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."