Put financial losses into perspective
Based on insights from a series written by Amanda Levis, PhD, Center for Analytics & Innovation (CAI)*, Advanced Experimentation Team.
A financial loss can be haunting for many people. In fact, research suggests that the experience of a loss is psychologically more intense than that of an equally sized gain1, which goes some way to explain the risk-averse mentality of many seasoned investors. Allowing emotions to guide financial decisions is rarely fruitful, however, which is why advisers must be equipped to help put financial losses into perspective and keep clients on track to achieve their goals.
Clients will look to advisers for peace of mind if the market’s response to the Covid-19 crisis, for example, has left them sensitised to the pain of loss2 or hyper-focused on present outcomes3. A quick-fix solution might be to reduce equity exposure and increase cash, but changing asset allocation every time there is a bump in the road will only deviate from long-term goals.
There are ways other than portfolio tinkering to help clients deal with the pain of financial loss that can be more effective in the long-term. Here are some suggestions:
As much as possible, emphasise the power of lifestyle changes and direct attention away from their account balance.
- Given recent events, the probability of achieving goals will have decreased for many people. In this case, it is important to let loss aversion work for you by framing this reduced likelihood of success as something that can still be avoided – ‘play until the whistle’, to use a sporting phrase.
- Focus on possible lifestyle changes, such as spending habits, which would allow a client to preserve a high chance of achieving their goals.
- Other people will still have a very high likelihood of reaching their goal. By moving attention away from their account balance and toward their chances of achieving their goals, this group will avoid unnecessary anxiety.
Start a conversation with your client about their portfolio-checking habits.
- Rather than a one-size-fits-all approach, have a conversation with each client: ask them to assess the value they receive from frequently checking their portfolio, as well as any emotional cost.
- By taking a moment to reflect, some clients will view portfolio monitoring as an anxiety-provoking habit. Encouraging these clients to check their portfolio less frequently might decrease their likelihood of making unnecessary changes4 or, at the very least, lessen their anxiety.
- Other clients will say that checking their accounts alleviates their anxiety: perhaps it provides them with a much-needed sense of control (see Tips on empowering clients through the crisis) or a way of not over-personalising the news (see Keep perspective through the negativity). For these clients, simply recommend that they focus on thinking about spending or saving plans, rather than changes in portfolio value.
Suggest the client focuses on their life away from their financial goals and present portfolio value. Even fleeting changes in mood can alter risk-taking behaviour5.
- People are typically less loss-averse when making decisions for someone other than themselves6. Ask highly-anxious clients to imagine that they are making investment decisions on behalf of a friend.
Your client’s investment strategy certainly must take their emotional wellbeing into account. However, given free rein to focus on short-term losses, fluctuations in your client’s emotions could lead to many small (and cumulatively impactful) deviations from their long-term financial plan. As their adviser, you can help direct their attention away from financial loss to focus more on lifestyle changes.
*The Center for Analytics and Insights (CAI) supports Vanguard’s analytics and research needs. The CAI produces advanced analytics ideas and solutions, performs and synthesizes market and usability research, and promotes analytics enablement across the enterprise.
1 Kahneman and Tversky, 1979; 2 Barberis et al., 2001; 3, 4 Benartzi and Thaler, 1995; 5 Loewenstein, 1996, Hogarth et al., 2011; 6 Andersson et al., 2016
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This document is published by Vanguard Asset Management, Limited, based on research conducted by Vanguard Group Inc. It is for educational purposes only and is not a recommendation or solicitation to buy or sell investments. It should be noted that it is written in the context of the US market and contains data and analysis specific to the US.
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© 2020 Vanguard Investments Switzerland GmbH. All rights reserved.