Merrill: Using Clients’ Emotions to Build Better Portfolios

Merrill Lynch Wealth Management doesn’t want clients to stuff down or shrug off their emotions about money.  Instead, in a push that gives new meaning to buzzy behavioral finance, the wirehouse is coaxing folks to put their feelings right on the table.

The idea is that, by deeply exploring whatever is personally meaningful to clients, advisors can better recommend solutions that merge psychological needs with monetary goals.

Behavioral finance, a field that blends psychology with economics, has dwelled chiefly on exploring emotions-based biases that cause investors to make bad decisions. Merrill, in contrast, is zeroing in on clients’ total and unique investment personality to reach better outcomes. En route, behavioral change may or may not be in order.

Leading the initiative is Michael Liersch, director of behavioral finance. He has an A.B. in economics from Harvard and a Ph.D. in cognitive psychology — the study of how people think, perceive and learn — from the University of California, San Diego. Liersch’s effort revolves largely around helping advisors learn how to synthesize clients’ qualitative goals, stemming from emotional concerns, and quantitative investment goals to reach desired outcomes.

It’s all part of Merrill’s five-step Goals-Based Wealth Management strategy. Though this was in place when Liersch joined the firm almost three years ago, the brokerage is now codifying clients’ thoughts and feelings about money to build a set of best practices and create a structured process.

The approach uses tools such as a 27-question Investment Personality Assessment, wherein clients write down their feelings about money and investing, and the firm’s Wealth Management Outlook, which determines whether a client has sufficient resources to meet goals.

A member of Merrill’s client solutions and segments team, Leirsch, 37, a native of Stanford, Calif., travels the country training financial advisors in practical applications of behavioral finance. For ultra-high net worth clients and corporate executives with concentrated stock positions, he even participates in client-advisor meetings to foster dialogue and promote collaboration.

A former visiting professor at New York University’s Stern School of Business, Liersch joined Merrill as part of its investment analytics team. He was previously head of behavioral finance at  Barclays Wealth for North and South America as well as research director at Behavioral Research Associates. Earlier, he served as a management consultant with Deloitte Consulting and, in the dot-com era, consulted to startups.

ThinkAdvisor chatted recently with the New York City-based Liersch about how Merrill is redefining, and refining, behavioral finance.

ThinkAdvisor: Why do investors make lots of errors and irrational decisions, known as behavioral biases?

Liersch: I would challenge that notion and say that when investors are behaving in a particular way, typically there’s a cause. Being judgmental by calling it rational or irrational isn’t productive. Focusing on the behavioral biases isn’t the key; focusing on the behavior is.

How do advisors use Merrill’s behavioral finance approach in working with clients?

By finding the underlying concern, need and goal that’s driving a certain set of behaviors, then evaluating whether or not they need to change. Many times they do not. So instead of talking about rationality and irrationality, we’re talking about behavioral change, if needed. This tends to be a more productive conversation that gets clients to better outcomes.

But there’s been a great deal of behavioral finance research showing that people make bad investment decisions based on emotions. Isn’t this something you try to help clients avoid?

How is it possible for an investor to completely divorce themselves from emotion? We’re all human. The idea of not being human isn’t a possibility. Instead, we say that we want you to bring your humanity, your emotions, to the table. We want to talk about them to understand why you feel the way you do. At the end of the day, what’s perceived to be emotional may be completely sensible based on the client’s experiences and situation. Investing in a way that’s human can help clients stay invested and get better outcomes than if they try to be robotic investors, something we know isn’t possible.

But advisors don’t usually go into financial services because they are “feelings”- oriented. Generally, they’re oriented to numbers and sales. So, are you trying to coach FAs to key into what makes clients tick?

In a conversation about what matters most, many people, including advisors, clients and the media, bundle the investment selection — the quantitative — with the qualitative: thoughts and feelings. Many even talk about quantitative concepts and qualitative concepts in the same sentence. For example, the client may say, “I want a large return, and I never want to be down.” “Large return” is the quantitative piece; “never want to be down” — thoughts and feelings — is the qualitative piece. The idea is to separate those two [initially].

What’s a real-life scenario?

In our recent research on sustaining family wealth, 23% of wealthy individuals said they could distribute 10% or more from their investment portfolio and have that portfolio last forever. Here we see a disconnect between the qualitative concern, or desire to sustain family wealth, and the quantitative — what can actually get you there. That disconnect is the opportunity to focus on.

Some advisors say that discussing personal needs and anxieties with clients makes them feel like therapists – and that’s not what they “signed up” for. How can they get into the mode?

The focus is the process, not the notion of being a therapist. It’s preferable to have a structured process for clients to write down — codify — things like their primary intent and priorities, and evaluate whether their goals are feasible. The next step is to establish a set of expectations around the tradeoffs they may need to make, and then move to the [appropriate] investment selection, followed by managing the investments ongoing.

Can behavioral finance help advisors to a more profitable practice?

A structured, goals-based approach is a win-win both for the client and the advisor. By starting with what’s personally meaningful to the client, advisors can more effectively utilize the most relevant and broadest set of products, solutions and services to [meet investment goals]. What else is the upside for advisors?

A clear, structured process where everyone can communicate about data, and thoughts and feelings, can create efficiencies and help advisors have more capacity to serve clients in a differentiating way. It can lead to opportunities to serve clients more broadly or perhaps even serve a greater number of clients by increasing referrals.

Do you educate Merrill advisors about behavioral-finance investor biases, such as overconfidence, herd instinct and loss aversion, among others?

We certainly do. But instead of concentrating on, say, overconfidence as an error, we focus on what the opportunities are when you’re very confident versus the drawbacks. Underconfidence can also drive a certain set of behaviors. The idea is to collaborate on what confidence creates to make sure it’s driving toward the right set of decisions.

What’s a specific example?

Women tend to say they know less about investing than the average investor; men tend to say they know more. If a female client [part of a couple] expresses this — even if it’s not true — it can cause her to lean out of the conversation, when in fact she should be leaning in. It helps if the advisor says, “Even though you may feel you don’t know a lot, you certainly know enough to participate. But if you feel that you don’t, there’s a seat open for you at the table; and we want you here.” So rather than focusing on the bias, we’re focusing on the client’s perspective and what will get them to productively engage in the best way.

Another bias is called the “bird-in-bush paradox.” What’s that, and where are the opportunities?