How to save wealthy investors from themselves

Emotion can undo the best-laid financial plans. Not surprisingly, wealthy investors say they want help controlling such self-defeating impulses. They could use the help. It turns out that wealthy individuals are just as susceptible as the rest of the investing world to buying high and selling low, according to a new study from Barclay's Wealth. What's more, they are just as apt to trade too frequently and hurt their overall returns because of it. Forty-one percent of the over 2000 individuals surveyed for the report said they wished they had more self-control when it comes to their finances. “There's a strong awareness of their own lack of discipline,” said Greg Davies, head of behavioral finance and quantitative finance at Barclays Wealth. “People are looking for mechanisms to help them achieve more self-control.” Classical finance theory makes a basic assumption about investors: They behave rationally all the time. The panic during the financial crisis is just the latest evidence that that is not so. However rational and well-thought out a financial plan might be, it is useless if abandoned when the markets get volatile. Indeed, studies by Barclays and others show that emotional trading can cost investors up to 20% in returns over the long term. Mr. Davies said financial advisers need to do more to help their clients avoid the kinds of emotion-driven mistakes that can sink a solid financial plan. “To date, the financial industry hasn't provided much support with this. Telling people they're likely to behave in a certain way isn't enough to get them to change that behavior,” Mr. Davies said. “Investors need practical things they can do with their portfolios.” One option advisers take: advising clients to invest in illiquid assets that can't be easily bought and sold. Mr. Davies likens the approach to Ulysses, who had his crew tie him to the mast so he wouldn't heed the deadly songs of the Sirens. But the Barclays' behavioral finance expert believes such an approach can cause a lot of stress for investors. Instead, he suggests giving advisers greater discretion over a client's assets. He also advises using hedges or insurance to smoothen the ride, even though clients may be sacrificing some long-term gain. “If giving away 1% on returns stops an investor from selling at the bottom of 2008, it's worth it,” Mr. Davies said. In general, the wealthy investors surveyed for the report were prone to three kinds of behavior that can damage their financial health. The first is the natural human impulse to buy high and sell low. A second common problem is investors tend to do too much with too little. Mr. Davies said that investors will sit on large sums of cash and then take too much risk and usually trade far too often with the small amounts they are willing to invest. “Always do less than you think you should, in terms of trading,” Mr. Davies said. Lastly, investors focus too much on the short term. The psychological impact of investment losses is about twice as much as the pleasure derived from investment gains, Mr. Davies said. While there is nothing wrong with worrying about the downside, the bias towards loss aversion can adversely affect decision-making, particularly in times of stress. “We should all be long-term investors,” Mr. Davies said, “but we have much shorter emotional timelines.” Barclays Wealth now is encouraging its clients to undergo a financial personality assessment that dives deeper into a client's emotional makeup than traditional financial planning does. Based on the results of the assessments, wealth advisers can take practical steps that help their clients avoid some of the damage that irrational behavior can cause. Mr. Davies suggests that wealth management firms need to go beyond just training their advisers. They need to build the capabilities into their IT platforms and their product selections. “The industry is just waking up to the idea that behavioral finance can be practically employed with investors,” said Mr. Davies.