A steady, educational approach should yield positive results for your Independent behavioral investor type clients.
This month's article is the 11th in a series called "Building 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).
Individuals are different in the way they process information, vary in the way they behave when faced with a financial decision, and have different risk preferences, so 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.
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 because they don't understand what is truly important to the client and how to communicate and interact in a way that is meaningful and effective.
As you know by now, 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 the simple concept of investor types, which I refer to as "behavioral investor types," or BITs. BITs are defined in large measure by the biases themselves and are categorized in a way that makes intuitive sense and can be easily understood.
There are four behavioral investor types: the Preserver, the Follower, the Independent, and the Accumulator. In the last article, I reviewed the Follower BIT. In this article I will review the Independent BIT.
Independent Behavioral Investor Type
An Independent BIT describes investors who have original ideas about investing and like to get involved in the investment process. Unlike Followers, they are not disinterested in investing. They are quite engaged in the financial markets and may have unconventional views on investing. This "contrarian" mindset, however, may cause Independents not to believe in following a long-term investment plan, though many Independents can and do stick to a plan to accomplish their financial goals.
At their essence, Independents are analytical, critical thinkers who make many of their decisions based on logic and their own gut instinct. They are willing to take risks and act decisively when called upon to do so. Independents can accomplish tasks when they put their minds to it; they tend to be thinkers and doers as opposed to followers and dreamers.
Unfortunately, some Independents are prone to biases that can torpedo their ability to reach goals. For example, Independents may invest too quickly, without learning as much as they can about their investments beforehand. For example, they may mistake reading an article in a business news publication for doing original research. In their half-ready, full-on pursuit of profits, they may leave some important stones unturned that could trip them up in the end.
Independents' risk tolerance is relatively high, and so is their ability to understand risk. Independents are realistic in understanding that risky assets can, and do, go down. However, when their investments go down, they don't like to admit that they were wrong or that they made a mistake (sound familiar?).
Independents often do their own research and don't feel comfortable with an investment until they have confirmed their decision with research or some form of corroboration. They are comfortable collaborating with advisors, though typically they use advisors as sounding boards for their own ideas.
Independents are often comfortable speaking the language of finance and understand financial terms, including market- and economy-related terms. They aren't afraid to delve into the details of investments, including the costs and fees of making investments.
Upside and Downside to Independents
There are certain benefits that accrue to Independent BITs. At their essence, Independents are cerebral, strong-willed, independent thinkers who aren't afraid to put their investment ideas into action by implementing them in their portfolios. Successful investing requires the fortitude to not only have original ideas but also be able to put them into action when called upon to do so; Independents can take risks and act decisively.
Independents can also be contrarian investors and can be very successful, since there are many investors who are herd followers (and are often not happy as a result). As they are analytical in nature, Independents may help themselves by finding the lowest-cost service providers. They tend to be thinkers and doers, as opposed to followers and dreamers.
The downside to the BIT has mainly to do with biases that can torpedo their ability to reach their financial goals. As we will see in the next section, Independents can act too quickly without taking the time to learn as much as they can about their investments before making them. They may also seek information that confirms their decisions as opposed to finding information that may contradict their hypotheses. They may also irrationally cling to their self-generated ideas as opposed to being open to new ideas that may prove they are wrong. Their analytical nature may actually work against themselves at times. For example, some Independents may focus too much on taxes and not enough on selecting an appropriate investing strategy. In industry parlance, this is known as "letting the tax tail wag the investment dog."
Advice for Independents
These can be difficult clients to advise due to their independent mind-set, but they are usually grounded enough to listen to sound advice when it is presented in a way that respects their independent views.
As we have learned, Independents are firm in their belief in themselves and their decisions, but can be blinded to contrary thinking. As with Followers, education is essential to changing behavior of Independents, as their biases are predominantly cognitive.
A good approach is to have regular educational discussions during client meetings. This way, the advisor doesn't point out unique or recent failures, but rather educates regularly and can incorporate concepts that he or she feels are appropriate for the client.
Because Independent biases are mainly cognitive, education on the benefits of portfolio diversification and sticking to a long-term plan is usually the best course of action. Advisors should challenge their Independent clients to reflect on how they make investment decisions and provide data-backed substantiation for recommendations. Offering clear, unambiguous education is an effective approach. If advisors take the time, this steady, educational approach should yield positive results.
In the next article I will discuss the Accumulator BIT.