A survey identifies those mistakes-and the personalities behind them.
It could be said that one of a financial advisor's
jobs is to save clients from themselves-helping them avoid the common
mistakes and pitfalls that result from amateur investing. Now a new
survey suggests there are some common mistakes, and defined patterns of
behavior, that advisors can look for in their clients.
The study by Merrill Lynch Investment Managers, conducted by Matthew Greenwald & Associates, even claims that there are four sets of investor personalities, each with its own set of habits and common mistakes.
Merrill Lynch officials say they view the survey information as, at the very least, a starting point for advisors to begin conversations with clients about their commonly held beliefs and outlooks on investing.
"We think that type of conversation can only do good things for the relationship," says Jerry Miller, chief operating officer of global proprietary business at Merrill Lynch Investment Managers.
The survey polled 1,000 investors nationwide about how they view themselves as investors, and what they feel their most common mistakes are when investing. Perhaps not surprisingly, the way investors view their mistakes diverges from how advisors may view them.
Investors, for example, say their most common mistake is waiting too long before they start investing-cited by 46% of respondents. This was followed by the mistake of holding onto an investment too long, 41%; not putting enough money into their investments, 36%, and waiting so long to sell a winning investment that they didn't realize the gains they should have made, 36%. Allocating too much of their portfolio to one investment was also cited by 28% of investors.
The answers, according to those involved in the survey, highlight the fact that advisors often have to contend with a gambler's mentality when it comes to dealing with clients.
Brian Perlman, who directed the study as vice president at Matthew Greenwald Associates, notes that investors focus on isolated trades when assessing mistakes-almost the way a casino gambler would regret taking a hit on a particular hand in blackjack.
"They really focus on specific events," he says. "They don't nearly talk as much about diversification or balancing a portfolio, which are the things a financial advisor would focus on."
Advisors, by contrast, would be focusing on a client's long-range plans rather than the up-and-down movements of a particular investment holding, he adds. The survey suggests that clients, meanwhile, are more focused on moments that represent big wins or losses, he says. "The people see the trees and the advisors tend to see the forest," Perlman adds.
Viewed from a different perspective, the differences in outlook point to individual investors as more prone to act on emotion than advisors, he says. That once again suggests that advisors need to assess the habits and beliefs of their clients-an aspect of their jobs that may somewhat enter the realm of psychology, Perlman says.
"I think a lot of advisors know that their clients act on emotion," he says. What advisors should assess, he says, is to which types of emotional responses their clients are most prone.
"Certain investors are likely to make mistakes due to anxiety and fear," he says. "Others are likely to make them due to a lack of confidence, or overconfidence and greed."
Based on the survey data, the authors of the Merrill Lynch survey saw patterns they say advisors could use as a guide in evaluating their own clients. The answers of the 1,000 investors surveyed, according to its authors, fell into the following four profiles:
Measured Investors: About 32% of the investors fell into this group, which consists of people who started saving early, are financially secure and confident about their investments. They are deemed the least likely to succumb to fear and anxiety in making investment decisions. Their most common mistake, according to the survey data, is holding onto losing investments too long.
Reluctant Investors: Comprising 26% of those surveyed, this group isn't fond of investing and prefers to delegate the managing of their investments to someone else. More than a third describe themselves as apathetic about investing, yet most are secure and confident about their financial futures. Their most common mistake: waiting too long to start investing.
Competitive Investors: Repre-senting only 17% of the respondents, these are actively involved in their financial affairs and like to invest as much money as possible. They regularly rebalance-only 12% in the group have gone more than 18 months without rebalancing. Their vices are overconfidence and greed, making them prone to holding onto losing investments too long and not diversifying enough.
Unprepared Investors: The minority profile, with just 11% of the respondents, this group consists of people who are unhappy about their investments, insecure about their financial futures and generally lacking in financial knowledge. They are prone to making decisions based on fear and anxiety, and are also the most likely to chase a "hot" stock. They are, according to Perlman, the group that probably requires the most work on the part of advisors.
Merrill Lynch has created a free informational Web site, at www.hindsight2insight.com, which includes quizzes and questionnaires that advisors and investors can use to help profile clients.
Miller says he feels the greatest benefit of these tools is helping the advisor and the client in "having the conversations up front." They also give an advisor clues on how best to meet the needs of clients, such as knowing that measured investors need "a lot of information up front" or that reluctant investors embrace the idea of delegating.
"The competitive client may need some difficult conversation along the way, and that can be viewed as challenging but critical work," he says. "The unprepared investor is the one who desperately needs professional advice."
Some advisors, meanwhile, say they have indeed picked up patterns of behavior among clients and common mistakes.
Not all of them coincide with the mistakes cited by investors in the study.
Kacy Gott, principal of Kochis & Fitz in San Francisco, feels the No. 1 mistake investors make is to forget about the very reasons they should be investing-helping them achieve their financial goals. "The number one mistake is failing to tie their investment goals to their planning goals," he says. "There is a total disconnect there."
Gott does agree, however, that not starting investing early enough is a common problem, and that too many investors think more like gamblers than investors. He feels, however, that clients are less prone to look upon their investments moment-to-moment if they have a financial plan in place. "If you're planning for your retirement and you're 30 years old, you're not as worried about your small-cap stocks," he says. "You know you have 30 years before spending that money. So by connecting to the time horizon, they are more apt to do the right thing and stay in the markets when they are performing poorly."
Sean Sebold, president of Sebold Capital Management in Naperville, Ill., has taken stock of investors and feels that their most common mistakes fall into one of three categories: psychological, strategic and tactical. Overconfidence and emotional decisions come into play on a psychological level, he notes, but so do homespun approaches to investing. One common mistake, he says, is when people invest in companies they feel they know well, possibly because the company is based close to home, they know many of its employees and follow news at the company.
Such an outlook, he says, often causes people to devote too much of their portfolio to one stock and to not pay enough attention to a company's financial fundamentals.
Another pattern he sees repeatedly: People are open to risk when their portfolios are down, and risk-averse when they're up. This comes from a quiz he gives every new client. First they are given a choice between getting $80,000 or flipping a coin and having an 80% chance to win $100,000. Everyone who has ever taken the test, he says, takes the $80,000. The second question asks clients to choose between losing $80,000 or flipping a coin that gives them a 20% chance of breaking even and an 80% chance of losing $100,000. In the five years he's been giving the test, Sebold says, only one person has declined the coin flip.
Sebold also finds, ironically, that the most educated investors can often make the worst mistakes. "If they have never worked with an advisor before, and achieved a high level of influence in business, they can be overconfident," he says. "They can be prone to being overweighted in one company or going after something big, like the Google IPO."