Getting Clients Off the Sidelines

After experiencing nearly 30 years of benign, cooperative capital-markets behavior, today many financial advisors are baffled or frustrated by how difficult it has become to get clients to accept new investment ideas.

The market correction of 2008 and 2009 and the ensuing economic and political volatility have revealed that many advisors don’t understand what motivates clients and don’t know how to craft messages that get clients to make necessary changes in investment behavior.

You’ve most likely heard about the two primary motivators of human behavior, fear and greed, and how they correspond to the core motivators, pain and pleasure. But when working with investors, there’s a complication: time. Fear and greed are emotions of anticipation; we anticipate pain or pleasure in the future, and we organize our behaviors as best we can to avoid pain and pursue pleasure.

Unfortunately, when it comes to making investment decisions, the actual dynamics of motivation are a bit more complicated, and this is why advisors are struggling today. Most advisors don’t understand the differences between motivational forces that worked in the past and those that can work today. But if we can understand more accurately how humans cope with anticipating various outcomes, we can structure our messaging to be more effective at getting clients to take the right kinds of actions.

What the Research Reveals

As Daniel Kahneman discovered, when it comes to investing, pain motivates behavior twice as much as pleasure: “The response to losses is stronger than the response to corresponding gains.” This is the essence of loss aversion—humans are hard-wired to feel the pain of a loss much more profoundly than the pleasure of the same amount of gain. Kahneman’s research is compelling, but until recently it’s been difficult for advisors to realize how this part of human nature affects client management.

In the past, the positive effects of capital markets disguised this element of client behavior. For the last three decades, capital markets were remarkably benign. In the absence of meaningful pain and after years of anticipating reliable and robust, positive returns, advisors rarely saw clients in a full-scale loss-aversion reaction. When they did, they were likely to chalk the reaction up to a lack of maturity on the part of the investor, not to a deeply rooted aspect of human nature. 

Pleasure is a primary motivator of human behavior, and anticipating positive results does cause investors to take action, but only when there’s no pain or fear of loss. Once investors experienced how quickly and deeply the markets can inflict pain, it became impossible for them to respond to greed-based messaging. After 30 years of lulling investors (and their advisors) into a false sense of positive expectations, the “real” markets showed their fierce side in 2008 and 2009 and, in spite of offering attractive returns over the years since then, investors will never be the same.

So What’s an Advisor to Do?

Actually, the last sentence is misleading; investors will be the same, eventually, once they learn the painful lesson about volatility and loss. In other words, when afraid of losing money, investors will tend to enter and leave the markets on the basis of loss aversion. This also means that fear will be a more powerful motivator than greed.

This dynamic is critically important for advisors to understand, because it defines the kind of messaging that you will need to use to get your clients to take the actions you believe they need to take. After 30 years of appealing to the feelings of greed, opportunity and positive anticipation of future outcomes, it’s very difficult for many advisors to shift gears and message to the primary motivator: fear. By looking more deeply at this dynamic and understanding some basic concepts, we can create a road map for messaging.

Taking a Closer Look

To build better messages, we need to start with a more detailed understanding of investor behavior. For most advisors, the power of loss aversion to push clients out of the market makes perfect sense. After days or weeks of declining prices, the pain of loss becomes too great, and the investor capitulates. He calls his advisor and instructs him to sell everything “until the markets start to recover.” Today there are trillions of dollars sitting on the sidelines waiting for some signal that markets are “back to normal.” Plenty of writers have addressed the issue of how damaging to long-term results this kind of “in and out” behavior can be—we don’t need to reiterate this message.

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