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.

We do need to consider the additional impact of another human behavior on investing: “inappropriate extrapolation.” This label describes our natural tendency to assume that a series of events or patterns will continue into the future in the same way they behaved in the past. Nate Silver warns about the limits of extrapolation in his book The Signal and the Noise: “Extrapolation is a very basic method of prediction—usually, much too basic. It simply involves the assumption that the current trend will continue indefinitely into the future.”

In his book Antifragile: Things That Gain from Disorder, Nassim Taleb offers a more colorful explanation in what he calls “The Great Turkey Problem.” His point is that by feeding a turkey every day, the butcher increases the turkey’s statistical confidence that it will be fed every day in the future. In short, both turkeys and human beings tend to project current patterns into the future—and they do this with good and bad experiences.

The important point is that the investor who has been spooked by a painful loss tends to feel as if the loss will continue forever. No amount of rational conversation will shift this emotional reaction. This is also the root of euphoric bubbles in the markets. This was precisely what happened prior to the correction of 2008: no matter how much an investor may study the history of the markets, when everyone else has been enjoying wonderful returns, the feeling of “I’m missing out” can overwhelm even the most prudent investor.

The Key to Messaging

What most advisors don’t understand is that it’s precisely this negative feeling that moves the majority of clients back into the markets. Once investors have been hurt by a major, unexpected loss, greed is no longer strong enough to counteract the loss aversion.

Originally, it was the feeling of loss and the fear of more losses in the future that drove the client out of the markets: “I’m going to lose all my money!” Importantly, it is also loss aversion that will ultimately cause the client to get back into the markets: “Everyone else is winning—I’m losing out!” This can be difficult to see in investor behavior because most people don’t articulate the thoughts behind their emotional reaction to rising markets. We prefer to think of ourselves as rational people who make thoughtful decisions, even when we are being thrown around by our emotions.

This, then, explains why messaging like “Here’s a great idea that will likely generate some meaningful outcomes in the near future!” no longer moves clients back into the markets. Intellectually, the investor will hear the message and may even agree, but the deep aversion to further losses interrupts his ability to respond. The key to messaging effectiveness is speaking to these feelings of loss; in other words, push on the pain. Here is a simple, four-step model for activating motivation:

Step One: “You have a problem!”

Remember that once investors have been traumatized and feel fear, it’s the loss aversion that defines their view of the world. Instead of trying to push a positive opportunity, frame the conversation as a way to avoid more pain. Start by suggesting the investor has a problem that needs to be addressed.

Step Two: “Here’s how the problem happened.”

Now you are in sync with the thinking patterns that the investor is already using to make sense of the world. For most investors, this will tend to galvanize motivation and focus attention. Continue the message by explaining in some detail the market mechanisms that caused the problem or that will cause the investor pain in the near future. In this step, you are making the problem a real issue for the investor.

Step Three: “Here’s what may happen to you if you don’t take action.”

In steps one and two, you are engaging the thinking part of the investor’s brain. Ultimately, it will be the emotional part of the brain that moves the client into action. In this step, you push on emotions by painting a picture of the possible future—negative consequences that the investor may experience if she doesn’t take action. This step makes the problem real and personal for the investor.

Step Four: “Here is the action I recommend that can help you avoid further pain.”

Conclude your message by offering a remedy for the problem and describing the steps that can be taken to address the situation.

When you realize that investors are more motivated by fear of loss than anticipation of gain, you can build on feelings the client already has, and then use those emotions to direct behaviors toward a remedy—and take action now.

Ken Haman is managing director of the Advisor Institute at AllianceBernstein


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