Fear of loss and greed for gains aren't new ideas in the world of investing. In fact, they probably date back to humanity's ability to think, worry and reason.

But the fact that these behaviors accelerate when investors retire has financial services firms working overtime to find ways around investors' emotions. After all, with millions of baby boomers marching into retirement, getting it right is critical. The good news is that the mounting body of behavioral economics research is yielding a bonanza of practical insights and solutions that may help advisors keep clients from doing the most deleterious thing at the very worst possible time-as they enter retirement.

"What we're trying to find out is what are the biases of human beings on every decision involving personal finance," says John Cammack, director of third-party distribution at T. Rowe Price in Baltimore. "What we're learning is that in general, investors are inclined to do the wrong thing with money in retirement. The major tendency is to become too conservative. Something goes on when people give up the ability to earn income."

To garner greater insight into investor behavior, companies and academics are using behavioral economics, a discipline within the field of finance that looks to psychology for the explanations behind investors' decision-making. Simply put, by understanding what makes investors behave erratically, an expert can help them achieve great investment success.

One thing is certain, researchers are learning that when paychecks stop, the tendency to become ultraconservative with investments sets in. In his best seller Predictably Irrational (Harper, 2008), MIT professor Dan Ariely writes that expectations, emotions and social norms guide investors more than reason. And it is noteworthy, he says, that we make the same mistakes again and again.

How does this play out for retirees? They tend to overvalue what they have in their retirement nest eggs, something Ariely calls the "endowment effect." The upshot is that they focus more on what they can lose than what they can gain.

But on the other hand, they may pursue more costly investment strategies to avoid losses. One example of loss aversion in action: The phenomenon that occurs when investors retire and move their portfolio into CDs, money-market funds and short-term U.S. bonds. By earning just 1.5%, they ensure that they won't lose principal. But at what cost? A portfolio earning just 1.5% is actually costing an investor who faces a 4% annual inflation rate, plus taxes, all the while shortening the life span of their nest egg.

More than 70% of retiring investors at T. Rowe Price move into money markets or stable value funds, according to surveys and focus group research the fund company has conducted. "What we hear over and over from them is: Protect principal, invest more conservatively," says Mark Mitchell, vice president and director of marketing at the firm. "What drives retirees is blind faith. They think, 'Oh, it will work out. I'll spend less. I have some home equity.' But do they? They believe that because things have worked out before while they were still fully employed, they'll work out now. They forget that the safety nets can really start to diminish."

Can investors and advisors counteract these emotional and irrational behaviors, especially the risk and loss aversion that sets in at retirement? Ariely says the answer is yes and that once we understand how and when investors make erroneous decisions, financial services firms and advisors can work to stem the irrationality. The best bets are counseling, visual tools and technology, which, when used properly, can overcome what are, as Ariely calls them, investors' inherent shortcomings.

"Advisors need to do a lot more coaching to enable the customer to do the right thing," Cammack says. "We have to reinforce the importance of having money in the equity markets. When retiring investors understand longevity risk, they begin to understand that they have to grow their money to ensure that they don't outlive it."

Advisors can also help retiring investors drop another irrational belief that T. Rowe Price and others have identified: investors' strong but incorrect feeling that their pot of money, regardless of size, will provide more income than it can realistically generate.
T. Rowe Price was the first firm to use Monte Carlo simulation to show investors how their asset allocation decisions would impact risk and reward. After more than a decade of behavioral economic research, the firm has now created a counseling campaign for advisors to help them address the pressing issue of baby boomers and their $15 trillion in assets.

The issue becomes more critical for advisors when you consider one remarkable T. Rowe Price discovery: More than half of investors will find a new advisor after the age of 40. And while 86% strongly believe they understand advisors, they don't think advisors understand them.

The education and counseling campaign, called "Can You Read Me? Understanding and Advising Today's Pre-Retirees," provides facts, figures, investor training ideas and tools-all in an effort to help advisors "fix" pre-retirees' known investment irrationalities. The goal, boiled down, is to help boomers maximize the longevity of their portfolios by using asset allocation to increase long-term gains and by timing their retirement appropriately (the later they retire, the better).

When advisors understand the foibles of investors, especially those approaching retirement, they can work to counter the weaknesses and improve the chances of investment success, Cammack says.

Pre-retirees' anxiety rose significantly between 2004 and 2006 when they confronted a host of issues-fear that they would outlive assets, fear of insufficient guaranteed income and illiquid savings and fear of rising health expenses and taxes. That's important to note, because the older investors become, the more emotions determine how they think about a matter. Advisors must understand the investors' capacity for emotionally driven investing based on greed and fear, as well as understand strategies for altering bad behavior.

How should advisors sell to pre-retirees? It pays to be very mindful, not only of their emotions, but of the fact that boomers expect unique experiences and solutions. Here are other T. Rowe Price suggestions for marketing to pre-retiree boomers:
  Use empathy and client-centric presentations. Ask open-ended questions. Listen.
  Determine what has driven a client to your office and what they want to result from their meeting with you.
Address the fears and anxieties of each pre-retiree with a presentation that confronts their growing conservatism as they approach retirement. Show them the options and outcomes of a variety of investment portfolio scenarios (ranging from super-conservative to overly aggressive).
Provide pre-retirees with planning options to increase their investment income (they might delay retirement, increase savings levels and unlock other assets like real estate and businesses).
Discuss guaranteed products, such as variable annuities, for a percentage of income.
Make sure that boomers understand the short- and long-term value you will deliver through asset allocation and portfolio modeling.
Make clear how distribution levels above 4% may severely shorten the longevity of a retirement portfolio by years, as investor longevity increases.
Deliver an experience unique to the boomer's needs and aspirations, as well as unique planning and investment solutions. T. Rowe Price has come up with a slide rule calculator of sorts called the "Pre-Retiree Decision Maker: How to Increase Expected Retirement Income," which allows investors to choose different retirement ages and savings and investment scenarios to see what their success rate will be. This helps investors understand that how much they save and spend are trade-offs that will have significant and long-lasting effects. If you are getting closer to retirement age and looking for ways to boost expected retirement income, the calculator evaluates the impact of several retiree actions:
Increasing current savings earmarked for retirement by freeing up assets (home, business, etc.);
Delaying their retirement until after age 62; or
Increasing their savings rates from now until retirement.

This tool and others being created by T. Rowe Price allow advisors to present investors with informed trade-offs, says Carol Waddell, vice president of retirement plan services at the firm. "If you have a million-dollar portfolio and retire at 62, are you comfortable with an income level of $20,000 a year?" Waddell asks. "What would happen if you deferred retirement and Social Security payments by three or five years? And increased your savings rate to 10% of annual income? What would retirement look like then?"

Few people want to work longer when they have their heart set on retirement, but they might if they think about it a little and have someone like an advisor to counsel them.

"OK, maybe instead of staying put in the same job, you do take that trip you've been dreaming of and when you come back, you start a different, less-demanding job. The idea is if you keep working, it will help preserve principal," Mitchell says.

"If an investor is trying to retire without enough assets, the best an advisor can do is triage," says Cammack. "If someone leaves work earlier than they should, we're not good enough to make up the deficiencies with performance. No one is. Sometimes the best thing advisors can do is say: Keep working."

Stay tuned. The company is working on turning that very notion-strategically timing retirement-into a new series of tools for advisors and investors.