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How to Disrupt Your Clients’ Stress Response

June 22, 2018

This time we hear from Paul Sydlansky, founder of Lake Road Advisors in Corning, N.Y. He recounts an experience that sparked his interest in using behavioral economics to help his clients make smarter decisions.

A new client couple told me during one of our first meetings that they felt like they had missed out on growth opportunities in the market in the past several years because they had been invested very conservatively. Now they wanted to make money to purchase a vacation home, but they had different opinions on risk tolerance. One gentleman was in his early 60s and had a more aggressive investment style, while his partner, the primary provider, was in his early 50s and much more conservative.

The older man continued to push for aggressive investment moves, so I talked to him about the realities of higher risk. “How would you feel if your portfolio lost 10% in one day?” I asked. “Are you okay with losing principle for the sake of a short-term gain?” I put a lot of effort into educating this client about the implications of high-risk investing. Ultimately, he backed off the idea. By the end of the onboarding process I believed he had all the facts to remain calm throughout market fluctuations.

Fast-forward to February 2018 when the market dropped more than 1,000 points. I got a call from this client and he was panicking. He informed me that he had just logged into his online investment account and was trying to sell everything to avoid losing money. Before he completed the process, though, he had received a pop-up that read, “You are creating a taxable event.” The pop-up showed him the amount he would owe in taxes if he went through with selling his securities. Fortunately, this made him pause and call me for advice.

Ultimately, this client decided not to sell, largely because he couldn’t bring himself to write a check to the IRS for this amount — even though he’d be realizing a gain after the tax. Just the idea of having to pay taxes on a gain prevented him from making a big mistake in a state of panic. People hate to see money leaving their hands.

I realized that I had seen similar behavior when working with clients who are primarily contract workers. It was often painful for them to proactively put money from each paycheck into an account for taxes. When your employer does this for you, it’s out of sight, out of mind. When you have to write the check yourself, though, your brain registers it differently — as a loss. This was the first time I’d seen this mechanism kick in for a capital gains tax situation, though.

Figuring out just why our brains work this way led me to become fascinated with behavioral economics. I’ve since learned how this field can help explain the large mental block some people have when it comes to taxes. If a client realizes a $20,000 gain on a long-term position and they have to pay 15% capital gain tax on it, they can put $3,000 aside in a high-yield savings account so it’s there come tax season. Even though they realized a $17,000 gain, it still pains them to put that tax money away and they tend to focus on the money they “lost.”

I’ve found that working with — instead of against — these thought patterns helps me prepare clients in a more realistic way. I take advantage of what behavioral economics teaches about loss aversion and use it to encourage clients to stick to their financial plan. I educate them about the tax implications of buying and selling assets in a non-strategic fashion. Sometimes their unwillingness to pay taxes is what keeps them from making unfortunate, hasty decisions when the market is volatile.

Paul Sydlansky

It’s also critical to have tools that help disrupt the stress response if clients do panic, whether that’s an automated pop-up online, a real-time update on clients’ online activity or regular outreach to those who are open to learning about how behavioral economics can work for them. As investors, behavior is the only factor that we can truly control. The better we advisors understand typical patterns, the better we can help our clients make good decisions.