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How Advisors Can Help Clients Overcome Behavioral Biases

Behavioral Finance

Being easily influenced by recent news is one of the most common behavioral biases that impact investing decisions, but helping clients overcome such bias remains an ongoing challenge.  

That’s one finding from the BeFi Barometer 2019 survey of 301 financial advisors. The survey sponsored by Charles Schwab Investment Management (CSIM) and conducted in collaboration with the Investments & Wealth Institute and Cerulli Associates set out to learn how advisors view and use behavioral finance when working with clients.

In the resulting white paper, “The Role of Behavioral Finance in Advising Clients,” the firms advise that understanding the various ways behavioral tendencies can impact investors is fundamental to building a successful wealth management practice. 

“With the prospect of increased volatility and lower returns on the horizon, advisors who understand the psychological or emotional factors that predispose investors to behavioral biases can differentiate their services in what is becoming an increasingly competitive environment,” explains Omar Aguilar, PhD, Chief Investment Officer of Equities and Multi-Asset Strategies at CSIM.

According to the results, the top five behavioral biases that advisors say significantly affect their clients’ investment decisions are:

  • Recency bias (being easily influenced by recent news or experiences): 35%
  • Loss aversion bias (playing it safe or accepting less risk then they can tolerate): 26%
  • Confirmation bias (seeking information that reinforces their perception): 25%
  • Familiarity/home bias (preferring to invest in familiar/U.S. domiciled companies): 24%
  • Anchoring bias (focusing on a specific reference point when making investment decisions): 24%

Biases by Generation

The survey results also suggest that vulnerability to specific behavioral biases varies by client age. Advisors say they observe that the following biases are most prevalent within each generation:

  • Millennials: Framing bias (54%)
  • Gen X: Recency bias (64%)
  • Baby Boomers: Anchoring bias (75%)
  • Silent Generation: Familiarity/home bias (84%)

Asher Cheses, Research Analyst, High-Net-Worth at Cerulli Associates, notes that recognizing behavioral biases is an important first step. “Advisors who incorporate behavioral finance principles into their practice can help their clients put guardrails in place to avoid irrational decisionmaking and better adhere to a long-term financial plan,” Cheses explains.

Mitigating Behavioral Biases

In asking advisors what the most effective methods are to help clients avoid the impact of behavioral biases, nearly two-thirds (62%) cite helping clients take a long-term view as a “very effective” strategy. This is true particularly in periods of volatility, reminding clients of their investment goals and ensuring they adhere to a sensible financial plan can help them reduce emotional reactions and avoid making poor investment decisions, according to the study.

Advisors also cite implementing a systematic process (e.g., automatic rebalancing) and a goals-based planning approach as effective strategies to help take the emotional decisionmaking out of the process and reduce the likelihood they will overreact to a drastic market move.

The research also highlights that it is important for advisors to not only understand client biases, but also be cognizant of their own. Advisors ranked loss aversion (29%), overconfidence (17%) and confirmation (9%) as the top three biases that impact their own perspectives and decisionmaking.

Bridging the Gap

Notably, nearly three-quarters (71%) of advisors surveyed say they incorporate behavioral finance principles into their client communications and interactions, while just 58% say they apply the concepts to portfolio construction.

The survey results indicate that advisors are aware of the benefits of incorporating behavioral finance principles into their practices. Nearly half (46%) of respondents indicate that incorporating behavioral finance allowed them to better manage client expectations, while 40% say this gives them the ability to reduce their client’s short-term emotional decisions.

Many advisors also say, however, that they lack the resources and tools to bridge the gap between the concept and practical application. Nearly two-thirds (65%) of respondents say the primary reason they don’t integrate behavioral finance into their practice is because they have difficulty translating behavioral theory into implementation. 

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