Erik Johnson, marketing optimization manager at Morningstar's Behavioral Insights Team, chats with Ravi Samalad about the importance of behavioral coaching for advisers while dealing with clients.
Client's goals keep changing. How do advisers incorporate all these changes in the plan?
I think there should be some flexibility. As a financial adviser, you can only help clients meet those needs. Some goals are fixed. For instance, retirement. Other goals like buying a home children’s education and the kind of lifestyle they want to lead are evolving. Advisers need to adapt and change the plan to fulfil clients evolving needs.
How can advisers help clients stay focused on their goals when markets are volatile?
It is natural for investors to react emotionally when markets turn volatile. You have to prepare clients to handle volatility in advance. No matter how good our intentions are or how well versed we are in investing we're always going to have some kind of a natural emotional reaction to volatility.
A key insight from behavioral science is just that our will power is very limited, and it is often not a good strategy for trying to achieve goals. Our will power is going to break down. When market volatility hits, investors will not have the strongest will power. They are going to make rash decisions to fix the problem in the short term, ignoring the long term. Thus, setting the expectation right in the beginning is important.
One strategy that we've employed and tested with some clients is we ask clients to write a letter to their future self while making a financial plan. They write this letter to that future person, which might be panicking when the market is volatile. Through this, you are making it clear that this is something that is probably going to happen in the future. This helps remind investors and bring them down from that emotional state to stick to their long-term plans.
Is it practically possible to remove emotions from investing?
I don’t think you can ever fully remove emotions from investing. Just be conscious of the role emotions play and build systems around your decision making so they don’t have an outsized impact. We should also prepare ourselves for times when emotions are going to override our rational decision making.
You should know your weak spots. For instance, if you are the type of person that gets excited about trendy investment, you want to have a framework in place for when that time comes to push back against your worst tendencies. Take contrarian point of view. Have some sort of tool ready for yourself to say let me think about it factually. Try to find out the other explanation. if it is such a good investment, why is someone else selling it.
So that gets you out of that emotional state and help you think a little rationally and looking at other opinions beyond kind of the decision you may have emotionally already made.
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How can investors avoid herd mentality?
I think that’s another example of kind of being conscious and building in those frameworks. Herd mentality is a common behavior in investing and it's one of the things I that trips people up the most. People feel safety in numbers. But investing is the opposite of a lot of things in life.
Warren Buffet has a famous quote of “Be fearful when others are greedy and greedy when others are fearful.” Even though you might have some sort of emotional temptation use that as a red flag. If a lot of people are flocking to something that seems too good to be true.
There is going to tons information confirming why you should follow the crowd. So you've got to take it upon yourself thinking why should I not follow the crowd and build that contrarian case. In investing, nothing is ever universal. Sometimes the crowd is right and sometimes they are wrong.
Investors today are inundated with information overload from different sources. How can they avoid noise and stick to their goals?
Yes, we have probably way more information than we would ever need as investors. Every phone that we get comes with pre-loaded with stock app for example. That could be a challenge for advisers when clients are training to be constantly paying attention to the market to stay updated. But we know through research that that’s usually not a winning strategy because we tend to overreact to information in the short term while missing a lot of long-term information.
As an adviser, you can't stop people from looking at too much information. As behavioral scientists, we generally think you don’t want to block somebody from doing something. You should always give your clients the freedom to seek whatever information they want. What we can do is to set a good expectation or maybe a healthy habit on what that information is. If you are meeting and making plans with a client, you can give them the freedom and say that this is kind of you are welcome to check whatever information you want and you are welcome to ask questions any time. But I am going to send you all the information you need on a regular basis maybe that’s weekly email, a monthly newsletter, or a quarterly update. But you can set that expectation and saying that I'll take care of the information for you in these intervals that I think is best to help you succeeding as investor.
Some people acquire sudden wealth through lottery or inheritance. We have seen many examples of people splurging that money and end up getting broke. So how do advisers deal with such kind of situation?
If you have a good long-term relationship with the client, it shouldn’t be really any different than any other type of income. If you have a clear long-term goal, then that money should go to support that cause. You should look at the progress on those goals and see how this windfall can support them.
In some ways, the psychology may work with us in this particular scenario. There is a research which shows that people may handle the windfall more responsibly to secure their lives.
There’s a concept called mental accounting. And that’s where we put money in these psychological buckets that are little vague in different ways rather than making rational calculation of how much money goes where and that’s why having real clear goal set and direction for where money is going is helpful with these scenarios. Because then if you get this big windfall of money then you can very easily separate it into those buckets of goals wherever those are.
How can advisers learn more about behavioral coaching?
We have a Behavioral Science guide for advisers. It is available as free download here. It is a short book that summarizes a lot of key concepts about Behavioral Science as it applies to financial advising and also has a number of ready-to-go toolkits, worksheets things that you can use directly with clients.
