Investment decisions can be found embedded in portfolios, retirement/pension planning, corpus in escrows, equity type insurance products (e.g. variable annuities, etc.). Every decision we make for such purposes contain both rational and emotional inputs. This discussion surrounds the understanding of the forces of reason and emotion, their interactions and the implications on investment outcomes from suboptimal inputs and input mismatches.
I believe that the power of external influences such as media, friends and the new “social-Media” sights boils down to the emotional fear of failure; we want what the highest level of success in our investing endeavors with the least amount of risk or loss, but we have a tremendous amount of uncertainty as how to get achieve that goal. That fear of failure, coupled with the thousands of investment options and variables available out there, leaves the common investor feeling very
vulnerable. When we are vulnerable, as the text says, we “herd” or go with the group and lean on that which is familiar and those which we feel are more capable than ourselves for help and support.
This is the perfect setup for the media. They earn our trust by coming into our living rooms, onto our computers and our blackberry’s all day long spouting numbers and information that astound us. Therefore we trust that their opinions and advice must be correct or at the very least better than our own. When the news and television shows tell us that folks investing in housing are getting returns in 25 to 50% range; we want returns in the 25 to 50% range and do not want to be left behind the herd. So, we buy a fixer upper. When Suzie Orman tells us to sell bonds, Suzie has her own show and she is so likable, so she must know what she is talking about. The evening news reports that the rest of “the herd” is selling their bonds now, so we sell our bonds as well.
forget is that the media’s goal is to gain the highest level of traffic so that they can sell advertising. To do this they may exaggerate, inflate or even adjust information to fit their needs. These calculated exaggerations are what cause the hype and emotions that lead us to make faulty decisions. Although we have steadfastly held to our retirement plan for this long…perhaps Suzie really is right and I am wrong…
Unfortunately, there does not seem to be any relief in sight. Instead, it seems that the more complex that investment decisions become and the greater our constant exposure is to media and other sources of investment information, the more overwhelmed we become by the process and the more likely we are to turn to the wrong sources for help.
I think advisors have a huge responsibility to be a good listener, educator, and counselor for their clients. Many clients need a place where they can feel safe and protected from outside
noise and distractions. They need an advisor that they can truly trust and understand. If the clients do not feel this way 100% of the time, then many decisions that may be made, and questions that may be asked will be skewed. Advisors should spend hours and hours reviewing a clients history, goals, objectives, time horizons and risk tolerance. Although this is a discussion for another day, I think almost every advisor has a different bias and view point on how to address ones risk tolerance.
A good way to be prepared would to show graphs and data of past performance of different investments and asset classes. A “make-believe” tracking system in a visual manner would help the client to understand the different types of risk/reward trade-offs. I know many CFP’s at Vanguard have been discussing with clients the bond market. The CFP may bring up a good point to a client that wants to move 100% out of bonds into high dividend yielding stock funds. The advisor will ask why, and they will say
that what everything in the media is telling them to do. They have no clue how much more risk they may be taking on. They think that is more safe, and do not realize that the worst year in history stocks lost almost 50% and the worst year in bonds lost under 10%. Clients must be educated about what they are investing in, before they make drastic changes to there portfolio, that can and would have huge implications down the road. The advisor must try to understand if the clients are more visual, listener, or hands on. The advisor should be skilled enough to develop this data and information that is customized for each client.
I think I financial advisor should focus on positive scenarios with clients to show how being proactive has helped other people. However, if a client is stubborn to change their misconceived belief, a scenario of the poor decision might help to show them the error. One example I can think of is a client wanting to take an
early withdrawal of a retirement account to pay-off debt. With this scenario it would be important to tell the client how they may continue accumulating debt after they pay off the original debt. So they may be in the same position and have less retirement funds. An example would be taking an early withdrawal from their 401k to payoff all their credit card debt. They would be hit with taxes and a 10% penalty. So they would end up paying what equated to 40% interest for that money. They you could offer a different solution of looking closer how they can budget to save differently. They may have to let go of some wants, but they would be proactive with money they are making and not drawing from investments they made in the past for the future.