Advising a High-Earning, Risk-Taking Pre-Retiree Using Behavioral Investor Types

This is the seventh article in a series focusing on behavioral investor types and intended to help advisors strengthen their relationships with their clients by helping them better understanding clients' financial personalities. Once advisors understand the various investor types at play, they can adjust their advisory approach for each type. 

We have reached the point in this series where you will practice applying your learning of behavioral finance using a fictional client case study. The key questions to be answered are:

• What personal biases might drive the client's behavior and decision-making?
• What is the client's behavioral investor type?
• How might the client's personal biases affect the investment strategy and solution decision?
• How should the advisor approach the client to moderate or adapt the impact of these biases?
• What is the best investment strategy and solution for the client?

For the case study, assume today's market environment.  That is, the U.S. stock market is fairly valued--not overvalued or undervalued.  Interest rates are rising.  Volatility is present in the market. 

As you read the case, try to identify any biases you see based on the fact pattern.  When solving for the investment strategy, for simplicity reasons, assume that all client portfolio allocations will be divided among three asset classes:  stocks, bonds, and cash. 

When thinking about the case, remember that every advisory relationship is unique, and there is no absolute way to understand and respond to client behavior and biases. Keep this in mind while reading and thinking about how you might handle similar situations in your own way with clients. Focus most on applying methods of behavioral analysis, investment strategy and solution proposal, and tailor your advisory approach to the given market and client situation.

Case Study: Situation
Mr. Rossington is a single (divorced) 58-year-old, hard-charging technology executive earning $1.5 million per year. He lives extravagantly (enjoying cars, travel, and his art collection) by spending nearly three fourths of his annual income, but has managed to save approximately $20 million. He has achieved these savings in large part because of his high income level and some stock options, along with an aggressive investment posture that, luckily, has produced more winners than losers. He also received an inheritance along the way.

Mr. Rossington had a mild heart attack last year but seems to have almost fully recovered. His primary financial goals are to retire comfortably at age 65 and to donate $5 million over time to a healthcare foundation. The rest of his assets will be used to fund his own living expenses (including alimony) and provide a $3 million inheritance to each of his three sons; two of his sons are business professionals and one is an artist who occasionally needs money and has a history of medical problems. Regarding his extended family, Mr. Rossington's parents are no longer living, and he has one sister who is married and financially secure. 

His current allocation consists of about 85% equities, 10% bonds, and 5% cash. Your concern is that a severe and sustained downward market or another health scare may jeopardize Mr. Rossington's ability to meet his post-retirement daily living expenses, (including health expenses), his donation and inheritance goals, and any possible support for his son who has requested such support in the past. Your experience tells you that with a more balanced portfolio, Mr. Rossington can continue with his current lifestyle and still meet his primary financial objectives.

You have been working with Mr. Rossington for two years. You have developed a good working relationship with him. You realize, however, that perhaps the reason you have a good relationship is because you don't pressure him too much to follow your recommendations. Given his health problems and financial goals, you have proposed a moderately conservative spending and investment plan. Mr. Rossington refuses to agree to your plan, because he prefers to spend the money today on his lifestyle instead of planning and saving for tomorrow's goals and investing in a more risk-tolerant fashion.

Mr. Rossington told you that he sees himself as a very successful investor because he is successful in business. He knows exactly what the best investment strategy is for him: high risk. You are also worried because over the past two years he has invested in two venture capital technology deals brought to him by his friends at his tennis club who are also in the technology industry. Mr. Rossington sits on the board of directors for one of these investments, and he has already put more money into the deal because the company needed a second cash infusion. 

Case Study: Analysis
Assume you are Mr. Rossington's advisor. Your job is to advise him on the best allocation you believe is appropriate for him given his unique circumstances and behavioral profile. You are trying to ensure that he feels comfortable enough with your investment solution that he will not decide to change it six months from now.

To help further analyze his situation and devise a plan, answer the following questions. In next month's article, we will review the answers to these questions and provide a suggested solution.

1. What behavioral biases might drive Mr. Rossington's behavior and decision-making? What specific evidence leads you to this diagnosis?
2. What is his behavioral investor type?
3. How might Mr. Rossington's personal biases affect the asset allocation decision?
4. How should the advisor approach the client to moderate or adapt the impact of these biases?
5. What is a reasonable allocation recommendation for Mr. Rossington? 
6. How should you as the advisor facilitate the client conversation so that the client makes a good and thoughtful investment decision and shows more consistent investor behavior?

Michael M. Pompian, CFA, CAIA, CFP, is the founder and chief investment officer of Sunpointe Investments, an investment advisor to family offices based in St. Louis, Missouri.  His book, Behavioral Finance and Wealth Management, is helping thousands of financial advisors globally build better relationships with their clients. Contact Michael at michael@sunpointeinvestments.com.

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