According to legend, F. Scott Fitzgerald once said to Ernest Hemingway, “The rich are different from you and me,” to which Hemingway replied, “Yes, they have more money.” A recent On Wall Street article citing a study by Barclays Wealth, reminds us that being rich does not make one immune to a lack of self-discipline. In fact, the study finds that the wealthier the investor, the more concern they have about their level of self-control.
The bottom line is we’re all human. And new research tells us that, as humans, the emotional centers in our brains influence what we feel in response to an event well before we even experience a conscious thought. Helping your clients recognize the fact that they may be trading emotionally (and that it can cost them 20% of returns over 10 years) is just the first step in preventing this phenomenon.
According to Peter Zimmerman and Jennifer S. Lerner (“The emotional decision maker”, Harvard University, June 28, 2010, and forthcoming in Government Executive) two different types of emotions influence decision making. One of those, integral emotion, is rational. For instance, if you’re considering taking a risk, and you sense alarm, apprehension and fear, your gut likely has some sense of whether or not you’re making a good choice.
On the other hand, incidental emotion is less legit in terms of rationalizing a decision. Our minds are hardwired to assume that the past can reliably predict the future; the neural pathways associated with prediction actually mirror those associated with memory. Basically these emotions are based on past experiences that aren’t necessarily relevant to the situation at hand. An example of this would be a client whose father passed away with little or no life insurance, yet his family remained financially secure in his absence. You then find your client refusing any type of life insurance. This is likely tied to a past experience, but it’s an experience completely unrelated to rationality and the current situation.
There are three ways you as an advisor can play a role in reducing the influence of these incidental emotions on your clients’ decision-making processes.
1) Help them diagnose their emotions. If you see that your clients are over-checking their portfolios, or requesting to buy or sell more often than average, speak to them about what is prompting these decisions. Help them identify whether these emotions are rational and whether they are appropriate for the situation.
2) Offer different perspectives. Offer your view of the situation, and possibly even the view of someone else in your firm. Looking at problems through the eyes of others can improve your clients’ judgment.
3) Treat each situation as unique. Especially if you’re a long-time advisor who understands their trading history, help recognize past situations that the client has encountered that may be affecting their current decision making process. Help them understand why the risk in their current situation is not dependent upon, or related to, previous experiences they may have had.
Assisting your clients in their self-control—for example, by helping them create limits on the frequency they check their portfolio, or recommending they always check with you before buying or selling—can help them become 12% wealthier than those who don’t put themselves in check. Perhaps a reasonable response to “The rich are different from you and me,” should be “Yes, they have an emotionally intelligent financial advisor.”