Behavioral finance seeks to understand why investors often work against their own interests. Disclosure and transparency are central to fighting this tendency.
By owning up to biases and recognizing emotional triggers, the thinking goes, informed investors can learn to resist their flight-or-fight instincts and act in ways more likely to foster financial success.
But experts say wealth advisors have to come to terms with their own shortcomings before they can be of real and lasting help to clients who don’t readily grasp that their gut reactions cloud their investment decisions.
The problem for advisors is acute because investing is predicated on making decisions based on incomplete information. And where there’s uncertainty like that, something social scientist Jonathan Haidt calls the “divided self” emerges to make decisions even more fraught, according to Mimmi Kheddache Jendeby of State Street’s Center for Applied Research, who draws on Haidt’s work.
Haidt sees the divided self — a sort of internal committee of conflicted interests — as an obstacle to improvement and by extension a hindrance to personal and societal progress.
The divided self shows up in the hyper-competitive, knee-jerk defensiveness that makes learning difficult and relationships more contentious than they have to be. Through this fractured lens contradiction abounds — exacerbated in workplace settings and in advisor-client interaction generally.
As a result, we ask to be enlightened, but we hate not already knowing. We prize open dialogue but we’re touchy when we’re questioned. And we claim responsibility for positive outcomes but blame others for our failures.
“If we don’t recognize the divided self, we hinder our own learning and we let investors’ habits and unquestioned assumptions keep them away from their financial goals.” says Kheddache Jendeby, who is based in Gothenburg, Sweden. “We focus on solving problems within the system when sometimes we need to change the system.”
That’s just what Alan McKnight is trying to do at Birmingham, Ala.-based Regions Bank, where he is chief investment officer.
For him, the process of combatting biases and keeping divided selves in check among his investment professionals starts with communication.
“We work to establish common metrics so we’re speaking the same language,” says McKnight. For instance, he says equity and fixed income specialists sometimes use the same words to mean different things — which can result in imprecision in an FA’s dealings with clients.
Meanwhile, as an example of the individual biases that can cause confusion, McKnight says that what a given asset manager means when she says a stock is “overvalued” depends on the earnings lens she uses: forward, historical or adjusted.
The point of this push for common parlance among Regions Bank’s investment pros is to “demystify what we do and try to ensure our biases don’t interfere” in the name of fostering as much consistency in investment discipline as possible, says McKnight.
Along with efforts to provide clients with a comprehensive online “dashboard of information,” this is meant to help advisors at Regions convey to clients that the bank’s skill, not its luck, is responsible for long-term investment outcomes.
“Clients should be paying for skill,” says McKnight.
Evidence of the divided self as a bar to the education advisors should impart to clients is something Mike Brown sees “all the time.”
As a partner and portfolio manager at Dowling and Yahnke, a San Diego RIA with $3.3 billion under management, he says he’s committed to helping clients understand market dynamics in the name of rational and undivided decision making.
“So many people think they hire an FA and don’t need to know what’s going on,” says Brown, who’s quick to add that’s not a stance he encourages. “We want people to understand the strategy and philosophy of what we’re doing and really understand what’s going on,” he says.
The best gauge of this program’s success is in the questions clients ask. “When the market is down and they ask if we’re going to buy, you can tell they understand what we’re trying to do,” says Brown.
On the other hand, “where you get a lot of the wrong questions, either more learning is required, or it’s just a bad fit,” he adds. “We’re in the business of educating, not selling.”