I came across an interesting article today in the InvestmentNews on “How to save wealthy investors from themselves.” The article lays out a solid argument that most investors, including those who work with an investment advisor, tend to make poor financial decisions.
IN interviewed a representative of Barclays Wealth who observed that while the financial services industry is aware of the high cost of their client’s emotional trading (a 20% under performance over a long term) the industry hadn’t found ways to help clients implement discipline in the face of market volatility.
Some of the options? Put clients in illiquid assets that can’t easily be sold and use hedging strategies or insurance products to lessen volatility, even if the cost of those products will sacrifice some long-term gain. Another is to evaluate the financial personality of the client to determine their emotional makeup.
While all these options can work, I hate to see clients pay unnecessary fees or give up potential returns to modify hurtful behaviors. Strategies like this are akin to putting a band aid on the problem when a better long-term solution is to attempt to get at the core of the difficult emotions.
Of course, going down this path is the road less traveled for most advisors. It means developing competencies, structures, and processes that help a client understand and modify their behaviors. We use a combination of communication skills like motivational interviewing and appreciative inquiry, collaborative engagements with counselors, hard-wired structures like written Investment Policy Statements that address a process when the client wants a sudden asset allocation change, and lower volatility asset allocations.
Our experience is that these methods work. During the bottom of the recent stock market crash in 2009 about 50% of our clients reached out to us expressing a desire to significantly reduce or eliminate their equity exposure. In the end, 77% of our clients made no changes to their allocations. Of the 23% that did, all but two made a small 10 to 20% reduction to equities. Only two clients made significant reductions.
Certainly, placing our clients in illiquid investments with high penalties for liquidation may have produced similar results. However, we believe the advisor and their clients are better off spending the time and effort to implement tools and strategies that leave the most in their client’s pocket.