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.
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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.
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By GlobalDataAt 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.
