Seven deadly sins to rid investment clients of

There are certain traits hardwired into the human psyche which can trigger seemingly rational people to make irrational decisions at times of stress.

We all harbour cognitive and emotional biases that can lead us to place greater value on instinct than an objective perspective. Investing is no exception.

The market experience for many investors over the last year or so has been painful.  It is hardly surprising they withdrew money from funds at unprecedented levels over the course of 2022 – an act of seeming self-preservation driven by fear of further sell offs, which in fact crystallised their losses when markets were trading at their lowest point for some time.

At times like this, it is the job of the adviser to act as a voice of reason, to remind clients they are investing to meet longer-term financial requirements and to demonstrate how their short-term biases and behaviours are endangering the likelihood of meeting their investment objectives.

Without intending to trespass into the realm of psychologists, we have identified seven damaging traits common among investors that advisers should take into consideration when guiding them along their financial journey.

1. Information overload

In today’s 24/7 news environment, clients are constantly bombarded with information and, at times, misinformation from friends, family and the media. With so much noise to interpret, it can become difficult to hone in on what is of consequence for their own particular circumstances.

It’s therefore crucial to explain to clients that your advice is tailored to their specific financial position, sensitivity to risk and reward and long-term aspirations. After all, you have been retained as an independent specialist with no vested interest other than to help them achieve their financial objective.

2. Overconfidence

The belief clients are better informed on a topic than they are in reality is also problematic. No matter how well informed an individual is – investment professionals included – no one can know with certainty the direction of markets.

Overconfidence can impact the ability to make sound investment decisions grounded in fact. It is therefore essential to measure this by drawing on solid market analysis and research to demonstrate your credibility.

3. Confirmation bias

This is the tendency to seek or interpret information through a lens that supports pre-established views on a decision or a topic. A client, for instance, that believes a specific company is a great investment, will only seek out information that confirms that belief and discredit any information that offers any conflicting views.

It is important to acknowledge a client’s opinion while offering factual, objective content to demonstrate there are alternative means of achieving their investment goals. By opening clients’ eyes to other more compelling opportunities, an adviser can reinforce the value of their expertise.

4. Status quo bias

Clients may demonstrate a ‘status quo’ bias, reluctant to veer from their current position for fear of incurring losses.  However, in doing so, they may sacrifice any potential benefits that might outweigh the risks.

It is important to appeal to clients’ rationality, showing the positives will more than likely outweigh the negatives over time. Tables and charts allowing the client to compare and contrast outcomes can be particularly effective in countering this particular emotive reaction.

5. Herd mentality

Another prevalent instinct which, at scale, can create asset bubbles or market crashes, is caused by investors blindly following others in the assumption they are acting on informed market intelligence.  By providing clients with alternative, more credible research, an adviser can encourage them to make decisions for themselves based on fact rather than the perceived wisdom of the herd.

6. Anchoring

Anchoring, meanwhile, is the common tendency to rely too heavily on one piece of information when making decisions. To overcome this, provide clients with differing perspectives for them to process to help them view information more objectively.

7. Loss aversion

Finally, loss aversion is a well-documented trait which leads people to have a higher emotive response to a perceived loss than a commensurate gain. The sting of a short-term loss during a recession could prevent an investor from taking on the level of risk required to ensure long-term portfolio growth.

However, by encouraging clients to consider making smaller investments, or drip-feeding money into the market to take advantage of cost-price averaging, advisers can help build client confidence.

Clients will always exhibit behaviours that can act as an impediment to attaining their investment objectives. However, perhaps the most valuable skill an adviser can have is the ability to understand their clients’ personality as well as their financial goals.

This ability to empathise enables an adviser to frame the tone of their communications, helping clients turn potentially damaging tendencies to behaviour patterns more likely to be financially beneficial over the long term.

John Lester is business development director at Square Mile Investment Consulting and Research