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May 1, 2008updated 04 Apr 2017 3:58pm

Getting inside the client’s head

Behavioural finance is coming to the fore as a technique to understand and cope with irrational actions by clients that often lead to a clash with their advisers.One of the toughest tasks for a private banker adviser is to understand the basic psychological drivers of clients, beyond their apparent rational personal investment and planning requirements Often decisions are taken by the client that are irrational, leading to tensions with the adviser who fails to get inside the head of the customer.One classic example is that clients often go to great lengths to justify previous investment decisions, especially losing ones, as many wealth management professionals will have noted

By PBI Editorial

Acquiring private clients is difficult and expensive, and losing them is often all too easy. Behavioural finance is coming to the fore as a technique to understand – and cope with – irrational actions by clients that often lead to a clash with their advisers.

One of the toughest tasks for a private banker adviser is to understand the basic psychological drivers of clients, beyond their apparent rational personal investment and planning requirements. Often decisions are taken by the client that are irrational, leading to tensions with the adviser who fails to ‘get inside the head’ of the customer.

One classic example is that clients often go to great lengths to justify previous investment decisions, especially losing ones, as many wealth management professionals will have noted. Clients often delay unloading assets that are not generating adequate returns because they don’t want to admit to having made a mistake.

Not understanding the client

Indeed, financial advisers lose clients for a host of reasons – and, contrary to popular belief, the primary reason is not poor investment results. The most common reason why financial advisers lose clients is the failure to effectively understand their clients, and their personality types, to build a solid personal and financial relationship.

Sometimes building that relationship is easy – the client being advised is rational in approach, has reasonable expectations and a good understanding of asset allocation. For these clients, the typical method for arriving at an asset allocation is to administer a risk tolerance questionnaire and use financial planning software to create a mean-variance optimised asset allocation.

At other times, financial advisers encounter irrational behaviour from clients. Irrational clients might overestimate their risk tolerance, be unrealistic in their return expectations, or generally behave in a way that appears resistant to rational investment principles. Advisers can get frustrated and impatient when confronted with an irrational client.

However, this impatience need not occur; there is an education strategy that can help, experts contend. A new report* on behavioural finance – understanding how clients actually behave – asserts that this approach is the key to retaining private clients. It is destined to become an established part of the financial ‘curriculum’ alongside efficient market topics, ratio analysis and the host of other core concepts taught to young financial professionals.

Increasing use of behavioural finance

Advisers are increasingly using behavioural finance with their clients. Major US brokerage firms, such as Merrill Lynch, teach their advisers about behavioural biases and how to account for these biases when advising their clients. Why? Because understanding clients will help them reach their financial goals and lead to increased client retention.

Experienced financial advisers know that defining financial goals is critical to creating an appropriate investment programme for the client. To best define financial goals, it is helpful to understand the psychology and emotions underlying the decisions behind creating the goals.

Behavioural finance permits financial advisers to understand clients when engaging in the critical task of setting financial goals. Such insight helps equip advisers in deepening the bond with the client, producing a better investment outcome and achieving a better advisory relationship.

As behavioural finance is increasingly adopted by practitioners, clients will begin to see the benefits. There is no doubt that an understanding of how investor psychology impacts investment outcomes will generate insights that benefit the advisery relationship. The key result of a behavioural finance-enhanced relationship will be a portfolio to which the adviser can comfortably adhere while fulfilling the client’s long-term goals. This result has obvious advantages – advantages that suggest that behavioural finance will continue to play an increasing role in portfolio structure.

There is no question that measures taken which result in happier, more satisfied clients will also improve the adviser’s practice and work life. Incorporating insights from behavioural finance into the advisery relationship will enhance that relationship – and, will lead to more fruitful results.

It is well known by those in the individual investor advisery business that investment results are not the primary reason that a client seeks a new adviser.

The number one reason why practitioners lose clients is that clients do not feel as though their advisers understand, or attempt to understand, the clients’ financial objectives – resulting in poor relationships. The primary benefit that behavioural finance offers is the ability to develop a strong bond between client and adviser.

By truly understanding the client and developing a comprehensive grasp of his motives and fears, the adviser can help the client to better understand why a portfolio is designed the way it is, and why it is ‘right’ portfolio for him or her – regardless of events in the markets.

Need for consistent approach

The most successful advisers exercise a highly consistent approach to delivering wealth management services. Incorporating the benefits of behavioural finance can become part of that discipline, and would not involve large-scale changes in the adviser’s methods.

Behavioural finance can also add greater professionalism and structure to the relationship because advisers can use it in the period of getting to know the client which precedes the delivery of any actual investment advice. Clients will appreciate this step, and it will make the relationship more successful.

It provides a context in which the adviser can ‘take a step back’ and attempt to really understand the motivations of the client. Then, having got to the root of the client’s expectations, the adviser is better equipped to help realise them.

The behavioural finance practitioner can help the client to better understand why a portfolio is designed the way it is, and why it is the ‘right’ portfolio for the client – regardless of what happens from day to day in the markets.

 

* Behavioural Finance, by Michael M Pompian, CFA. Published by VRL KnowledgeBank, London. ISBN No. 1-905457-64-2. For further details, telephone: +44 (020) 7563 5600.

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