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Behavioral Finance: How to Help Clients Avoid Bad Investments

By Suresh Sadagopan, CFP, India

Do we change the fundamental course of our lives based on what is happening in our environment? We may do some course correction, but fundamental changes are unlikely and we most likely persist with what we have believed in all along.

Unfortunately, in the case of our financial lives, we tend to act differently to our detriment. First of all, most people do not have any overarching plan at all. Those who have decided on goals and the way they are going to go about achieving the goals are prone to quickly undoing their strategy, due to some hot investment idea. On the face of it, it appears to be right. Normally, such changes should be taken into consideration – not acted upon. Financial planners know that it is not always in their best interest to act on financial news because news items are not actionable information. We cannot alter our lives at every turn based on news that filters in.

Secondly, we tend to believe what is happening at present and discount long-term trends. People get carried away by the latest frenzy. Housing, gold, technology stocks etc. have had periods of frenzy in the past couple of decades. Looking back, these things look foolish. But, at the peak of the frenzy, it would have been a herculean task to wean a client away from those investments.

The upshot is that our clients sometimes unravel a carefully pieced portfolio to indulge in a trendy investment.  But, weaving in and out of assets without thinking through their suitability in the big scheme of things will only end up in disappointment.

Financial Information from the Media – What can we do?

Clients normally get their information from the media – be it TV, internet, social media, print media etc.  We can do nothing about the access to information our clients have. However, we can do the following –

  1. Communicate with clients about the latest investment theme that is trending. It is best to analyze the latest “idea” from all angles and share both the pluses and minuses of the investment theme or idea. Then, it is best to put in perspective whether this investment theme is really a worthwhile option at all and why it may or may not fit the client’s requirements. For this to be effective, the planner must have this conversation with the client before the client makes up their own mind. The benefit of talking to clients early on is that any investment information they receive after the conversation, they will evaluate against what the planner has already told them.
  2. Clients also have to understand that one’s goals in life can be achieved with simple instruments. There is no need to look at arcane investments or keep looking for the next winner investment. A properly created portfolio with a clearly articulated asset allocation strategy is his/her best bet for achieving goals. Communicating this is difficult, as most clients will find it difficult to understand the value in certain portions of the portfolio, like debt, when there are hot assets giving thrice their returns. But communicating this and convincing them about this is crucial.
  3. It is necessary to keep communicating with clients constantly to keep them from getting carried away by the hype. We need to keep reiterating the big picture and the fact that we have already done allocations to take care of their goals & other provisions. Once they are assured that their goals will be met, they may not be as keen to unbundle the portfolio and invest in the newfangled theme.

Credible Information Sources

Rather than rely on the wisdom of the talking heads on TV, the rabble rousing media or the freewheeling discussions on the net, planners should redirect clients towards primary sources of information like the statistical data that government or other sources that don’t have vested interests such as Morningstar.

But, primary information itself may not hold their interest or even make too much sense to them. The planner should emphasize that he/she is interpreting the information for the client and presenting the implications for their easy use. This assurance should put them at ease as they know that the interpretations that are flowing to them are indeed right for them.

Building Consumer Trust is Everything 

Ultimately, it’s the trust that prevails. Though many clients may be itching to go for the hot button investment, the planner’s view will prevail, if enough trust has been built.

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