Investors Need Continuing Education, Advice

Janet Kidd Stewart

As we learn more about what makes investors tick, will it move them? Calling on financial advisers to take a closer accounting of how investors’ mental errors can roil markets and personal portfolios, AllianceBernstein Capital Management Chairman Lewis Sanders recently devoted his keynote address at the Morningstar mutual fund industry conference to research on behavioral finance–and what to do about it.

“Good [investments] alone aren’t enough if investors aren’t using them intelligently,” Sanders said. Investor emotions move markets and can drag individuals from one implausible scenario to the next, he said, noting a string of behavioral research studies showing irrational investor decision-making.

Among them were studies showing investors trade too much. Others found investors, to their detriment, overreach for certainty and gamble too much to avoid losses. They find abhorrent the notion of rebalancing a portfolio, or periodically siphoning off winning investments into comparative poor performers that might have more potential. They follow trends like lemmings, often misreading market information and forming opinions based on too narrow of a time frame.

“Investors are not terribly introspective,” Sanders said, urging financial advisers to help investors tune into their mental shortcomings. “As advisers, quality is not in the investment return alone. Looming large is how clients feel along the way,” he said, adding that advisers should view this duty as a way to keep clients from destructive behaviors.

Advisers, for their part, report that effort is already under way, with mixed results.

“From a psychological standpoint, investors are becoming more savvy, but too many are learning just enough to be dangerous to their portfolios,” said Ty Bernicke, a financial planner in Eau Claire, Wis. They may know that aggressive trading often lowers returns, for example, but don’t have a grasp of basic investing tenets such as asset allocation–so they get stuck in an undiversified portfolio too long.

Learning about our biases educates us, but doesn’t eliminate them, said David B. Yeske, a San Francisco planner and past president of the Financial Planning Association.

“Nothing we’ve learned about behavioral finance has changed the way the human brain is wired,” Yeske said, referring to the field of economics that studies the impact of emotional factors on markets and investing.

For evidence, he said, just look at the real estate boom that is spurring more people to leverage their mortgages to buy additional properties or support fancier lifestyles.

“This is a prime example of behavioral bias,” he said. “I have several clients who have bought [investment] properties in Arizona and their impulse has been to take out equity immediately and buy another property.”

Investors have a tendency to load up on previously winning investments, but Yeske said he is managing at least to persuade clients to sell one property before buying another to limit their exposure. It’s not much, but it’s a start, he said.

“You can’t succeed by trying to work against people’s biases,” he said. “You have to plunge deeper in and work with what’s there.”

Often, it means dredging up old family taboos about money, he said, such as lingering aversions to certain types of investments based on bad experiences with them in previous generations. “Often, you have to reframe their whole outlook about money,” Yeske said. “Rather than arguing with them about embedded attitudes about a certain investment, you create a broader context for talking about outcomes.”

When clients became skittish about stocks during the market correction in 2000 and felt as though they had to react by selling off certain ones, he said, he convinced them instead to redirect that nervous energy into reviewing their overall financial plans.

“They realized that a shaky market wasn’t going to push them too far off the mark in the long run,” he said.

But it can be a constant battle, said Wisconsin financial planner Bernicke. “Re-education is more important than ever,” he said.