Fear, stress and uncertainty—three factors that have been present in abundance in recent months—shrink an investor’s time horizon, according to Sarah Newcomb, director of behavioral science for Morningstar.
An investor’s inability to think long term can prevent the person from reaching his or her financial goals and is a warning sign advisors should look out for in their clients in the current environment, Newcomb said in an interview yesterday.
“Crises make people less flexible and more rigid and that can lead to knee jerk decisions,” she said. “Advisors should help investors understand their own behavioral instincts and help them navigate their investment choices wisely. These uncertain times can lead to heightened emotions, but this is the time to stay calm.”
Clients have financial goals that are impacted by their personality traits and an advisor creating a portfolio needs to incorporate both finances and behavior. A client who thinks short term and is impulsive is more likely to have a higher debt load.
“Financial decisions that require waiting for results may be difficult for this type of personality,” Newcomb explained. “The advisor needs to help them make better decisions” than they would on their own.
Advisors can help clients with these impulses in two ways. An advisor can “nudge” a client toward better decisions or the advisor can make set up finances so that some actions, such as saving and investing, can be done automatically. “People who struggle to stay organized can benefit from this,” she said.
“Then there is the deeper side of providing guidance because the financial numbers are only a small part of a financial advisor’s job. The biggest financial decisions frequently accompany life’s milestones. The advisor has to help the client navigate these emotional times,” Newcomb said.
For instance, if the planning shows a client needs a 10% or 12% return each year to meet their financial goals but the person is adverse to risk, some adjustments are going to be needed. Another client may only need a 4% annual return but feels he or she is being left out of the market if the portfolio is not earning more. One client may relish being a landlord and being invested in real estate, while the same circumstances may put off or frighten another client.
“The advisor needs to integrate the two sides of the client—the financial needs and the emotional needs—by knowing the client’s strengths and weaknesses,” Newcomb said.
A financial planner also needs to look at the structural changes the economy is undergoing in order to take advantage of investing opportunities for the clients. For instance, “we know the the economy of 2040 will be low carbon. We do not know which companies will be successful, but the investor and advisor should look for companies that are innovators,” she said. Diversifying in a way that leans into the long-term trends will help protect a portfolio.