Q: I've had some frustrating conversations with clients recently—trying to get them back in the market. Very few are taking my advice, even though they seem to know that staying on the sidelines is a mistake. What's going on, and how can I get them “unstuck”?
A: Problems like this have to do with how people make decisions. Behavioral finance uses the term “inappropriate extrapolation”--and insights about it can help you understand your clients and respond to them more effectively.
To make any decision, human beings create a mental picture of the future. That's what “expectations” are--the ability to take information from the past and present, and project it into the future. Unlike most animals, human beings can project far into the future; as a result, we are able to “plan ahead.” Unfortunately, we usually don't create these future images terribly well. Instead of making a thoughtful assessment of what's likely to happen in the future, we typically picture the future as just a continuation of the recent past.
That's how investors get stuck: they create a negative image of the future based on bad experiences from the recent past. As a result, your clients need two mental operations to get unstuck. First, they have to create a positive, attractive mental image of the future. This helps them feel like taking action to get a reward--what we call motivation. Second, they must decide if this future picture is likely to happen in real life--it's the difference between being hopeful and being confident.
Think of it this way: When you get on a plane for a long trip, are you hopeful you'll land, or confident you'll travel safely to your destination? Put yourself in that position for a moment: do you notice that there's a big difference between hopefulness and confidence? The difference comes down to how real the future event of landing is: you feel confident only when that future event feels real. That's why some people cancel their flight after they hear about a crash somewhere--a bad experience in the past powerfully affects how we think about the future.
How can you apply this to your work with clients? Essentially, you want to learn how to install a positive picture of the future that the client feels is likely to happen in reality. Start by explaining the mechanisms of the market and illustrating visually how those mechanisms work. Many investors have only the vaguest understanding of the cause-effect dynamics in the markets. Instead of making thoughtful, well-informed decisions, they react to their perception of patterns and trends. Market “mechanisms” are those cause-effect relationships that equip financial professionals to invest rationally instead of speculating randomly.
By looking at how market mechanisms operated in both the recent and more distant past, you teach your clients how to think more strategically about the markets. This allows them to build a more vivid mental picture of market behaviors in the future. Make sure you explain market mechanisms visually as well as verbally: use charts and graphs that show market behaviors over time. Whenever possible, connect your investment recommendations to a clear explanation of the mechanism that is involved.
Second, provide an adequate level of detail about the mechanisms you explain. There's a commonly held myth that clients aren't interested in hearing about the markets. So, many financial advisors gloss over important information and rush to their proposal without creating a case the client understands. But clients are interested in understanding the mechanisms that drive their investment results--as long as your explanation is clearly illustrated and easy to understand.
Finally, you have to deliver your message with personal conviction--that you fully believe the future will look the way you anticipate. Your clients need to borrow your conviction and clarity about the future. That's how they'll build their sense of confidence in the decisions you're asking them to make. Take a stand on what you believe about the future, and add the courage of your own convictions to the clarity of your explanation.
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