I recently met with the president of a large trust department to talk about how clients were reacting to the markets and how it impacted the way they manage their accounts. He shared with me that their seasoned portfolio managers were focused on the fundamentals of selecting individual securities and do so in a way that I would expect from a trust department. He seemed surprised when I suggested that good fundamentals may be important when it comes to selecting appropriate stocks, but psychologically it's not very effective with clients. I believe financial advisors of all types can dramatically improve their client relationships (resulting in more client loyalty, and referrals) by paying more attention to the psychology of decision-making than to investment fundamentals, especially when it comes to retirement income planning.
Over the last several years many investors have experienced a general disconnect with the markets. Something I call "actual" economics rather than micro, macro, voodoo, or any of those other euphemisms. Put simply, headlines like Dow 15,000 or touting supposed fundamentals such as "lowest PE ratios since the 1988" aren't translating into client's account balances. Furthermore, the volatility we've experienced recently can be paralyzing and numbing, causing clients to distance themselves from their accounts, which eventually can devalue your role and relationship with them.
Research supports the need for advisors to look beyond just the fundamentals. A 2011 Prudential survey on investor concerns and attitudes finds that 56% of respondents question whether their investment strategy is right for their retirement needs, 68% say they are more cautious than ever before, and still 84% are concerned about inflation eroding the value of their retirement savings.
Retirement income strategies and behavioral finance are two of today's most popular topics. They dominate magazine articles, conference presentations, and online conversations, but I rarely find theories that advisors can actually put into practice without first becoming a psychologist or inappropriately assuming the role of therapist or researcher. In my practice I employ three basic principles with clients based on common sense, Psychology 101. Both my partner and I have been successful in using this approach and have found other advisors doing much the same.
Psychology 101: Everybody Loves A Winner
I've managed money at a typical broker-dealer, insurance company, bank and trust company and, no matter who my clients were, they all had one thing in common: They want something hot, sexy or successful within their portfolio. It's similar to an alcoholic or compulsive gambler who won't divulge the damaged relationships or money they've lost, reverting instead to talking only about the good times, such as all-night binges or hoards of cash they had in their hands. Investors, particularly retirees, like and usually want some aspect of their portfolio to talk about.
It's actually pretty simple to accomplish this with individual stocks without saddling them with too much risk. Remember, clients only want something to talk about, so don't feel you have to go in with 10-20% of their funds to accomplish this. It can be as little as 1%, or a series of low correlated investments equal to 3-5%. Recently, we created a small portfolio option for clients that maintains an average dividend yield above 11%, and maintains the same correlation to the major indices as a corporate bond. It's founded in Modern Portfolio Theory (MPT) and offers the possibility for a winning stock selection or, at a minimum, a welcoming yield.
While I only advocate allocating a small portion of portfolios to such a strategy, holdings like these can also serve as an "adult child fund." For clients with adult children who require more withdrawals than the clients themselves, this strategy can provide what I call a "dividend allowance" that, for the time being, protects their other assets.
Psychology 102: People Like What Is Familiar
In my years of selling and investing, I've found one of the hardest things to do is sell a client something they are not familiar with or that's initially out of their comfort zone. This is a huge problem right now for income-oriented investors since they generally have to take more risk in order to achieve even just a rate or return equivalent to the historic rate of 3% inflation. This makes it critically important to use examples and analogies that are understandable and easily explained to a spouse, family member or colleague.
For example, when it comes to building a dividend-paying portfolio for conservative clients, I frame the concept in terms of a rental house, which is easily digestible and repeatable. I've gotten some great mileage out of saying, "Dividend investing is like owning a rental house. The value of the house can go up or down, but what's important -- especially during retirement -- is that the rent keeps coming in." Obviously you can take that analogy much further, particularly for analytical clients who want to see some numbers. By keeping it simple, familiar and repeatable, though, when the market does pull back and account values go down, you can point to the dividends or "rent" still coming in.
Using analogies when it comes to the markets can also be helpful. Someone is always communicating with your clients. Whether it's the media, neighborhood insurance agent, or church member, investors are constantly being barraged by news and information, which makes it critical to help your clients frame the news and information in the proper perspective.
Recently, I described this current market as being a lot like trying to lose weight as you get older. As you age it takes longer and more effort to lose weight. You could eat well and work out for two or three months only to lose it all in a week or two when family obligations, health or work superseded your weight control program. Therefore, just as someone trying to lose weight can combat falling off the wagon by hiring a trainer or documenting their calories to stay on track, advisors need to develop a series of resources and tools such as a consistent communication pattern and approach in order to reduce fears and stem losses.