Knowing what kind of person your client is emotionally will greatly increase your efficacy.
In applying behavioral finance to client situations, advisors face their own decision-making problem. Practitioners must decide to change or moderate their client's biased behavior or adapt to it. Future articles will discuss guidelines practitioners can use to make this decision. The first step is getting to know the mind of the client you will be working with during the decision-making process. The guidelines are drawn from observations and knowledge of client emotions, thought processes and tolerance for risk.
Our last article introduced the three elements of the client decision-making process and offered some sample conversation points. These conversation points help advisors begin to elicit the kind of dialogue that will help them observe the client decision making process and begin to draw conclusions about the presence of unseen obstacles.
Emotions are the most damaging of all obstacles. Fear of loss can paralyze a client, causing not just an obstacle but an aversion to facing the decision at hand. In divorce scenarios, we often see one party moving through the emotional roller coaster of the change and transition at a much slower pace than the other. It may be because they are the party being left, because they have built their dreams and aspirations around a family structure that no longer exists. It may be they are navigating the grieving process stuck somewhere on the line leading to acceptance. Divorce is after all the death of a family in many people's eyes. Denial, anger, bargaining, depression and acceptance are the commonly accepted steps in the grief process, whether grieving the loss of a patriarch, mother, business, child or family structure. If a client is stuck somewhere on this cycle, financial advisors will have trouble shepherding them toward an unbiased and healthy decision-making process. At this stage, emotional obstacles are more than the average financial advisor can handle, and drawing upon the assistance of a mental health professional is strongly suggested. Much of the problem might be linked to fear of an unknown future. Generally, advisors should focus on how decisions affect emotional aspects of clients' lives, such as lifestyle or legacy, in order to help them concentrate.
Clients may also exude emotional biases in the ways they relate money to success or power. The most successful entrepreneur may measure success by fortune or income. This is an aggressive client who likely risked personal capital to seek reward and constantly seeks affirmation of value through money. Faced with becoming a failure in their own mind, clients with emotionally aggressive money tendencies may have immense difficulty navigating their way out of a financial quagmire. Their answer is often "I will make it work" and they may forsake the future for the benefit of today. This is often the entrepreneurial spirit embodied in 70-hour work weeks and no retirement savings. Control can also become a problem for a more aggressive client as they overestimate the quality of their own judgment. Some believe they possess more control over the outcome of a decision making process than others involved in the decision which can be an especially difficult road-block to negotiating a divorce settlement.
Emotions can be the most crippling complication in financial decisions. Those two examples offer a glimpse into how an advisor is faced with emotional bias in financial decisions of their clients.
Risk tolerance plays a huge role in every financial advisory practice, and for good reason. Understanding how clients perceive risk versus reward creates opportunity in many corners of an advisory relationship. Risk-averse clients command a different set of planning assumptions than risk-seeking ones. Similarly, risk-averse clients will make broader financial decisions using a different set of variables or assumptions. They will judge decisions on "will I be OK?" instead of "can I make it work." Understanding how clients developed their certain risk appetites will help advisors guide decision-making processes. The risk-seeking entrepreneur in our second example may be willing to take on greater risk to see the end of a bitter divorce battle. The risk-averse client may see their future prospects as dire and be unwilling to take on additional risk, much like the client in our first example .
Discussions about thought processes can help the advisor determine if a client is likely to be more passive or active in the decision-making process. The example of a client paralyzed by loss and the fear of unknown future lends itself to characterization of passive tendencies. A passive client may rely totally upon the advice of others and avoid being a participant in the decision-making process. The idea of financial planning for transitions (such as divorce) has its roots in encouraging self-determination. Passive clients will seek expert opinions to determine outcomes rather than making decisions themselves. This leads to litigation in a divorce setting and disengaged clients in the greater financial-planning relationship. All advisors want engaged clients and quality relationships with those clients. Those with passive tendencies are likely to accept expert advice, say yes, and regret it later. Regret is never healthy in a professional relationship. Clients may also anchor on past data (like a poor month of market performance or how much spousal support their friend receives). They will be slow to make changes and prefer the safety of the status quo.
Aggressive clients are also likely to be active. An active client will be on top of homework assignments and generally eager to learn or make changes for better or worse. They may be contrarian, looking for every angle and hoping to find an edge. Very active clients are also emotion-driven, seeking affirmation of their power or pursuing the high they get with success. Active clients will seek professional advice but prefer to process and choose which parts fit their agenda. They have a tendency to search for or interpret data in a way that confirms their preconceptions.
Compiling behavioral finance observations allows advisors to work more closely, more efficiently, and more effectively with clients in transition. An understanding of emotional processing can also help advisors understand when situations may benefit from collaboration with a mental-health professional.
Next month we will share some of our observations and provide guidance for advisors dealing with financial decisions that elicit real client emotions, as encountered during divorce and other transitions.