Slideshows

6 Things Clients Get Wrong About Investing

The counsel of an advisor or financial planner, well researched and rational, often runs headlong into the strongly held yet irrational beliefs of the client.

Here are six widely held financial biases; for each one, we offer a chart designed to explain the bias and prompt a productive discussion with the client. (Click through to see the full list, or view as a single page here.) -- Carla Fried for YCharts

"I'll have enough money." "I'll have enough money."

Call it the money illusion: Clients think in nominal dollars and tend to minimize the impact of inflation on retirement costs. The above chart shows how the purchasing power of the consumer dollar has declined over the last 30 years. Show them this -- and then talk to them about a 30-year-long retirement.

"I can handle that loss." "I can handle that loss."

Show clients the performance differences among the various funds in order to tee up a discussion of the true risk of income investments to help prevent excruciating pain.

"I know stocks will keep rising." "I know stocks will keep rising."

Because of recency bias, clients tend to think that today’s investment trend will just keep on going -- so clients want to buy in a rising market and unload after a rout.

The red line on the chart above shows the percent of bearish sentiment among investors; note that it's now near a 10-year low. Help your clients be courageous when others are fearful and vice versa.

"I know how to pick a winner." "I know how to pick a winner."

Picking a winner persuades many of us just how right we were, cementing our judgment. The blue line on the chart above shows Apple's stock price, while the gray shading represents range between 52-week high and low. Note that the past year's rally created a wide gap between the current price and the 52-week low.

Help clients learn to beat overconfidence, objectively checking their decisions as conditions change.

"I know when to sell and when to stand pat." "I know when to sell and when to stand pat."

The disposition effect can inspire clients to sell winners too soon and hang onto losers, which a study showed costs investors dearly. As the chart above shows, just because Google's price has soared doesn't mean its value proposition has become worse. Help clients focus on a stock’s current and future value.

"I know that stock is coming back." "I know that stock is coming back."

I call it "get-back-itis": Clients want to hang onto stocks until they “get back” to that investor's purchase price -- or some other high-water mark. Show clients the chart above -- which shows the total returns for three major tech stocks after the dotcom-driven tech bubble, which burst in March 2000 -- to help them see the lost opportunity of dead-money stocks.

You can download a copy of the entire report by clicking here. Carla Fried has covered investing for more than 25 years, writing for The New York Times, Bloomberg.com and Money Magazine. Her twice-weekly YCharts columns are available at: ycharts.com/analysis

Understand the most common behavioral financial biases -- and know how to confront them when your clients are trying to sabotage their own portfolios.

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