Conversation Guidelines

Understanding your client's financial behavior

Overview

A thorough understanding of an individual's risk profile is critical to the success of any client/advisor relationship. However, the typical risk evaluation survey is not well-suited to capture an investor’s real attitudes towards risk. That is because these surveys usually do not effectively evaluate the underlying behavioral characteristics and personality traits of the investor that affect how he or she approaches financial decision-making.

This lack of understanding can present major problems during the course of the client/advisor relationship. The inability to successfully match client behavioral characteristics with product and service offerings can result in dissatisfied customers and loss of business.

On the other hand, conversations that take these often emotional factors into account are much more likely to lead to smoother communications and richer relationships.

Studies undertaken by behavioral economists and psychiatrists have consistently shown that individuals do not act rationally when it comes to decisions about money.

For example, studies of financial decision-making have shown repeatedly that for most (but not all) people, the pain of losing money is stronger than the pleasure of winning money. This means that while a person can be “risk seeking” when pursuing financial gains, she can also be “risk averse” when it comes to losses. This has very important consequence for financial planning and client education. Such a client would need to have a portfolio that shields her from large losses. Such a portfolio would also limit upside potential, and this fact would need to be explained to the client.

In general, research has shown that most investors:

• Make decisions based on "rules of thumb", and not on an exhaustive review of all available information
• Feel more pain from a loss than pleasure from a gain
• Mistake a random series of events for a reproducible, non-random trend
• Act impulsively without careful consideration of longer-term consequences
• Over- and under-react by following “the herd”
• Overstate their knowledge of financial concepts and underestimate the role of chance
• Overvalue the assets that they own
• Ignore evidence that does not align with an existing set of beliefs

It is recommended that you ask your clients to take the behavioral questionnaires included in this platform to fully understand their psychological and emotional attitudes towards money. You may discover important aspects of their personality that could profoundly shape the way you invest their money, and also how you communicate with them. For interested clients, you could also suggest some of the readings provided in the behavioral finance bibliography.