A lot has been discussed about behavioural finance and how advisors can benefit it from during client interactions. But what are advisors actually doing about it? Now you can put the most powerful principles of behavioural finance to work for your practice and your clients. A whitepaper published by Wells Fargo Advantage Funds, a US based advisory firm, shows five client case studies where each one represents a specific type of investor and how advisors can deal with them.
Client 1: Fixated on the past
These clients tend to be focused on one dramatic event in the past and are unwilling or unable to see beyond it—making their investment decisions overly conservative. This client anticipates a repeat negative experience and expresses counterpoints regardless of the advisor’s evidence to the contrary. For example, clients who felt so threatened by the economic downturn of 2008 may have completely missed the record highs in the later years.
What should you do?
- Prepare clients for the potential range of events that can arise, instead of allowing them to fixate on worst-case scenarios.
- Predetermine actions that will be taken during and following high impact events.
- Set realistic expectations—preparing ahead for negative-impact events can help clients cope and can increase the likelihood they adhere to the plan in place.
Client 2: Paralyzed by uncertainty
These investors are fearful of the uncertainty that is an inherent characteristic of the markets. This fear prevents them from moving their portfolios in any direction. These clients see inaction as smart, safe and prudent and become visibly anxious when you shift the conversation towards taking action. For example, clients who feel better doing nothing rather than trying something new are doing nothing to help their portfolios.
What should you do?
Use triggers to automate future decision-making, relieving the investor of painful uncertainties that prevent them from moving forward. Predetermine allocations so your client is not forced to second-guess the decision later.
Client 3: Resistant to change
Some investors have fixed their expectations on market characteristics that no longer apply. They continue to stay fixated on historical allocations that may have been completely appropriate in the past. These investors may boast about their past investment successes, without regard for the current market environment.
What should you do?
- Goals versus timing. Encourage clients to think about investment decisions relative to their goals instead of “Is it a good time to invest?”
- The test bucket. Designate a comfortable bucket of money that will be used to test the waters. The goal is to minimize the fear of loss by allocating the money for this purpose and removing the connection to funding retirement. This will move the emphasis from trying to time the right entry point into the market to getting back on track in a comfortable way.
- Speak with clients about how they can better accomplish their goals by factoring reality into their decisions. Look at how investment decisions affect goals—including the investment decision to sit in cash for too long.
Client 4: Prone to overreacting
Some investors tend to overreact to new information, especially when that information is outside the scope of their past experiences. This client often shows a pattern of impulsive decision-making and may request action be taken before considering important information presented.
What should you do?
The over-reactor needs a reality check that starts with self-examination:
- Ask the mirror: Challenge clients to take a good look at them and examine whether their reasons for making certain decisions matched up well with what actually happened. Ask, “And how did that work out for you?”
- Check your reflexes: Encourage investors to consider the possibility that their decisions should be based not on involuntary reflexes but on a rational evaluation of real historical data. This is precisely the kind of counsel they seek from you, their advisor.
Client 5: Attached to cash
These clients are severely overweight in cash and refuse to change their perception and they frequently overstate the importance of having cash available. They may rationalize their behaviour by saying, “At least I didn’t lose money.”
What should you do?
Help these clients gradually introduce change:
- Rethink risk: Instead of the risk of loss, encourage clients to think of the potential growth they are losing. Avoid focusing them on investment gains; instead focus them on the opportunity cost of what they may lose if they don’t invest.
- Find the exits. Before they invest, encourage clients to set a trigger for when they will sell. An exit strategy can bring peace of mind.
- Focus on the goal. Help clients keep perspective by focusing on the long term outcome.
Fear is the investor’s worst enemy. As an advisor, you need to remind clients of the realistic opportunities that exist in the markets at any given moment. These case studies will help you to handle client’s investment fear more effectively. By bringing these ideas into your conversations, you may find that your clients are ready for a more substantial discussion about opportunity and achieving their goals.
SOURCE: CAFEMUTUAL.COM