Many financial professionals believe that investors focus heavily on investment performance when evaluating the relationship with their advisor, but the relationship between investment performance and client satisfaction is not always as straightforward as it may at first appear. In reality, the interplay of client expectations and performance truly influences how happy investors will be with their investment experience. Clients are most satisfied when both the performance of their investments and the level of service provided are better than expected. Conversely, they are dissatisfied when their investment performance and level of service do not meet expectations. In other words, expectations play a major role in the client–advisor relationship.
One factor making it more challenging for investors to form and maintain realistic expectations is the changing nature of investing itself. Too many investment products paired with an overload of financial tips and information from the media, internet, friends, coworkers and family have resulted in an increased complexity, making the need for an experienced financial advisor more critical than ever.
Studies of human psychology and decision making show that in the face of greater complexity and competing opinions, individuals tend to resort to mental shortcuts and hidden biases to make their decisions(i). By learning more about these shortcuts and tendencies, advisors can position themselves to better identify and address them with their clients, to help manage expectations and provide quality advice around their investment decisions.
Behavioral finance is a discipline that explores how emotions and unconscious biases affect investor decision making. When looking at how individuals form expectations for the future, behavioral finance studies have found that people tend to rely too heavily on what has happened in the recent past. Common tendencies that often affect an investor’s expectations include the following:
• Anchoring. Some investors have a tendency to settle on some arbitrary value as the “correct” asset price in their mind. Once they adopt this anchor value they may consciously or unconsciously wait for their investment to reach this price, even if there is no fundamental reason for it to do so. As a result, an investor may hold on to an investment too long or may resist the need for portfolio changes.
• Runaway expectations. As noted, investors also have a tendency to overemphasize recent experience when it comes to predicting future market trends. For example, when asset prices are rising, investors may be lulled into thinking this trend will continue, even as values get more and more out of line with underlying investment fundamentals. Similarly, after a period of poor stock performance, investors can become fearful and flee the market altogether.
• Fear of regret. People hate to be wrong, especially when it looks like everyone else is right. Investors are afraid they will miss out on potential returns if they sell an asset too early or fail to jump in on the next big investment trend. Fear of regret may also influence how willing investors are to sell underperforming assets or change course when the current approach is not working. Some fear that the stock will rebound as soon as they sell. This tendency may reflect a general misunderstanding of the cyclical nature of investing.
• Fear of Loss. The ability of investors to plan and set expectations for the future may also be influenced by the very emotional human response to the threat of loss, a concept known as Prospect Theory. According to studies, investors tend to react twice as strongly to losses as they do to gains of a similar magnitude(i). Fear of loss may also make investors take on more risk than they would otherwise be comfortable with.
• Overconfidence. People tend to exaggerate their abilities to identify trends and predict the future. They are also more likely to attribute any positive outcomes to their own abilities, while blaming setbacks on their financial advisor.
THE IMPORTANCE OF FRAMING
Knowing these tendencies does not necessarily make it easy to change their minds or their cognitive behaviors. No investor wants to be told they are displaying erroneous judgment or acting irrationally.
One useful concept borrowed from the world of behavioral finance, is framing. Experts have found that the way a problem is worded, or framed, may have a lot to do with how people respond. Look for ways to position conversations with clients so that the focus is on a range of possible future outcomes, both positive and negative, rather than on recent performance.
Always be sure to emphasize realistic expectations. Remind clients that the main priority is not to beat some arbitrary benchmark or index but to help them achieve their personal financial goals.
(i)”Managing Expectations”, Texas State Securities Investor Education Program,
http://www.texasinvestored.org/eig/articles/managing_expectations.html Accessed 1/23/2013
Keith Johnson is vice president of Practice Management for Curian Capital, responsible for advisor-facing educational content, sales and marketing presentations, tools and resources. Practice Management also works closely with the organization’s broker-dealer partners offering business consulting and coaching programs that enable financial advisors to improve the efficiency, productivity and profitability of their practices.
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