions inconsistent with achieving long-term financial goals.
When you understand these nonrational tendencies and learn how to deal with them more effectively, you can add significant value to your client relationships. A good time to help clients deal with their nonrational tendencies is during periodic client meetings, when clients are focused on investment issues and may be more receptive to your suggestions. You can interact with them face to face, gauge their reactions, and deal directly with any questions they might have. Here are some ideas to help your clients overcome their nonrational investment behavior:
When to Meet?
What Your Peers Are Reading
The first issue to address is how often to have client meetings. Many financial advisors meet with clients quarterly and review in detail the performance of their portfolios. This practice grew out of the quarterly performance reviews investment consultants traditionally conduct with institutional clients. It is questionable whether this approach makes sense with individual investors, as it sends a message that short-term performance is important. If we want clients to focus on long-term goals, we should reinforce that message by conducting performance-oriented client meetings less frequently. Yet many advisors have found frequent contact with clients helps strengthen their client relationships. Therefore, you need to find a focus for meetings other than simply performance.
Focus on Personal Goals
What is a relevant benchmark for a client whose personal financial goal is to accumulate $1 million in investable assets in 10 years? To reach this goal, the annual rate of return is more relevant than a benchmark, correct? To measure the performance of a client’s portfolio against any other benchmark is inviting the client to use inappropriate “anchors” to judge investment success. Clients experience anxiety if they see their investments performing below a certain benchmark and may be tempted to take action to fix the situation. Often such action is unnecessary and could even be seriously counterproductive. As the client’s advisor, you may use a variety of tools and benchmarks to assess the performance of the portfolio or its components. However, the focus of your client meetings should be progress toward the client’s goal, not judging “winners” and “losers” based on index-related benchmarks. Turn your “performance reviews” into “progress reviews.”
The “State of Wealth”
Progress toward a client’s personal goals should be judged in terms of his or her overall state of wealth. Since a client’s long-term goals are expressed in terms of total net worth at a particular point in time, attention should be firmly fixed on that target. Yet client meetings often involve a detailed review of every investment in a client’s portfolio. As an investment professional, you should spend a good deal of time focusing on the components of the client’s portfolio without involving the client. At any given time, some investments in the portfolio will not be performing well, particularly as asset classes, styles, sectors, and industries go in and out of favor. This is why you construct diversified portfolios.
When you walk clients through a review of each investment, you invite them to do two things you do not want them to do. The first is to experience the symptoms of loss aversion for every investment not beating the market or performing up to the anchor your client may use to judge investment success. The second is more subtle. Clients take their cue from you. If you consistently walk them through a review of every investment in their portfolios, you are saying this is important. If, on the other hand, you teach them to focus on the big picture–growth of their overall net worth–most will follow your lead.
How Long Is Your Time Frame?
Remember your clients are prone to use very short time horizons in assessing their portfolios. Help them overcome this tendency by constantly refocusing their attention on their long-term goals. Time is an important dimension to discuss in order to alleviate the symptoms of loss aversion. Moderate ups and downs in the short term are of little relevance if a client’s time horizon is 10 to 15 years. Clients do not usually think in those terms unless you help them. If your meetings focus on short-term performance or recent market trends, you are telling the client these are important issues. Is this the message you want to send? Use the meetings to listen, build trust, and make sure the client is still within his or her comfort zone. Focus on things you want the client to focus on.
Use Meetings to Educate
Periodic meetings are a great opportunity to educate clients and reinforce the view you want them to have. Make sure your clients look at investing as a probabilistic venture. Help them understand that not every investment will pay off. The key is to make solid progress toward their goals.
Help your clients distinguish between bad decisions and bad outcomes. The fact that not every investment works out as hoped does not mean the decision to invest was bad. Investing is inherently risky. The key is to be right enough of the time so your clients reach their goals. Clients who grasp this idea will be more satisfied investors.