“Unlearning” is defined as “putting out of one’s knowledge or memory.” As a financial advisor, you play a crucial role in guiding clients through the complex world of investing and personal finance by helping them “unlearn” habits and impulsive patterns they may not be aware of.
If left unchecked, these behavioral biases can prevent clients from achieving their practical financial goals, such as saving for retirement, building a college fund, and gaining investment income. By understanding and gently correcting these biases, you can empower clients to increase their self-awareness and make more stable investment and financial choices.
Are you ready to help clients hack their own decision-making to work in their financial favor? Let’s unpack common bias types you may encounter at your firm and review strategies to help navigate them.
Overcome Behavioral Biases: 5 Client Focus Areas
1. Loss aversion
The pain of losing something is often more intense than the pleasure of gaining something of equal value. Think about it: If you lose $100, you have to find at least $200 to make up for that initial loss. And when you’re talking about thousands of dollars in investments, that’s a lot to overcome. Often, loss aversion is why we see panic selling during periods of market volatility.
What can you do about it? Acknowledge your clients’ feelings. But also remind them that you’ve worked together to develop a defensive investing strategy that can help their portfolio withstand volatility—and even take advantage of the opportunities a down market can present.
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2. Anchoring bias
Do you ever notice how the first price you see for something tends to stick with you? When clients become fixated on a specific number, it’s typically due to anchoring bias.
Suppose your client retired with a significant amount of shares in their former employer’s stock. Initially valued at $150 per share, the price has dropped to just $75 per share. Although you’ve suggested selling, based on the belief that the company’s fundamentals justify that price, the client refuses to consider this option until the price returns to $150, the “anchor.”
What can you do about it? Your task is to help clients understand that their perception of value at a certain point in time will not always reflect reality when it’s time to sell. Ask clients what their decision is based on and help them reframe their outlook with data and facts that counteract anchoring bias.
3. Confirmation bias
It’s easy to seek out information that aligns with what we already know. When it comes to financial decision-making, we prefer to consider information that confirms our existing beliefs while sometimes ignoring facts or opinions that don’t serve our narrative. This bias has a well-known influence on investment decisions. It could lead your client to ask you to overweight their portfolio to a particular sector or holding, which could increase their investment risk.
What can you do about it? Try to get clients to see that they’re relying on a single point of view. To reframe the discussion, tell them that you were curious about the information they shared, so you conducted research on your own and found reasons for concern. By taking this step, you acknowledge that you’re listening, taking their beliefs seriously, and ensuring that they get the best possible outcome.
4. Recency bias
People often incorrectly think that recent events have greater significance and weight than past events. For instance, when gas prices drop, SUV sales often rise as consumers become overly optimistic about sustained low fuel costs. Similarly, clients (and advisors!) may try to time the market, rushing to buy a stock that’s been hot for the past month while overlooking longer-term market trends.
What can you do about it? In the movie Wall Street, Michael Douglas’ character Gordon Gekko says, “Don’t get emotional about a stock.” Instead, present historical data that illustrates how a long-term, buy-and-hold strategy has been found to be more effective than trying to time the market.
Returns of the S&P 500
5. Herd mentality bias
Not too long ago, the financial news was all about how non-fungible tokens (NFTs) and cryptocurrency were the next hot things. If your clients wanted in, they were likely influenced by herd mentality bias, which is the tendency to mimic the actions of a larger group, whether those actions are rational or not.
What can you do about it? Help clients do their homework. Emphasize the importance of considering facts over groupthink, and provide concrete data on the historical track record and potential outlook for your client’s desired investment.
What If Clients Ignore Your Guidance?
Influencing behavioral change is a process. In some instances, clients may not even know that their decisions were emotionally driven or reactive—in which case, they may thank you for guiding them in the right direction. In other cases, they may be resistant to your guidance, which can introduce risk to your client relationships.
In these situations, remember to take the following steps to help protect your business.
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Set boundaries. Establish and communicate what clients can expect from you and what you expect from them.
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Document everything. To guard against misunderstandings, create an accountability mechanism for documenting all discussions, including the advice you provided, the decisions your clients made, and any other pertinent communications.
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Conduct regular risk assessments. Make sure you understand your client’s risk tolerance and how that aligns with their actions and your recommendations.
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Educate your clients. Maintain open lines of communication, and make sure you’re regularly sharing information to help clients learn about the ramifications of any investment decision.
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Consider ending the relationship as a last resort. If a client is consistently ignoring your guidance, it may be time to terminate your relationship with them. You can offer to refer them to another advisor whom you feel would be a better fit for their needs.
Approach Investing with Empathy
The act of investing is personal. As clients move closer to or farther away from their goals, the more emotional the process can become. By providing clients with institutional-quality research and support tools, you can help them overcome behavioral biases and make choices that align with their long-term goals. The result? A powerful framework for decision-making that strengthens your relationships and improves your clients’ financial outcomes.
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This article is intended strictly for educational purposes only and is not a recommendation for or against cryptocurrency or NFTs.