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Behaviorally Modified Asset Allocations for Active Accumulators

The Active Accumulator is the most aggressive behavioral investor type.

Michael M. Pompian, 05/20/2010

In the last article, we learned how to create a behaviorally modified asset allocations (also referred to as "Best Practical Allocation") for an Independent Individualist behavioral investor type. We will now continue this learning process by examining the Active Accumulator.  Our process will be to review the basics of the AA and the biases at work with AAs, present a client scenario, and then discuss how to modify an asset allocation based on the behavioral characteristics of the AA. Note that in this exercise we will not be examining standard of living risk. We will tie in that concept in subsequent articles. 

Review of Active Accumulators
The Active Accumulator is the most aggressive behavioral investor type. These clients are entrepreneurial and often the first generation to create wealth, and they are even more strong-willed and confident than Independent Individualists. At high wealth levels, AAs often have controlled the outcomes of non-investment activities and believe that they can do the same with investing. This behavior can lead to overconfidence in investing activities. Left unadvised, AAs often trade too much, which can be a drag on investment performance. Active Accumulators are quick decision-makers but may chase higher-risk investments than their friends. If successful, they enjoy the thrill of making a good investment. Some AAs can be difficult to advise because they don't believe in basic investment principles such as diversification and asset allocation. They are often "hands-on," wanting to be heavily involved in the investment decision-making process. Biases of Active Accumulators are overconfidence, self-control, optimism, and illusion of control.

Scenario
Suppose you are beginning an engagement with a new client, Bob. You give him a standard risk-tolerance quiz and determine that he is an aggressive, growth-oriented investor. After that, you give him a test for behavioral biases of aggressive clients. Based on the answers to the bias questions you determine that Bob is an AA. Some of your other clients are aggressive growth-oriented in their risk tolerance but they are not biased like Bob. The object of this exercise is to see how to create a BMAA for an AA versus a nonbiased or mildly biased aggressive growth investor. Generally, this can mean that an AA should accept less risk in his portfolio than those clients without bias. Since Bob is an Active Accumulator, he may believe that he can control the outcome of his investments or be overly optimistic about the prospects which may change the risk level in his overall portfolio without him realizing it. This makes working with an AA somewhat more challenging than with some other BITs.

The following analysis presents two investment programs, one for Brandon (a nonbiased aggressive growth investor) and one for Bob (an AA). You are using Brandon's portfolio allocation as a baseline for creating Bob's. Your basic task as to assess a retirement goal for Bob and the risk associated with the return needed to reach that goal. When working with actual clients, you will need to adjust this analysis to suit your purposes.

Active Accumulator (Bob) versus non-biased Aggressive growth Investor (Brandon)
As we know, AA clients:
* are driven by emotional biases;
* may believe they can control the outcomes of their investments
* may be overly optimistic about the prospects for their investments

For Bob, an AA, we are going to make an assumption that he may have difficulty sticking to a portfolio with a probability of a loss year at greater than 45%.  For Brandon, a nonbiased aggressive growth client, 45% may be just fine.   

 

A Active Accumulator (BOB)

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