Giving Clients What They Need

It’s important for financial advisors to tell clients who are still young that risk-taking isn’t a luxury and that if they put all their money into Treasury bills, they’re going to live on very little in retirement.

Let’s say a client is feeling very sad, and this sadness is influencing her to make a bad investment decision?

Sadness causes people to want to get rid of investments. The advisor can refer to some of the studies in my book that support this. If people are sad and disgusted, and want out or want to do something rash, the advisor can delay it by saying, “Let’s talk about it next time we meet. Let’s give it some time because all of us are rattled by the market today.”

How should an advisor deal with clients who are overconfident about a specific investment they’re intent on making?

Say to them: “If you want to buy emerging markets because it will diversify your portfolio, go ahead. If you want to buy emerging markets because you’re confident they’re sure to go up, stop.” The question to ask whenever you’re buying is, “Who is the idiot on the other side of the trade? Is it possibly Goldman Sachs?”  Also: “What do I know that isn’t known that’s going to give me an advantage relative to the person on the other side?”

TV broadcasters and their Wall Street guests get excited when the market goes up, leading viewers to believe that it must be the time to buy. What should FAs tell clients?

Individual investors tend to extrapolate from recent returns. If the market has been up, they think it will continue to do so; if it’s down, they think it will continue to go down. But we know from systematic studies, including my own, that the relationship is just the opposite and that when investors are bullish, markets are more likely to go down.

What advice should the advisor give in the above TV scenario?

Say: “When you heard someone on television [recommending] to buy such-and-such stock, who do you think was also listening to the same program? Who is taking advantage of this before you have a chance to? It’s possible that some people knew ahead of time that the person was going to say that and positioned themselves to profit from it.”

Please talk about the danger of hindsight.

Hindsight is most pernicious. If the client decides: “Don’t buy stocks on Mondays or those whose names begin with ‘A,’” they’re going to find that in hindsight, that rule worked or didn’t work — and they’ll think they found the rule, when in fact it was luck. Investment performance is so much luck and so little skill. People believe it’s in the opposite proportion. This is something advisors have to educate investors about.

You write that it isn’t wise to buy early into a revolutionary new industry. That’s so counterintuitive!   

Again, the fundamental question is: Who else knows what you know? You have to take into account how good the prospects are for the new industry. It might have wonderful prospects. But in all [probability] everybody knows that, and the price is likely to be too high. Advisors should provide clients with evidence that buying early wasn’t a good idea with either the automobile or the Internet industries.

Still, many investors are looking for a thrill — the thrill of winning, of getting rich. Does the FA simply ignore that?

The advice that we academics provide feels like, “Eat spinach, never taste a cheesecake.” So advisors can say, “How about if we let you have 5 percent of your money to get thrills — just don’t get thrills with money you’ll need for retirement or your kids’ education.” It’s a matter of not prohibiting fun and games altogether, just that you need to have a balanced portfolio. As with a balanced meal, it cannot be all ice cream.

Financial advisors warn against mixing investments with patriotism, you point out. What’s the harm?

We have evidence that people who are [very] patriotic are more likely to restrict their investments to those in their own country, or at least tilt that way. This is taking away the benefits of diversification. It’s possible to persuade clients using logic: “If you want to show your patriotism, there are many ways that are useful and are actually going to do some good. You can volunteer at the Veterans [Administration] or make donations to organizations. But by concentrating your investments in the U.S., you’re not going to add anything to any veteran.”

This approach of trying to keep clients from making mistakes isn’t something that traditionally many, if not most, advisors have used.

If they haven’t, it’s about time!  Some advisors are frustrated hedge fund managers. To them, clients are a nuisance — what they really like to do is pick stocks. Those advisors should quit the business. The role of the advisor is to advise, to guide, to help clients get to their financial goals.

That doesn’t mean you have to be a certified psychiatrist; but you need to find what the client wants, consider whether it’s reasonable to be achieved and show them how to get there — while all along the way, avoiding the problems of their misleading emotions and cognitive errors.

If advisors say, “That’s not for me because I’m a numbers guy,” I tell them what I’d tell a physician who says he doesn’t care about bedside manner:  “You can be a pathologist!”

A final word for FAs?

Financial advisors are very much like the physicians who resist science. Such advisors just want to think about their work as art, when it’s really science. They want to consider themselves painters, when in fact they should be more like technicians and good physicians — people who are on the frontier of financial knowledge but who also have a good bedside manner.

It’s important for advisors to know that their job isn’t just maximizing wealth but maximizing well-being at least as much, if not primarily.