Advisors can’t prevent investor biases, but they can help guide reactions

Everyone has biases and understanding them is part of the advisor-client relationship. Omar Aguilar, Chief Investment Officer of Equities and Multi-Asset Strategies, discusses the importance of advisors knowing their clients to help them avoid potential behavioral pitfalls.

Essentially quite interesting, the results that we have for the survey. And you know in many cases a lot of that is related to behavioral finance. And there is two types of behavioral finance that usually have biases that people have. Either emotional or they're cognitive. What is interesting about this is that the two that ended up at the top, both availability bias and confirmation bias are both cognitive type of biases in behavioral finance. The third one is loss aversion.

Now, if you were to ask the same question now after the market is down 10%, I got to believe that the loss aversion will be number one. A lot of what has happened is the function of the market being up so much for the last seven years has actually driven a lot of advisor's behaviors and a lot of their views.

So let's start with availability bias. Availability bias is usually the bias where you tried to find information that is available to you and you don't need anything else other than that information to make your next decision. That's very typical. If you have a bull market that goes up and you actually wake up every morning and you see the future is going up, the market ends up. Of course, that's going to give you enough information to know what your next move is and you will see people moving money into equities, we'll see risky assets and that's typical availability bias.

Second is confirmation bias. Confirmation bias is that when you actually find other ways to confirm your own decision. Usually that happens after you made the decision. This happens to me every time. Usually I try to make a decision and then I go to my wife to make sure that she confirms what I'm saying. That's usually the typical behavioral that most people have. An investment actually works the same way. Advisors usually try to make a decision and then try to look around for any information that confirms what they made. Again, very typical cognitive bias that you see out there.

The last one is loss aversion. That's very typical. That's emotional. That's usually something where people get worried about losing capital. People get worried about potentially having effects on their wealth or what may happen and there's all kinds of those biases that are out there. That's very typical, especially when you have assets being involved and risk in the markets.

We do a lot of work related to demographics. We tend to evaluate how behaviors and different biases change depending on the generations you are. You know, we know the traits of each generation, the baby boomers, highly competitive. There tend to be a lot of them and therefore they're very entrepreneurial. They love to take risks. They have to elbow each other because that's how they were raised. You have the millennials. The millennials tend to have a very different trait. Different trait where they basically tend to be less excited about the market. They tend to be more conservative about their investments. They tend to be less trusting about what happens out there. But at the same time, they're very influenced by social media. They're very influenced by their friends, even though they don't necessarily have deep relationships, they tend to actually pay attention to what is going on in the world.

So herding is the typical bias. And again, it's a typical, more emotional, more than cognitive, where people tend to look for what's going on around them and they don't want to miss out. It's a typical, I don't want to be left out of what everybody's doing. And millennials tend to drive a lot of those, and especially advisors when they tried to look around and see, all right, how many stars, how many likes do they have? Is this the right decision for my client? And usually even though they may know that that's the right thing to do, they will look for ways to see what other people have done before they can make those decisions. So, herding tends to be just the fear of missing out. The typical FOMO.

The reason why millennials are, in a way, a little more skeptical about risky assets is because how they live or how they have seen as they were growing up. One of the areas that I always try to look for is if you look at the history of baby boomers in the market, usually they go from being in a bull market, a little bit of a correction and another bull market followed by another bull market. And that's how they lived from the time they were in elementary school all the way to when they got their job.

If you think about the millennial experience, it's a completely different one. Usually when they go into high school, they saw the first crash of the market. They probably brought changes in their lives. Then as soon as they went into college, they basically graduated from college, we had the 2008 financial crisis, they couldn't find a job. And then all of a sudden, they get a nice period and now they see another crash in the market. So even though it's been better since 2009, it's still, the skepticism in their lives is something that actually has not been as prevalent as it is for the other generations. So that's a big part of it.

First of all, everybody has biases. All clients will have biases. They just need to understand what kind of client you're dealing with. Different clients that have different experiences, different clients have different preferences. So, guess what? The advisors, there are also human. They also have biases. So, in many ways a big component of this business is related to how your own biases as an advisor relate to your clients. Learning overall what is the biases of your client is a big part of making those relationships last longer. So, learn your client, better understand what kind of client you're dealing with. If it's certain an emotional biased client or if it's a more cognitive bias, they have different ways to deal with it.

The number one advice I would provide is to say, maintain a very clear, disciplined process that allows you to mitigate a lot of those biases. Most of the behavioral biases can be mitigated by creating an investment process that is repeatable, that will allow you to have a rule, anytime that things go out of whack, you actually have a plan. Try to create those plans ahead of time. Make sure that you establish a clear communication with the client to make sure that you keep them in constant view of what is going to happen and remind them anytime that you see volatility in the market, we talk about this. You don't have to panic. I know it's unnerving, but we talk about at the plan and try to make sure that you adapt to those pieces.

At the end of the day, it is you have to make a balance between what the client needs and what the client wants and that is the balance of the advisor. The advisor is in between trying to understand how they mesh the two to make sure that the client is getting the best advice possible.

Related Content

Survey reveals advisors’ attitudes toward behavioral finance

CHART: Are behavioral finance biases sabotaging your clients’ future?

Biagnostics®: Behavioral finance meets client experience

PODCAST: How cognitive and emotional biases can impact a financial plan