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Merrill: Using Clients’ Emotions to Build Better Portfolios

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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?

It relates to the idea of loss aversion — specifically, letting go of an item that someone values. It’s another name for the asymmetry between people’s willingness to sell an item they value and the market clearing price. That is, the minimum selling price may be higher than the maximum purchase price. This effect presumably exists because the individual is adding a premium for “giving up” — or losing — the item.

Can advisors use this to help investors?

It’s an opportunity to collaborate with the client to identify a set of investments aligned with personally meaningful goals. That way, “giving up” the investment may be less likely because the investor has not only assigned value to it but to the approach itself. This may help them stay the course in both bear and bull markets. Behavioral research suggests that sticking with a well-designed strategy is a key to positive investment outcomes.

Other research indicates that men’s and women’s brains are physiologically different and that therefore the genders think differently, which affects their attitudes toward investing. Where do you stand?

Individuals are individuals, and basing client-advisor interaction on assumptions and generalizations isn’t productive. Having clients [discuss] what’s on their mind is the most productive approach. In one of your studies, you found that about half the women were “very concerned” they would outlive their money. I’ve seen other research suggesting that even quite wealthy women are worried about becoming “bag ladies.” What’s behind this, and how should advisors handle it?

If the individual spends a lot, that fear of running out of money can be well founded, even when someone has a lot of money. So it’s not necessarily about the amount of resources they have but [money] in the context of spending patterns, the way they’re investing, the time horizon and risks they’re comfortable taking.

What tack should an advisor take in that case?

 Evaluating the feasibility of the client’s goal in today’s dollars can be critical to either validate or invalidate that concern of outliving their assets. Find out what’s on the client’s mind when they’re thinking about running out of money. Get it down on paper. Evaluate the feasibility of the goal in a structured way. Talk about time horizon and what’s actually needed in terms of dollar amounts. Will their spending needs grow or decrease? Is the client comfortable spending down principal?

What’s critical for advisors to know when working with couples who are at loggerheads? For example, one wants to invest aggressively; the other, conservatively.

It’s common for couples to disagree on many things. Disagreement is normal and is actually extremely productive. We know in behavioral finance that healthy levels of conflict lead to better decisions. Setting the right framework can empower couples to articulate their true thoughts and feelings, and discuss what’s going to get them where they want to go.

What’s Step No. 1 for advisors in dealing with this situation?

Starting with similarities and then moving to differences can be very critical. If the couple has a common perspective, such as placing a priority on family, a discussion around their thoughts and feelings about that — i.e., coming together on a topic — can be a great starting point. Then move to a difference: lifestyle, for instance. How much would they like to spend in retirement?

Background plays a big role, doesn’t it? If one spouse comes from comfortable means and the other doesn’t, that informs their attitudes.

You’ve hit the nail on the head! It [depends] on the individual’s experiences, and also who holds the wealth. There are many contextual differences that drive a lot of what we perceive to be gender differences or age differences.

Speaking of age, what do millennials want from their advisors?

There’s a misconception that millennials have a different set of values from older generations, particularly their parents. In our research, the majority of millennials identified with their parents’ values — from investing to philanthropy and [beyond]. They wanted one-on-one engagement, just like any other human being, and to understand in their terms and at their life stage, what will constitute good investment decision-making. This means approaching the client with an open mind and hearing directly from them what they’re trying to accomplish. But you surveyed 18- to 35-year-old millennials with $1 million or more in investable assets. Can the findings be extrapolated to millennials who don’t have that much money to invest?

Yes. Millennials are human beings, and that creates a common thread about how people like to interact with others. This is what behavioral finance is all about: acknowledging that we all have thoughts and feelings. Also, you can extrapolate [their wanting] that one-on-one interconnection and that having someone who can talk to them about their needs is very, very important.

Your study and those of others, suggest that millennials are skeptical, even suspicious, about the financial services industry. What challenge does that bring to advisors?

The notion of trust is critical to any client interaction. Our research with millennials shows that the financial crisis didn’t set a lower trust level; it reconfirmed the low level of trust they already had in institutions around investing. This challenge highlights the need for advisors to connect with millennials on a one-on-one basis and in their language. They need the advisor to educate them about what investing can and cannot offer, the pros and cons of a set of decisions, the framework in which they can think about their future, how investing can help them reach their goals — and what the risks are, because transparency helps build trust.

It’s my understanding that Millennials aren’t too interested in meeting with their financial advisors face-to-face. They prefer to communicate by email and texting.

Our research shows that millennials certainly do like face-to-face meetings. But electronic technology can be an enhancement as a way to facilitate communication. For example, using a Web-based tool — versus traditional paper-based statements — Millennials can provide advisors with data about their wealth. So when [the advisor] meets with the client, they’ve already evaluated the assets and the context in which the accounts are set up. That way, the advisor is [all prepared] to provide advice and guidance around the total picture.

What new research do you plan to conduct?

It focuses on the theme of creating a set of decision-making best practices and connecting them with the wealth structures and strategies that will get clients to [desired outcomes]. That’s a huge theme in our business and what a lot of our clients are asking for: setting the framework for how they can look at opportunities and options and then selecting what resonates most.

What’s the behavioral finance team’s ultimate goal?

The exciting part is collecting a set of best practices about how advisors can help individuals, families and even institutional investors based on their thoughts and feelings about what they’re trying to accomplish. The goal is to build a structured process and an investment strategy.

Related on ThinkAdvisor:

Getting Clients to Share Their Secrets, and Their Assets

Ex-Schwab, Fidelity Exec: Be Careful Whom You Trust

Ben Inker: Don’t Outlive Your Money