Helping your clients with financial decisions during market volatility
During times of crisis, it is important for financial advisers to be a voice of reason. As one expert notes, it is sometimes hardest getting clients to do nothing.
Some clients are experiencing challenges as markets fall as a result of the COVID-19 pandemic, while others may by relatively insulated and looking for investment opportunities. In both cases, it can be useful to apply a behavioural finance lens.
Tracey West, a Griffith University lecturer and expert in behavioural finance and wealth management, has several pieces of advice for financial advisers who hope to reassure clients and assist them in making financial decisions during this time of crisis.
With the ongoing economic disruption and market volatility certain to make some clients anxious, it is essential that advisers are the voice of reason and logic.
This means educating clients in the long-term trends of markets, and how that will affect the investment strategies they consider.
“In most cases though, the best course of action when in doubt is to do nothing. However, doing nothing can often be the hardest thing to do. It’s important the adviser remind the client of the original plan and the rationale behind it,” she explains.
Wealth versus health
This also means being prepared for the reactions investors may have when markets fall and how loss aversion instincts can leave usually rational clients susceptible to exiting at the bottom of a market cycle.
“People feel losses more than a gain of the same magnitude. It’s the emotional response to witnessing market volatility that can cause clients to want to act. Unfortunately, the action they want to take may not be aligned to their investment goals,” West says.
For the adviser, this can be a difficult situation, as there may be a trade-off to make between wealth and health.
“Money stress can cause serious anxiety. If a share portfolio and household income have taken a hit simultaneously, that person might need to act for reasons that include reducing stress,” she says.
“Otherwise, the adviser can focus the client’s attention on long-term trends. This puts the focus back on achieving the goal and not compulsively checking the portfolio account or market news on a regular basis. It may also mean considering other options like delaying retirement.”
Preparing for volatility
By illuminating the psychological influences on investor behaviour (and subsequent market movements), behavioural finance can be used by advisers to help investors make better decisions. For instance, inexperienced investors have a tendency to get caught up in the short-term hype and want to follow what other investors are doing. This herd mentality is often influenced by emotion rather than facts and can lead to poor investment decisions. It is important that advisers are mindful of this behaviour and are able to respond with fact-based advice.
West believes behavioural finance is a lens advisers can use to help clients avoid unwise decisions and refocus on important decisions around saving and spending, portfolio construction, asset pricing and market efficiency during tumultuous periods.
“Advisers need to lay a solid foundation by developing the client-adviser relationship in the good times,” she says. “Education around the potential range of market outcomes over long periods of time is important to set up expectations about any end result.”
To do this, West suggests when advisers meet with their clients, they prioritise updating their clients’ risk profiles as their perspective may change as they move through different phases of the lifecycle.
“Clients have more feelings about risk and loss than thoughts about it,” she says.
In many cases, clients will expect their adviser to be thinking about risk, rather than themselves.
“So active listening is key to understanding how your client may react during a crisis and preparing them for it in advance.
“For example, in a ‘good times’ meeting, the adviser can lead a discussion on what each party wants from the other in a crisis and include this plan in the documentation the client receives.”
By viewing risk tolerance from a behavioural finance perspective, advisers can identify not only how clients may react to known risks but also to unknown risks, which are far more likely to alter an investment plan.