Advisors often find it more difficult to deal with behavioural aspects of their clients than making a financial plan for them. This is because when it comes to investments, the emotional part seems to hold sway over the rational one in decision-making.
Let us understand what are the most common behavioural biases and the possible ways to deal with them.
Mistake 1: Due to overreaction bias
Often investors tend to overreact to events and information and pull out their money at the first sign of trouble. In such a scenario, advisors have to deal with investors’ habit of giving overdue weightage to news flow, most of which by definition focuses on adverse news.
Solution: IFA Azeem Jagani of Composite Investment Services feels that since the client is giving undue importance to news, advisors must start by acknowledging what the client is getting right. If clients feel shot down, they are less likely to listen.
Gradually, the advisor can include additional information and place its impact in the larger context. This can help mitigate the tendency to react too strongly.
Mistake 2: Focusing on short-term performance
Often investors initially agree to stay invested for the long term. However, that long-term focus does not necessarily mean they are not looking at short-term performance.
Solution: IFA Sadshiv Phene feels that in such a scenario, advisors must get their clients back to a long-term frame of mind. To begin with, ask clients if their long-term goals or time horizon have changed. If not, remind them of the reasons of their allocation.
A face-to-face expression of reassurance is much more likely to be effective than sending a binder full of charts and statistics. Storytelling is also another effective tool for easing client anxieties.
Moreover, advisors should work with the client right from the beginning to build a comprehensive financial plan and shed any irrational expectations.
Mistake 3: Following the herd
A lay investor is likely to follow other investors as this gives him a sense of security. As a result, such investors end up buying when the market is high and then sell in a panic when things start to go south.
Solution: In order to counteract the behaviour, advisors have to find another way to make clients feel confident about their investments.
Gajendra Kothari, MD & CEO, Etica Wealth Management said that he often shows his own portfolio to win the client’s trust.
Moreover, advisors can also give examples from the recent past to explain their point. Suresh Sadgopan, founder of Ladder7 Financial Advisories, said that he often cites the example of crypto currency. And asks investors what would have happened to their investment had they followed the herd and invested in crypto currency?
Mistake 4: Confirmation bias
Confirmation bias is the habit of noticing information that affirms your beliefs, while ignoring contrary information. Let us assume that a client is convinced about the prospects of a certain company. Now, he will only pay attention to positive indicators such as strong recent performance, while not paying attention to negative indicators such as a high price-to-earnings ratio.
Solution: As with overreaction bias, the advisor needs to find a way to affirm what is correct about the client’s beliefs while also providing additional information that gives a more complete picture.
Suresh Sadgopan said that he often give such clients homework to research the position contradicting the belief they currently hold. This process may not necessarily change their thinking completely, but it at least encourages them to be a bit more objective in evaluating new information.
This feature has been presented by JM Financial Services, as a part of its investor awareness initiatives.
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