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.