Turning on a dime to solve the ‘investor problem’

The best time to start thinking about investor behavior was 25 years ago. The second best time is now. The truth is that great advisers with good tools were unable to prevent far too many investors from making emotional decisions amid the March 2020 market volatility. As an industry, we need to focus on solving the investor problem, and move beyond focusing so much on the investment problem. 

Even before the pandemic, the investment-first approach to advice left many people behind: Dalbar Inc. found that from 1999 to 2019, the S&P 500 averaged 6.06% a year, but the average equity fund investor earned a return of only 4.25%.

Covid-19 only made things worse. The constant barrage of headlines about soaring unemployment, supply shortages and lockdowns triggered a wave of panic selling. People went from bragging about their retirement portfolios on Twitter to jockeying for rolls of toilet paper. Forward-looking advisers did their best to talk their clients down from selling in a panic, but many needed additional reinforcement to address the “What About Bob” barrage of investors’ concerns.

The good news: Financial advisers have plenty of experience adapting imperfect tools to serve greater needs. Look at financial planning. It is invaluable for helping investors understand and articulate their financial needs over a period of time.

Let’s look at risk. Modern advisers talk about risk tolerance and capacity assessments as a way to figure out what makes our clients tick and match them with the right investments. But what about behavioral composure? Clients may understand markets, have the ability to take risks and feel comfortable about their financial planning goals. But in the heat of the moment, investors often feel that “this time,” it’s different. That emotion creates absolute behavioral panic.  

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As an industry, we know that a better grasp on investor behavior would have prevented more heartache last year, and during the mortgage crisis, the dot-com bubble and other market crises. So what are we going to do about it? Alex Murguia, CEO of retirement research and managing director at McLean Asset Management, shared some advice during the worst of the pandemic that still resonates with me.

It’s impossible to go back and do things differently, he said. Acknowledging our current circumstances, it can be helpful to ask, “What is the best thing I can do now?”

Alex was talking about personal finance, but his advice should be the top priority for wealthtech providers and advisers alike. We’re building tools to better understand investor needs and anticipate behavior. What is the next best thing you, as an adviser, can do for your clients?

• Stay current on behavioral finance. "The Behavioral Investor" by Daniel Crosby [Harriman House, 2018] is a great read for understanding what drives client decisions. Listen to podcasts and learn from people who study humans as emotional beings and apply those insights in your practice.
• Quantify what you can. Our research shows that knee-jerk investor decisions can incur losses of anywhere from 1.17% to 5.35% annually. What would that mean to your clients? Show the opportunity cost of bad moves in terms of deferred home renovations, retirement destinations sliding out of reach or family vacations missed.
• Get your clients ready for the next emergency. Investors have lived through multiple market crashes and catastrophes. They want your help to build financial resiliency into their lives — and they need your judgment to find the line between foresight and fear.

We know that investors want to be understood.  The best financial advice, as it turns out, is what clients will actually stick to over the long haul. And we can’t get there without solutions designed to cultivate real understanding.

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Eric Clarke is the founder and CEO of Orion.