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Build Better Client Relationships By Understanding Investor Types

A good first step to being a valued advisor is understanding the types of clients you deal with and tailoring your advice accordingly.

Michael M. Pompian, 01/17/2013

Welcome to 2013! This month's article is the first in a series called "Build Better Client Relationships By Understanding Investor Types."

This series is intended to help advisors create great working relationships with their clients by taking a step back and understanding the type of person they are dealing with (from a financial perspective). Why is this important? Well, in short, you don't want to be in the 43%. Which 43? In December 2012, Fidelity Investments published a paper based on two studies that highlight the characteristics of a "Valued Advisor," which was defined as advisors who proved their worth to investors while navigating recent market conditions. This resulted in their clients seeing clear value in their service offering. The bad news is that only 57% of investors said they felt their advisor proved his or her worth navigating recent market conditions.

What can be done to increase this number? In my view, a good first step is understanding the types of clients you deal with and tailoring your advice accordingly. Because individuals process information differently, behave differently when faced with a financial decision, and have different risk preferences, it is essential that advisors interact with each client effectively. This often means that you must change the way you speak to different types of clients, even though your advice may be similar across your client base.  For example, if you are in France and you start speaking Spanish to people on the street, they will likely get bits and pieces of what you are trying to say, but they will miss essential words and messages that you are trying to convey. The speaker in this case is not taking into account what is important to the listener--namely that the listener needs to be spoken to in a way he or she can comprehend and appreciate.

At the end of the day, the job of the financial advisor is not different. Some advisors fail in their tasks not because they don't have technical knowledge of the markets, understand the strategies of investment managers, or have systems that can deliver the best methods of portfolio construction--but rather they lack an understanding of what is truly important to the client and how to communicate and interact in a way that is meaningful and effective.

As you know, I have dedicated a substantial amount of time promoting the benefits of behavioral finance research and making it accessible to large numbers of financial advisors. In my latest book, "Behavioral Finance and Investor Types," my primary objective was to simplify the practical application of behavioral finance by "boiling down" many of the complexities involved in diagnosing and treating behavioral biases into a simple concept: investor types, which I refer to as "behavioral investor types" or BITs.

BITs are defined in large measure by the biases themselves. BITs are categorized in a way that make intuitive sense and can be easily understood. I have been a financial advisor for more than 20 years, and I know how every advisor is under time constraints. We don't want to spend weeks and months studying a subject--we want to spend an hour or two every few weeks to educate ourselves. Fair enough. This series should help you tremendously. I will not be able to cover everything in the book, but if you find the series helpful and want more information, you can purchase the book here.

As we all know, reaching financial goals can be difficult. This is not only because we have to work hard for our money in what seems like a more and more uncertain environment, but also because when we work hard, we want to enjoy the fruits of our labor--and delaying gratification is difficult.

In addition, there are psychological and environment factors that can impede progress toward meeting financial goals. By understanding some of the psychology behind why people have such difficulties, readers can set the table for applying the lessons we will learn using BITs as we progress through the articles to come in 2013.

In the first two articles of the series we will look at three financial and two non-financial examples of self-defeating behavior. By doing so, we gain a common understanding of the challenges of controlling behavior and emphasize the importance of why behavior must be managed.

This month we will examine the two non-financial examples. Next month we will review the three financial examples. These first two articles will set the stage for applying key concepts related to behavioral investor types later.

Non-Financial Examples of Self-Defeating Behavior
The Yo-Yo Dieter
: Everyone knows someone who is overweight and has tried on numerous occasions to lose weight but has not been successful. I'm not talking about the rare individual with such a severe problem that gastric bypass surgery or other drastic measures are needed, but rather the person who is 30- to 50- to 100-pounds overweight and systematically fails at weight loss. I'm also not talking about the uninformed person who does not know the amount of calories contained in food or the unhealthy effects of carrying around extra pounds.

The people I am considering know that what they are putting into their bodies is making them overweight. These unfortunate folks have often been traveling on a yo-yo or riding on a rollercoaster of diets: losing pounds then gaining pounds, gaining then losing, and back again. Through the dieting process, these people get educated on the calorie counts of food and, by doing so, consciously know how much extra food is going into their bodies in terms of the calories they eat per day. They also know that they don't eat enough fruits and vegetables (or none at all) or exercise enough (or not at all).

Attempts at a quick fix are therefore attractive, however unsustainable these types of diets may be. We've all heard about diets such as all meat or no meat or a host of others that work for a while but eventually fail as the old behaviors and the accompanying pounds come back. At some point, these folks just give up and say to themselves that they can't do it, and they just go on with life with the extra pounds. As with spending money, delaying the gratification of eating can be difficult.

The Educated Smoker: Have you ever met a doctor or other health professional who is also a smoker? This one astounds me. How can it be that people who have devoted their lives to the health and well-being of others can treat their body so carelessly?

As a teenager, I would play sports with my friends in my backyard and witness my next-door neighbor, a doctor, chain-smoking on her porch. I knew even at that age the health risks of smoking, and I could not understand for the life of me why she smoked (I knew she had to know the risks involved).

Later, when she was in her 40s, I heard she had died of lung cancer. This shocked me, but when I thought about it, I realized it shouldn't have come as a surprise. To this day, I still remember a poster in the hall of my middle school that showed an elderly, wrinkled, lifeless person holding a cigarette with the caption "Smoking is very debonair" across the bottom, which was meant to deter youngsters. It was shock treatment at an early age, and it worked.

So how is it that a well-trained doctor, with full knowledge of the health risks of smoking, chain-smokes herself to an almost certain death? As with the yo-yo dieter, there are psychological as well as physiological reasons why people who know smoking is bad still engage in the act. For many people, smoking is a reliable lifestyle coping tool; for others it's an addiction. In any case, controlling this behavior is difficult and there are lessons that can be learned when relating this concept to the financial world. In next month's article, we will review three examples of financial self-defeating behavior .

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

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