March 21 In a perfect world, investors would be calm, rational creatures who followed time-tested principles, did their math and achieved lofty returns.
But in reality, fear and greed get in the way - and that is where many advisers do their best work and spend much of their time, coaching clients to stick with their plans despite emotional discomfort.
Mutual fund investors who follow their feelings instead of a buy-and-hold strategy reduce their returns by 1.56 percent a year, according to a 2007 study by Geoffrey C. Friesen and Travis R.A. Sapp at the University of Nebraska-Lincoln. Between 2003 and 2013, emotion-driven investors made 2.49 percent less than they would have if they stayed fully invested in mutual funds, calculated research firm Morningstar.
Experts call that the "behavior gap".
THE ADVISER'S ROLE
To protect clients from those losses, advisers need to be part behavioral coach and part circuit-breaker, dissuading clients from chasing returns, says Fran Kinniry, a principal in the Vanguard Investment Strategy Group, the wealth management arm of fund company Vanguard.
That requires a long build-up of trust and some tough conversations, says Kinniry. For example, clients may resist when advisers tell them to rebalance their portfolios to maintain planned asset allocations.
"You're trying to convince your investor to sell top-performing investments and put them in bottom performing," he says. "It goes against human nature, intuition and what the media is talking about. You have to find tactful, diplomatic ways to help clients see the long-term benefit."
Brent Kessel, CEO of Los Angeles-based Abacus Wealth Management, which oversees close to $1 billion in assets, has been managing emotions and portfolios for high net worth clients since 1996.
"People look at their statements, and fear kicks in, and the 'what ifs,'" he says. "I tell clients, 'There will be times when your neighbor is doing better or things are going down more than you want and you'll have doubt, but that's part of being an investor.'"
Kessel, who once wrote a book about incorporating zen into finances (It's Not About The Money: A Financial Game Plan for Staying Safe, Sane and Calm in Any Economy, 2009), teaches clients to be mindful of their emotions and to allow doubt without questioning their entire strategy. He also has them visualize portfolio losses of, say, 40 percent, to get a sense of what they can handle.
If you play it safe with those issues that clients care about most, they tend to be less afraid, says Karin Maloney Stifler, a certified financial planner and founder of True Wealth Advisors in Hudson, Ohio.
She uses the bucket system, dividing clients' money among separate portfolios by goal. While a dream vacation may go in a riskier portfolio, basic needs go into a conservatively crafted one.
Stifler also brings the science of investing into the conversation and tells clients they might see some "ugly numbers". "They think it's all about money; they don't know it's an experience," she says.
Like Kessel, she talks them through a virtual market-drop, and asks them if they can stick with her. When times do get tough, she reminds her clients of the good reasons they chose their strategy.
EMOTIONS AS FRIEND, NOT FOE
Advisers have been slow to address emotions in the planning process, but those who have done so are seeing results. A 2007 study of 101 stock investors by Myeong-Gu Seo and Lisa Feldman Barrett at the University of Maryland's Smith School of Business may explain why. Investors who acknowledged, understood and regulated the feelings that arose during decision-making achieved higher investment returns, the study found.
In a recent white paper, London-based Barclays referred to such increases as "anxiety-adjusted returns". On its website, the company touts behavioral finance as being crucial to its asset management strategy.
"We're human beings," says Julie Murphy Casserly, president of Chicago-based JMC Wealth Management and the author of the 2008 book, The Emotion Behind Money: Building Wealth from the Inside Out, on money and emotion. "You must include that part of the equation in asset management."
She says she reduces anxiety by spending a lot of time talking with clients to learn what drives their financial decisions. She delves into their money history and shares her personal stories about racking up credit card debt and losing money before she understood the "why".
Sharon Doyle, a consultant, is a client who says Casserly's approach not only helps her and her husband stay the course, it improves the quality of their lives.
"She makes your financial goals about life, not money, and it changes how you think about it," says Doyle. (Editing by Linda Stern and Stephen Powell)