Key points

  • Investment plans that ignore, or pay only the whisper of lip service, to investor behaviours, are ultimately futile. Ultimately, the true job of a financial adviser is not to give clients a theoretically ‘optimal’ solution, but to give them the best solution they could realise in practice.
  • An investor’s feelings are part of an investment’s total return. In investing – and in financial decision-making generally – the right thing to do for long-term financial wellbeing is invariably an uncomfortable thing to do.
  • A suitable investment portfolio should be judged not only by whether it could ultimately afford the investor the opportunity to do what they wanted to do when they put the plan in place but also by how the investor felt during the journey, and the costs of all those emotional deviations from the plan along the way.

What should be accounted for in an investment return?

An investor may well ask why they should bother with any attempt to shoehorn behavioural evaluation, education and insights into the investment process. After all, people invest to make more money than they could without investing – so just pick investments that are going to make money and forget about the questionnaires and the psychobabble.

There is certainly a market for this view. Think of those businesses that offer a single fund, or perhaps a very limited choice of funds, with discretion to invest in whatever they believe will deliver the returns their clients want, tailored to nothing but the company’s internal analysis. Think too of the advisers – and the clients – who believe the client’s emotional state is no business of the adviser.

This, though, is like asking a personal trainer what to eat or what to do at the gym, without providing any indication of whether the goal is to get strong, or fast, or thin, or big, or flexible, or live to see 100. And, most crucially, providing no indication of what sort of plan the client will actually stick to.

The best health advice will concentrate not on the minutiae of macronutrient ratios, say, or the exact number of minutes to spend moving (not that these may not be helpful), but on building healthy habits, thereby ensuring adherence to a plan, and ultimately making success easier than failure. Minutiae are an irrelevance here if the individual never manages to make the leap from theory to sustained practice.

The same is true in investing. The results may not be quite so noticeable as the changing body in the mirror, but the behaviours that will ensure success or failure are just as familiar, and plans that ignore, or pay only the whisper of lip service, to those behaviours, are ultimately just as futile. The best financial advisers are those who have actually met a human being and start from the assumption each client is one.

An investor’s feelings are part of an investment’s total return. In investing – and in financial decision-making generally – the right thing to do for long-term financial wellbeing is invariably an uncomfortable thing to do. Investors, being human, will have anxiety along the investment journey, which will drive them to seek comfort somehow.

Some emotions will be so severe the ‘solution’ will be to abandon the whole journey. Some will be tempted into less drastic, but still financially costly, measures, such as delaying investing, over-trading, or incurring a costly behaviour gap through buying high and selling low. Some will just suffer in silence, paying not in money, but in mental fatigue. All of these costs are real and should be considered, both in their effects on the investor’s actual realised returns, and in taking preventative steps that limit the price being paid.

A suitable investment portfolio should be judged not only by whether it could ultimately afford the investor the opportunity to do what they wanted to do when they put the plan in place but also by how the investor felt during the journey, and the costs of all those emotional deviations from the plan along the way. The real-life return the investor actually receives is vastly more important than the theoretical one a plan could have delivered. The first hurdle for any plan is being able to stick to it.

The financial services sector is keen to highlight the importance of risk-adjusted returns. From the viewpoint of the investor, however, it is not risk-adjusted return that matters as this fails to consider the investor’s feelings along the way.

It is instead the anxiety-adjusted return against which a plan needs to be judged. Human investors simply want the best return they can get, relative to the stress, anxiety, and discomfort they are going to have to bear along the journey.

We can help investors reach this objective both by reducing anxiety and increasing returns. Those who ignore this ignore their clients’ humanity. The key is acknowledging each investor’s need for emotional comfort ahead of time, and proactively purchasing it in a planned, personalised, precise, and low-cost way, rather than watching them panic-buying their way back to comfort by panic-selling under stress.

Anxiety may be reduced by lowering risk, but this is often much more costly for long-term financial returns than using behavioural interventions and better communication to improve emotional comfort.

One way or another, we all buy emotional comfort at the cost of long-term returns – maybe through no other mechanism than that we are all more prone to mistakes when we are stressed. And each investor’s personality will make them prone to anxiety in specific ways.

By using psychometric assessments to establish each investor’s unique financial personality on multiple dimensions – not just risk tolerance – we can determine what makes each most emotionally uncomfortable, what is most likely to provide that comfort, and then deliberately aim to deliver it in a cost-effective way. Prevention is better than cure.

Preventative measures

The exact prescriptions for these preventative measures will differ for each patient, depending on their identified behavioural traits and tendencies. Just as some will avoid eating junk most effectively with a support group while others would rather work away in isolation, some behavioural interventions could target the portfolio itself by tailoring which asset mix will make the investor most comfortable, while others could tailor communication to help investors cope with times of market stress.

A rich financial personality profile allows each investor’s portfolio and adviser engagement to be deeply personalised and tailored to their needs, providing both financial returns and emotional comfort.

Ultimately, the true job of a financial adviser is not to give clients a theoretically ‘optimal’ solution, but to give them the best solution they could realise in practice. Ignoring the investor’s feelings, emotions, and need for comfort, and aiming only for financial returns means setting them up both for an unpleasant journey – and for failure.

There is nothing rational about offering a theoretically perfect solution in the knowledge that, as an imperfect human, the investor will fail to last the distance. Instead, the rational path is to provide an accurate diagnosis of the best strategy each investor can stomach, and then offer an appropriate prescription, be that changes to the portfolio, to its presentation, or to the decision-making process and interactions that define the adviser-client relationship.

Originally published in Professional Adviser on 21/3/2019.