How to Advise the Accumulator Investor Type

This is the eighth article in a series focusing on behavioral investor types and is 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.

Last month, we reviewed the case of Gary Rossington, a high-net-worth individual. Here are some of the salient points about the case:

• Rossington is a single (divorced) 58-year-old, hard-charging technology executive earning $1.5 million per year.

• He lives extravagantly, spending nearly three fourths of his annual income, but has managed to save approximately $20 million. Additionally, he received some inheritance along the way.

• Rossington had a mild heart attack last year but now seems to have almost fully recovered. His primary financial goal is to retire comfortably at 65 and to donate $5 million over time to a healthcare foundation. He does not plan to decrease his spending in retirement.

• The other assets will be used to fund his living expenses and provide $3 million inheritance for each of his three sons; two of his sons are professional business people, and one is an artist who occasionally needs money and has a history of medical problems.

• You have proposed a moderate spending and investment plan. Nevertheless, Rossington refuses to agree on your plan because he prefers to spend the money today on his lifestyle instead of planning for tomorrow's goals and investing in a risk-tolerant way.

• His current allocation consists of nearly 85% equities, 10% bonds, and 5% cash. Your concern is that a severe and sustained downward market fluctuation or another health scare may jeopardize Rossington's ability to meet his financial goals.

• He has invested in two venture capital technology deals brought to him by friends at his tennis club who are also in the technology industry. For one of these investments, he sits on the board of directors; he has already put more money into the deal because the company needed a second cash infusion.

• You are concerned that his aggressive allocation combined with his high level of spending may lead him to sell assets when markets are down. You suspect his discomfort at the prospect of reallocating his portfolio is due to one or more behavioral biases.

To better understand his situation, we are going to answer the following questions and then will provide a suggested solution to his investment situation.

1. What is his behavioral investor type?

2. What behavioral biases might drive Rossington's behavior and decision-making? What specific evidence leads you to this diagnosis?

3. How might 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 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?

Case Study: Answers to Questions Rossington's biases are very consistent with an accumulator behavioral investor type, or BIT. We know that he is an accumulator because, based on the descriptions in the case study, he exhibits the following biases:

• Overconfidence bias--the tendency to overestimate one's investment savvy.

• Affinity bias--the tendency to make an investment not based on economic soundness but rather because you have an affinity for the investment (friends, familiarity, and so on).

• Self-control bias--the tendency to spend today rather than save for tomorrow.

• Illusion of control--believing that one can influence events that are actually out of one's control.

The accumulator behavioral profile leads to a clear allocation preference for risk. Because he tolerates high risk and engages in high spending (overconfidence), invests in risky venture capital deals (affinity), and places a premium on spending today versus saving for tomorrow (self-control), he naturally prefers the current risky asset allocation. Also, Rossington believes he can control the outcome of his investments (illusion of control) and may be taking more risk than he understands; he has dismissed any attempt by advisors in the past (including you) to decrease his exposure to risk assets.

Rossington might outlive his assets if he adheres to his “spendy” ways, and your financial planning confirms your fears. His level of wealth, while adequate at present, may not last in the long run, especially if he has to sell assets at the wrong time: during a severe market downturn. So, if you adapt to his biases--consent to stick with his risky allocation and ignore his high spending--then Rossington's financial goals may become jeopardized. His biases are principally emotional (self-control, overconfidence, affinity) and typically cannot be corrected with advice and information.

It is therefore your task to make a blended recommendation--one that takes into account his financial goals while at the same time accounts for his emotional (difficult to correct) biases. Therefore, you decide that a reasonable compromise allocation is 65% equity, 10% cash, and 25% bonds. You also plan to recommend that he reduce his spending. You call him to schedule a meeting to go over your recommendations. When you have the meeting, you decide that you will accomplish the following as it relates to explaining your recommendations and his reactions to them.

• Listen--Seek to understand. Listen actively.
• Clarify--Confirm your understanding of his desires and ask clarifying questions to go deeper.
• Empathize--Summarize your understanding and demonstrate you see his perspective. If appropriate, acknowledge his feelings about the topic.
• Explore--Rationally explore the alternatives to consider.
• Answer--When you make your recommendation, explain why it is the rational choice.
• Connect--Connect the recommendation to the vision of the goal by inviting the client to "imagine" what success will feel like.
• Check--Check for agreement.

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.