Helping Investors Make the Right Choices in Challenging Times

All advisers know that difficult client conversations follow when market and economic conditions are most challenging. This article seeks to help advisers clarify their thought processes and approach to managing client decision-making in times of market turmoil.

It’s perfectly reasonable that clients want to know that their investments are best positioned for the current circumstances. However, times like these can be when it’s most challenging to align good financial advice with client expectations.

As an adviser, you can find yourself in a position where you feel like you need to choose between advocating financially sound options or simply doing what the client wants at that moment. Most advisers don’t want to lose clients through a lack of alignment or if the client perceives a lack of appropriate action. It’s a dilemma that requires a well-considered approach.

The problem

The problem is centred on well-researched investor behavioural psychology, particularly cognitive biases. These biases are often built on an innate human desire to avoid dissonance – the difference between beliefs and behaviours. The need to reframe situations to avoid dissonance is a powerful force that exists at a deep emotional level in our consciousness. People will change their attitudes or behaviour to resolve cognitive dissonance. Common cognitive biases in investing include confirmation bias, information bias, loss aversion, and probability neglect. See a summary list of cognitive bases at the foot of this article.

Common biases that can lead to poor decisions in times of market turmoil are action bias, confirmation bias and probability neglect. Action bias, in particular – a tendency to want to change something, anything, even when a change decision can be less effective than not changing – can be difficult to overcome. No adviser wants their client to jump out of the frying pan and into the fire, but that is what can happen if not carefully thought through.

For investors, there is a correlation between increased bias and poor performance.

How to help investors make good decisions

Providing advice in challenging times is not dissimilar to any situation that requires influence. However, times like these call for the highest possible quality. After all, the client’s financial future can hinge on this moment. Plus, of course, advisers are duty-bound to offer advice in the best interests of their clients.

Understanding, empathy, situation analysis, options, data and consequences are all vital.

Part 1. Define your approach

Being clear on your investment philosophy sets the scene for your approach.
A forward focus on the future prospects of asset performance is particularly important at this point in history as the structural makeup of the economy and markets has changed. ‘Past performance is not an indication of future performance’ has perhaps never been more pertinent.
At Dynamic Asset, we believe that diversification and active portfolio management using dynamic asset allocation are critical to minimising volatility, managing risk and positioning portfolios to capitalise on future upside performance.

The Future Fund has been vocal in advocating the need for an approach that meets the challenges of the times.

Part 2. Understanding and alignment

Contemporary financial advice is built on a well-rounded understanding of the client’s financial situation and goals. Client needs can change, so focusing back on the client provides a solid foundation. It allows everything to be framed around their present reality and future ambitions.
Empathy is derived from understanding what the client is thinking and feeling about the current situation. What are the concerns, why do these concerns exist, and does the client have any pre-conceived opinions or preferred course of action?
A situation analysis allows you to help the client fully understand the range of factors creating the current conditions. Also, the prospects for how those conditions may change or persist in the future. For example, while inflation is a current driver, only some people know that the main driver of inflation is supply-side pressure rather than a traditionally overheated economy. Fewer still understand that geo-political tensions are causing widespread restructuring of supply chains that is, in turn, a driver of cost pressures that may result in persisting high inflation.

Establishing shared understanding provides the best possible position to discuss potential and relevant courses of action.

Part 3. Solutions

Providing options is always the most positive approach to take. The client will see that their concerns and opinions are being considered, which builds or reinforces trust. Adding data and possible consequences sets the scene for sound decision-making.
Data concentrates decision-making on evidence and facts. It can include part performance data over various timeframes, comparative performance data, modelling and probability analysis. There is no shortage of data available today, which can be part of the problem. The caveat here is the need to be very considerate of Hindsight Bias which can lead to Action Bias and unintended consequences.
Finally, discussing potential consequences focuses the conversation on possible outcomes rather than

The process described here provides a framework for advisers to consider for clarity of thought and a well-considered approach to these challenging times.

While every adviser will choose their own approach, addressing both the rational and emotional drivers of investor behaviour in a way that best serves the client is essential.

The goal is to create a forum that fosters a high probability of making good decisions.

Common behavioural biases in investing

Action bias is a tendency to want to do something, even if doing nothing is a better decision.
Confirmation bias is a tendency to seek validation of an existing assumption or conclusion.
Overconfidence is a tendency to overestimate the quality of information or decision-making readiness.
Information bias influences decisions based on information. Any information, even if not relevant to the problem.
Loss aversion drives avoidance of loss, even if the prospects for the asset are poor.
Oversimplification is a tendency to simplify beyond the capacity of the issue to be simplified. When the prospects of an asset cannot be clearly understood or if rigorous analysis leads to uncertainty, there can be no logical reason to buy or hold.
Hindsight bias is a tendency to believe that positive past events are predictable and that past adverse events as unpredictable.
Groupthink is a tendency to follow the crowd and, therefore, a resistance to independent thought.
Restraint bias is overconfidence in one’s ability to exercise restraint, leading to wanting more of a good thing and not considering future consequences.
Probability neglect is a tendency not to consider or underestimate the range of probabilities for any problem.
Anchoring bias is the tendency to rely too heavily on past performance as an indicator of future performance.