Emotional reactions could destroy the dreams of your clients and it is your job as an advisor to prevent financial self-destruction.
That was the theme of a seminar entitled “Money, Markets and Emotions” held by asset management firm Bernstein at its headquarters in Manhattan on Monday night.
“A lot of financial planning is dealing with emotion,” said Hugh Massie, a behavioral finance strategist and founder of the firm DNA Behavior. He said 93.6 percent of financial decisions are based on emotion. “You can let your emotions cloud your decisions very quickly about what you are about to do rather than looking at the facts,” he said.
Borrowing one of Massie’s behavioral quips, “People have to check themselves before they wreck themselves,” Brenda Smith, a vice president and CFP with Bernstein and the moderator of the event, argued that more than information is needed for the investment process. One also needs self-awareness, she believes, to avoid wrecking a financial plan. Yet apparently, many investors have wrecked themselves over the past decades.
For example, the performance risk has cost many investors a bundle over the past 30 years. Investors actively managing their funds have earned about 7.5 percent less than the S&P 500 in that period (3.7 percent while the S&P returned 11.1 percent), said Massie, citing a Dalbar study.
Why the performance gap?
Most financial decisions are made emotionally, and if an investor doesn’t recognize the dangers of emotional investing it could be disastrous, panelists said.
Investors “can continually make flawed decisions” because of these emotions, Massie said. But the performance gap can be closed by someone who is objective and can help investors manage those emotions. He added that everybody is at risk of suffering that 7.5 percent lag.
It will be important to keep emotions under control in a lower return environment, said Jim Murphy, a senior portfolio manager at Bernstein. The firm projects that U.S. stocks will return about 5.5 percent a year over the next five years.
The low returns will come amid a period of low GDP growth and persistent high volatility, Bernstein said in an internal publication, “Headwinds Are Breeding Uncertainty.” The publication said bonds should still play a part in reducing overall portfolio risk but also that investors should consider other asset classes besides stocks and bonds—including alternative investments and real assets.