• / Free eNewsletters & Magazine
  • / My Account
Home>Practice Management>Practice Builder>Stirring Clients to Action

Related Content

  1. Videos
  2. Articles
  1. Experts Answer Your Retirement Questions

    Financial planner Mark Balasa and Morningstar's Christine Benz and David Blanchett tackled viewers' most pressing retirement questions, from determining savings rates and income needs to planning for Social Security and maximizing retirement accounts.

  2. Managing the Risk of Outliving Your Assets

    Morningstar retirement expert David Blanchett covers the pros and cons associated with the key longevity insurance products.

  3. Fund Favorites and Follies Over 20 Years

    In this special 50-minute panel discussion, Morningstar's Christine Benz, Russ Kinnel, and John Rekenthaler chart fund investing's course over the last two decades, discuss investors' biggest challenges today, and reveal some of their favorite longtime picks.

  4. Big Pharma Dividends Alive and Well

    Pharmaceutical firms' lower-than-historical valuations and high-margin, patent-protected products are positive signs for investors seeking more yield.

Stirring Clients to Action

Dealing with a client's status quo bias may also involve overcoming regret, anchoring, and loss aversion biases, too.

Michael M. Pompian, 09/20/2012

This month's article is the 12th in a series called "Managing Behavior in a Volatile Market" and Part I of a discussion on status quo bias. This series provides data and insight into the identification of key behavioral biases and also shows how to manage client behavior and emotion in this highly volatile market environment.

A substantial part of this series will be a review and analysis of answers to behavioral questions that were completed by a diverse set of 178 individual investors in 2011. The investors polled were not subscribers to Morningstar.com and/or Morningstar investor newsletter publications like the last survey, but they fit a similar profile in terms of investment objective and investor description.

By way of background, the survey questions were written to identify 20 key behavioral biases that I outline in my book, Behavioral Finance and Wealth Management. The second edition of the book, with updated biases and new case studies, is now available.

As noted in earlier articles, the intent of the survey was twofold. First, I wanted to identify the most prevalent biases ("Primary Biases"), so advisors would know what to look for when working with their clients. Second, I wanted to identify what secondary behaviors ("Secondary Biases") might also be lurking behind these primary biases. In other words, if client Smith has easily recognizable bias X, what other of the 19 biases might client Smith also be subject to?

The purpose in doing this is that advisors can hopefully recognize not only primary biases, but secondary biases as well. Often it is the unrecognizable biases that can cause substantial harm when attempting to keep clients on track to attaining financial goals. Advisors can hopefully gain significant insight into a range of a client's behavioral tendencies simply by being aware of a single common bias.

In order to rank as a primary bias, 50% or more of respondents need to answer at least "Agree" or "Strongly Agree" to a question designed to identify a certain bias.

There were seven biases that garnered at least 50% positive responses:

Loss Aversion Bias: The pain of losses is greater than the pleasure of gains

Anchoring Bias: Getting "anchored" to a price point when making an investment decision

Hindsight Bias: Believing that investment outcomes should have been able to be predicted

Recency Bias: Taking investment action based on the most recent data or trend rather than putting current situations into historical perspective

Representativeness Bias: Making current investment decisions using the results of past similar investments as a frame of reference

Status Quo Bias: Not taking action to change one's investment portfolio (i.e., doing nothing when prompted to do so)

Regret: Past (poor) decisions affect future investment decisions

When you are providing advice to clients, at a minimum you should be looking out for these seven biases, as they are likely to be the most commonly encountered. For example, let's say you identify that a client is loss averse. What are the other irrational biases they might be subject to? This series is intended to help answer this question for the seven biases listed above and provide tips on overcoming them.

In this article we will review the biases associated with status quo bias. Fifty-six percent of 178 people responded that they agreed or strongly agreed to a question asking them if they were subject to status quo bias (i.e., the idea that some investors don't take action on their investment portfolio when prompted to do so). Of that group, at least half of those people were also subject to the following six biases:

1. Regret (63%)
2. Anchoring (62%)
3. Loss Aversion (61%)
4. Endowment (61%)
5. Hindsight (57%)
6. Representativeness (55%)

For example, of the respondents who said they were subject to status quo bias, 63% of them were also subject to a question designed to identify regret bias, and so on for the other five biases.

Below, I will provide commentary on the first three of these biases: regret, anchoring, and loss aversion. I will discuss why these biases are likely linked with status quo bias and what you can do to counsel a client who has these biases.

Status Quo and Regret
As we know, investors subject to status quo don't take action on their investment portfolios when prompted to do so. Those influenced by regret-aversion bias tend to avoid making decisions that will result in action out of fear that the decision will turn out poorly. It is only natural for these two biases to go together. The major implication for status quo and regret is that these biases often keep otherwise good-intentioned investors out of a market that has recently generated sharp losses or sharp gains. Having experienced losses, our instincts tell us not to invest. Yet periods of depressed prices may present great buying opportunities. And we've all also been guilty of cutting risk out of fear of gains evaporating only to see the markets continue to run--especially when the Fed is so accommodating!   

Advice: My advice to those investors subject to status quo and regret bias is to accept the fact that investment mistakes will occur. Don't be afraid to invest! The important thing is that a structured process is followed and discipline is actively pursued. 

Status Quo and Anchoring
Status quo and anchoring are also naturally tied. Some investors are generally more emotionally comfortable keeping things the same than with change and thus do not necessarily look for opportunities where change is beneficial. Given no apparent problem requiring a decision, the status quo is maintained. Further, if given a situation where one choice is the default choice (i.e., keep things the same), people will frequently let that choice stand rather than opting out of it and making another choice. Anchoring to a given price level when called upon to make an investment decision is a natural extension of status quo bias.

Advice: When a client exhibits anchoring bias, I recommend that advisors focus that client's attention not on the purchase price but rather the prospect of a positive result from the current price. Would you make the investment now? If the answer is yes, then holding is the right course of action. If the answer is no, the right course of action is to sell.

Status Quo and Loss Aversion
Status quo and loss aversion also go together. Some investors are generally more emotionally comfortable keeping things the same, especially when they have a tendency to feel the pain of losses more than the pleasure of gains. Why change things when I might lose money by doing so?

Advice: Because loss aversion is an emotional response to losing money, it is often difficult to correct. It can be helpful to put recommendations in terms of what the decision means for the client's likelihood of reaching financial goals. To spur action, I often recommend taking investment activity in small increments. For example, if the task is to get invested, then clients can "average in" to the markets--taking three months or six months to get invested. This often puts the fear of losses aside; if an investment goes down, you can buy more at lower prices.

Hopefully you have learned something about status quo bias and the biases connected with it. When you encounter a client with status quo bias, think about the examples you have read about in this article. It might help to build a better client relationship!

In next month's article, we will review the second three biases associated with status quo.

The author is a freelance contributor to MorningstarAdvisor.com. The views expressed in this article may or may not reflect the views of Morningstar.

©2017 Morningstar Advisor. All right reserved.