Advisers who can get into the minds of clients and consider their biases when shaping their portfolios will achieve better financial outcomes because those clients will be more likely to stick with the plan, two behavioral finance experts said.
Clients don't come into their adviser's office with the intention of lying about their financial acumen or goals. But they come in “putting on their game face,” and they tell their adviser about the investor they want to be, not the one they are, Jay Mooreland, founder and owner of The Emotional Investor, said at the Financial Planning Association's national conference Oct. 20.
“Behavioral finance is about helping clients reach their goals despite the biases they have, not cursing them for going against what a rational person would do,” he said.
Mr. Mooreland, whose company provides education and financial tools for investors with respect to psychology's influence on investment decisions, has developed a series of questions meant to uncover the traits and tendencies that influence how people think and act. Advisers can use the answers to create portfolios that make sense for those particular investors, he said.
For instance, ask clients whether they would choose getting a $10,000 certain gain, or having a 25% chance of gaining $42,000 (75% chance of gaining nothing)? If they choose the guaranteed $10,000, then they are averse to losses, and advisers should consider strategies with guarantees, dollar-cost averaging and investments in diversified, non-correlated assets, he said.
Being proactive with clients is better than waiting to see how they react to the first market stresses or other events, Mr. Mooreland told about 200 advisers who packed into a conference room to hear his presentation.
“If you wait to deal with behavioral responses, it's too late. They are already overestimating the risk,” he said. “And when the market is going up and the dopamine kicks up, they will want to buy and they are underestimating the risk.”
Create a “pre-commitment plan” with clients stating the intention of buying low and selling high, Mr. Mooreland said.
“Because when the market goes down and there's a bunch of fear, they're not going to want to buy, even though they said that's what they were waiting for,” he said.
The plan is not foolproof because the clients still can decide not to follow through on the purchase or sale, “but it increases the odds that they'll do the right thing,” Mr. Mooreland said.
Carol Craigie, a psychologist turned financial planner, said advisers should present financial plans and investment decisions in a way that encourages the client to follow through with action instead of reverting to procrastination.
Explain the decisions in a way that helps the client understand how it will improve their lives — and describe it repeatedly, Ms. Craigie, founder of of Financial Fitness Clubs of America, a financial education and advice firm, told FPA conference attendees Oct. 20.
“The more people hear about something, the more comfortable they are and like it,” she said.