Help clients overcome these 3 common emotional biases

We are experiencing volatility in the markets not seen before in the U.S. It was the fastest bull-to-bear market in history, and daily volatility in March was essentially a record for a month. So we aren’t seeing just a sudden drop, but big ups and downs.

Recovery eventually will follow once the market drops and enters a bear market. However, the time it takes to do so will depend on a lot of different factors. The speed of the drop isn’t always important, but how long the market stays down tends to matter. Recovery could be a long time away for many.

How do you effectively communicate with your clients amid declining markets, high volatility, uncertainty and a global pandemic? One thing I want you to keep in mind is that people have feelings, and it’s important to let your clients express them. Give them permission to have emotions. Let them know it’s not just OK, but normal — especially with the recent market volatility. But it’s also important to remind them to keep their long-term goals in focus when making short-term decisions.

Over the past 10 years, we went through a positive economic cycle after the Great Recession of late 2007-2009. Investors were doing well in the market. Now this has all shifted because of the coronavirus pandemic.

People are worried about lost time and money. Naturally, their feelings are strong, and they might fall into behavioral and emotional biases when making decisions. Watch out for these common biases, which, when combined with high emotions and market volatility, can cause clients to favor short-term payoffs over their long-term goals.

Availability bias

Almost everyone is experiencing some availability bias when it comes to information about coronavirus. If you don’t know someone who is diagnosed with it, then you might think it’s not that big of a deal compared to someone who lives in a community with a high percentage of positive cases.

People naturally take the information that’s available to them, process it and then try to make decisions based on that information. You can't make decisions based on information you don’t have. This bias plays out in the market, too. As new information about productivity, the spread of COVID-19, government spending and unemployment comes out, the market reacts quickly, causing massive upswings and downswings.

Don’t let clients jump to conclusions — or decisions — after reading one article, watching one interview or relying on one source. Make sure that the information that they get or that you provide is from reliable news outlets.

Recency bias

A second behavioral bias noticeable nowadays is recency bias. During the financial crisis of 2007-2009, we saw people move out of the market and into safe investments. But when they stayed out, they ended up missing a 10-year bull market.

Recency bias is when you put more weight on what has happened more recently and project it as a long-term scenario. But remember that we won’t stay in the current situation forever.

Prospect theory 

Prospect theory is a well-known behavioral finance theory that says humans suffer more from losses than they are excited by gains. The average person feels the pain of loss about 2.5 times as much as they do the pleasure from gain.

The loss aversion aspect is accentuated in investors when they experience sudden market drops. The DJIA dropped from nearly 30,000 to below 19,000 within a few weeks — the fastest bull-to-bear market ever.

Many people had set a reference point for their accounts at a number they saw when they logged in during the bull market and saw an all-time high. Just weeks later, they are feeling the pain of the market drop. In their minds, their investment portfolio should be worth what it was when the DJIA was at 29,000.

Help clients reset their reference point or steer the focus from their portfolio balance to another planning point. It’s not a good idea to check balances on a daily basis. Each time the market increases, investors are tempted to set a new reference point, making the fall — and the pain felt from it — harder.

Instead, try leading with planning. Rather than worry about the daily, monthly or yearly value, keep the focus on the planning you’ve done and need to do, and whether you’re still on track. Moving your clients’ attention away from a reference point can help them feel less pain during volatile market cycles.

You should also be mindful about how you communicate to clients displaying these bias tendencies. Not every client experiences loss the same way, and not every client has the same goals or communication style. Some clients are drivers, others are analytical, others are more emotional and others more open to suggestions. Keep in mind these different communication styles when speaking with your clients.

Lastly, remember that people are people. We are emotional — we suffer, we worry, we get scared. Emotions are normal. Despite this, we often try to take the emotions out of personal finance. Give clients permission to be emotional. Personal finance is both personal and emotional.

Keep client emotions in check, though. Watch out for emotional biases that threaten to override decisions and long-term goals. When going through an emotional and difficult time, like we are now with the coronavirus, keep moving forward with your sight set on the end goal.

[More: SECURE Act creates wrinkle for annuities in inherited IRAs]

Jamie Hopkins is director of retirement research for Carson Partners and managing director of Carson Coaching.