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How Biases Impact the Behavioral Investor Types

Advisors need to be cognizant of the fact that emotional biases can appear at any time with any investor type.

Michael M. Pompian, 08/15/2013

This month's article is the eighth 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.

Updates to Behavioral Investor Type Theory
In the last article, we completed an in-depth illustration of a person's BIT. Similar to the psychological typing theories that we read about in earlier articles, BITs are models for various types of investors.

There are four behavioral investor types: the Preserver, the Follower, the Independent, and the Accumulator. Each of these types will be reviewed in detail; in fact, each has its own article later in the series, starting with the next article.

In this article I will provide some important updates I have made over the past year to the BIT identification process. This will set the stage for the next four articles that will review each BIT in detail.

Updates to the Behavioral Investor Type (BIT) Theory
When I first designed behavioral investor types, I built on my previous work by creating a natural grouping of various behavioral biases that created the foundation for each BIT. This involved a multi-step diagnostic process of bias identification that resulted in clients being classified into one of four behavioral investor types (BITs). Bias identification, which was done near the end of the process, was narrowed down for the advisor by giving the advisor clues as to which biases a client is likely to have, based on the client's BIT.

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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