Strategies for dealing with irrational clients

Asset allocation decisions beyond what risk-tolerance assessments might suggest can help advisers address individual behavioral finance issues

Jul 26, 2016 @ 3:49 pm

By Liz Skinner

Financial advisers can use strategies based on behavioral finance research to better handle difficult clients, sometimes even adjusting portfolios to tamp down irrational behavior.

A client who may be having a problem sticking to the investment plan designed for their needs, especially during periods of market distress, may instead require a best "practical" asset allocation, said John Longo, chief investment officer of Beacon Trust, who has written papers on using behavioral finance at advisory firms.

For instance, a client who is uncomfortable with the existing allocation may need more conservative investments than their risk tolerance would ordinarily suggest, at least until there is a correction, he said. Afterward, the adviser can suggest a return to a more normalized portfolio.

“Clients need to have a plan that they can stick to,” Mr. Longo said.

Len Hayduchok, president of Dedicated Financial Services, said clients often don't know how they'll really react to a substantial decline.

(More: The challenge of keeping clients away from shiny new investing trends)

With about 5% of his client base, he has had to make portfolio changes after the client called a couple of times upset about the overall market.

“It comes down to valuing and empathizing with people and wanting what's best for them,” Mr. Hayduchok said. “Often that overshadows what's best for clients financially.”

In addition to portfolio changes, advisers should work with clients before markets decline to identify potential problem investors and educate them.

Mr. Hayduchok lets clients know that significant stock market fluctuations are par for the course.

“So when a bad outcome does happen, and it inevitably will, I go back and remind them that this was a possibility,” he said.

Trying to figure out why a client continues to snub their advisers' recommendations or panics with routine volatility, though, takes a lot of time, according to Rick Kahler, president of Kahler Financial Group.

“About 90% of financial decisions are made emotionally; these clients are following their wiring precisely,” he said. “The question is whether advisers want to spend the time and have the tools to get at the root of their issue.”

(More: Advisers need to get real with clients about what reasonable investment returns look like)

If difficult clients are deemed worthy of the effort, advisers need to learn more about them to discern who are most likely to freak out during volatile market periods.

One way to get at this is to ask clients how they reacted during previous periods of market downturns, Mr. Longo said.

If they went to cash at the end of 2008 as the market was nearing a decade low-point, that's not a good sign.

Mr. Kahler said advisers should talk to clients in advance about what bad scenarios could happen, and set clear expectations.

“Set a client up for the best chance of success in the market,” he said.

Of course, another option is to decide not to deal with problematic clients.

Some advisers, such as Donna Skeels Cygan of Sage Future Financial, run their advisory businesses in a manner that allows them to avoid the most challenging clients.

“I have a small lifestyle practice on purpose,” Ms. Cygan said. “I don't have to work with difficult clients.”

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