Even shrewd, calm Warren Buffet can be trapped by his emotional need to buy only bargain stocks. He was looking hard at Wal-Mart in the 1990s when the stock was attractively priced—but he took a relatively small position hoping for a fraction of a point dip before committing to a full position. The stock only accelerated, however, and he later estimated that Berkshire Hathaway missed out in a very big way—a potential $8 billion profit evaporated because he wasn’t emotionally satisfied to make the deal at the right time.

Buffet understood the problem in others and later, in himself. As he told an interviewer, “success in investing doesn’t correlate with IQ … what you need is the temperament to control the urges that get other people into trouble in investing.”

In managing the client relationship, advisors face the challenge of explaining the short-term pain for the long-term gain. Clients often stumble with an investment or financial plan without fully acknowledging to their advisor what they view as the potential downsides. They cancel meetings, or postpone implementation until “the time is right.” Sure, they may have valid reasons—a major business deal they must close to focus, the wedding of a child, etc.—but often what’s stopping them are emotional roadblocks, not big events on their calendars.
With the right probing questions, advisors gain a better understanding of those barricades and help clients leap over the short-term emotional detours. “The advisor has to help them focus on the long-term gain and help spin the short-term pain as kind of this heroic act that gets them to that goal,” notes Richard Peterson, co-founder of MarketPsych LLC, which trains financial professionals to better understand the emotional drives in their clients’ and their own decision making.  

Emotional Return On Investment
Emotional return on investment or EROI—the hidden motivations behind an investor’s actions—is the term Peterson and his colleague Frank F. Murtha, who has a Ph.D. in counseling psychology, use in the their book “Market Psych: How to Manage Fear and Build Your Investor Identity.” If a client’s financial success requires patience and discipline, but his emotional needs call for excitement and risk, the advisor will constantly struggle to keep the client on the plan. When emotional needs and financial needs align, both the client and advisor are more likely to be successful and the implementation more time efficient.

The challenge for advisors is that emotional needs trump financial needs. The authors maintain that clients (and therefore their advisors) need to understand what someone gains besides money when investments perform well—and what they lose besides assets when they fail. They list common EROI that serve as hidden motivators: safety, excitement, pride, freedom, fulfillment, accomplishment, social desirability, tranquility, influence, power, attention and happiness.

It’s these drivers, the authors explain, that cause investors to do irrational things or take one of these factors to extremes.

Confronting a Client’s EROI
In Peterson’s training sessions with advisors, he provides a script to help them deal with emotional clients. Part of the instruction teaches advisors how to demonstrate to the client that they truly empathize with and understand them. The next step is to reframe the situation through a careful conversation that shows a different perspective to better understand the true nature of the challenge. This technique involves not abruptly stopping their line of reasoning or disagreeing with them, but gradually bringing them around to a better plan of action.

The script has five parts that follow the acronym IDEAS:

Inquire. Ask the client questions about how they are at that moment and what they’re experiencing. The client might say something like, “I’m really excited about precious metals. Silver’s been taking off.”

Describe. The right way to respond, according to Peterson, is to say, “Well, yes. I can hear the excitement in your voice. Silver’s really been taking off for the last month. I think it’s up 20%.” You describe what the client has told you, so he knows you understand the facts.

Empathize (or Ease). The client might say, “I’ve wanted to get into it a long time.” The advisor replies in a way to show he also understands the emotions of the moment: “I can see why you’ve wanted to get into it. It’s really been taking off and there are a lot of people talking about it now.”

Additional perspective. The advisor would go on to expand the view of the situation by saying, “Given your current portfolio alignment, it looks like we have about 2% in precious metals. Let’s consider how silver would fit into our long-term plan.” The advisor then suggests delaying a silver buy for a month and looking for a period when people start to get scared, because these things always do happen and the price trends differently.

Rather than acting that day, postponing the decision to buy with a good reason provides an additional perspective to get the client beyond the emotions of the present.

Solutions. The advisor then indentifies the next steps, such as, “Our plan is to increase your allocation to 1% the next time we see a real rout in silver prices. Next time we see a 5% or a 10% correction, we’ll up your exposure by 1%.”

IDEAS helps advisors reaffirm the client relationship while reinforcing their value by suggesting better alternative actions.

Business Owners Who Won’t Plan
Outside of investing strategy, clients with family businesses present many of the top challenges advisors confront—it’s a case where career, emotional and family dynamics are usually completely entwined. When a business owner needs to select a successor and the son-in-law is better suited for the job than the daughter or son who also wants the position, the decision will play out not only in the office but at family gatherings.

The advisor needs to have a conversation that shows he understands the owner’s position and empathizes.

Through a direct, confidential conversation, the advisor can often press forward on issues that are too hard for other family members to address. Once the owner believes that the advisor and the rest of the team will address his concerns, everyone can consider the strategic options for succession. (Of course, if the best path is a sell-off, the team will need to bring him to that option after first illustrating the consequences of other solutions.)

Client Investing Traps
Peterson and Murtha identify several traps or patterns that trip clients when investing, even with an advisor’s guidance. They include:

Win/Lose Mentality. With instant access to daily market numbers, it’s easy for clients to fall into a binary “Did I win or lose today?” scenario. The emotional up-and-down swings with the market reports, increasing stress and drawing too much focus on the short-term.

Down-with-the-Ship Syndrome. The pain of losing is felt more strongly than the joy of winning, so some investors will evade selling a down investment to avoid emotional discomfort. Some have an unrealistic sense of loyalty to their investments. Others believe they can eventually retrieve their sunk costs if the stock gains. While an investor dithers, the opportunity cost of doing nothing increases.

Anchoring. Investors who use an inappropriate reference point or benchmark, such as the day portfolio values reached their highest point, are acknowledging neither the daily dynamics nor long-term trends in true values.

Mean Reversion Bias. The concept of mean reversion bias, or more simply the law of averages, is sound, but some investors misapply it. Market prices do tend to reach a reasonable value if temporarily under- or over-priced. Some clients’ patience runs out long before reaching the mean.

For advanced planning teams and advisors to affluent families, some of the biggest barriers to implementation of financial and investing plans are found not in the nature of the assets but the nature of the client. The solution can be found in strong client relationships and a true understanding of their emotional needs—and the right way to respond.