Managing the Self-Destructive Behavior Of Clients

Let’s face it, as a financial advisor, managing client assets is not usually the hardest part. Rather, the bigger challenge can be managing client expectations.

I think this data from Natixis Investment Managers starkly illustrates the point about expectations:

When asked in 2023, investors said they expect their investments to earn 12.8% above inflation over the long-term. In 2024, advisors said it’s more realistic to expect 8.3% above inflation, leaving a 54% expectations gap between the two.

As individual investors attempt to achieve their expectations, research shows they tend to both over- and under-react to news and information, which can cause them to underperform the stock market. As an example, last year the average equity investor earned 5.5% less than the S&P 500, which is the third largest gap in the last 10 years. Multiply underperformance like that over many years, and it’s a big number.

Given this set of facts, it seems like the average investor might be better off if they simply select some assets at random and then use a buy-and-hold investing style.

For investors who choose to hire a financial advisor, they’re demonstrating a willingness to take a break from managing their own portfolio and let a professional take over. However, the decision to hire an advisor often doesn’t result in the client completely giving over the reins.

This showed up in the Natixis study, with financial advisors saying the top risk clients need to be aware of right now relates to trying to time the markets and chase returns (42%). Other risks that bubbled to the top were investors letting headlines affect the investment strategy (34%) and unrealistic return expectations (29%).

Common Forms of Client Self-Sabotage

An investor’s self-destructive behavior can show up in various ways, including:

Applying an Unfair Standard. The first thing that seems to happen is that clients forget how poorly they were doing on their own and begin holding their financial advisor to an unfair standard, one the client could likely never achieve on their own. For this reason, we often remind advisors we work with to keep a record of the client’s prior portfolio so there is a point of reference when questions about performance arise.

Being Tunnel-Visioned on Areas of Market Concentration. Related to the unfair standard example above is the “we don’t have enough [blank] in the portfolio” recommendation from a client. This potentially counterproductive behavior is particularly prevalent during times like now, when only a handful of stocks are driving market performance. The [blank] du jour is currently tech stocks. While we appreciate an investor’s willingness to lean into strong trends, arbitrarily doing so without a system and process for answering all the key questions about when to buy, how much to buy, when to exit with a loss, and when to exit with a profit is reckless at best and destructive at worst.

Getting Distracted by Shiny Objects. Another example we see is clients being preoccupied with stocks that are currently sitting at the popular table in the cafeteria. An initial public offering for some new, yet unproven technology is fertile ground for this behavior, and a client may insist the stock be added to their portfolio. I’ll again point out how making purchases without a process for deciding when and how much to buy, as well as the rules for selling, can be detrimental.

Digging in the Bargain Bin in the Hope of Striking It Rich. Perhaps my favorite example of self-immolating investor behavior is the penny stock bet. A client hears about some obscure, low-value stock from a friend or coworker and pushes their advisor to buy 500,000 shares for $25,000 until the advisor capitulates to keep their own sanity. In these situations, I can’t help but be reminded of the poor suckers falling victim to Jordan Belfort at the Investor Center in “The Wolf of Wall Street.”

How Systematic Investing Helps Financial Advisors Manage Client Expectations

To be fair to investors, some financial advisors don’t do themselves any favors if they fail to appropriately gauge the client’s appetite for risk, get sidetracked by their own emotions or predictions about the market, or make allocations to esoteric, illiquid, and/or expensive instruments.

At Blueprint Investment Partners, we suggest advisors shun these poor practices. We think advisors should center their practice on principles of transparency, candor, and information-sharing. Moreover, we think a systematic investing approach to making investment decisions is well-suited for such a practice.

Trend following, which is our flavor of systematic investing, is as much a system for handling client expectations as it is for managing their portfolios, in my view. By providing rules that answer all questions about what, when, and how much to buy and sell, trend following can:

• Allow financial advisors to communicate proactively about what to expect in various market environments
• Offer a more comfortable ride for clients by managing risk during worrisome periods of market volatility
• Help clients participate in the upside during concentrated markets while having a systematic exit strategy to manage risk when the eventual reversals come
• Provide a methodology for gathering and sharing data about a client’s preferred single stock purchases
• Enable the asset manager to pay as much attention to the sell discipline as is paid to the buy side
• Cut through the emotional biases held by both clients and advisors

Let us be clear, no system can cover every permutation of investor behavior, just like no system can anticipate all the possibilities for markets themselves. That shouldn’t be the goal, in our opinion. The goal should be to maximize the odds of a client’s portfolio accomplishing their financial target while minimizing the chances a client will feel the need to interfere.