When market conditions become volatile and scared clients are on the verge of panic about the potential to lose even more money, financial advisors are faced with the challenge of talking their clients “off the ledge” from making a potentially disastrous investment choice to leap out of the market near the bottom and risk missing the recovery. Getting clients to actually stay the course, though, is easier said than done, as simply telling clients “Don’t panic!” doesn’t necessarily help them to do so!
Alternately, when the pendulum swings the other direction and markets are ramping upwards, clients can become overconfident and as natural greed begins to kick in… often asking for even more of their top-performing investments (regardless of the additional risk), and less of the poorly performing ones in their portfolios (that may have simply been the conservative diversifiers). Which introduces yet another challenging conversation, as telling clients “don’t be greedy” in the heat of the moment isn’t necessarily any more effective, either!
In our 25th episode of Kitces & Carl, Michael Kitces and financial advisor communication expert Carl Richards revisit their earlier podcast discussion about how to talk clients off the ledge from ‘scary’ markets and then explore the flip side of the situation and how to keep clients from making bad decisions in the midst of a raging bull market.
Advisors can structure these ‘overconfidence’ conversations using a three-question framework, asking the following questions:
- If you proceed with this decision and it works out as expected, how would your life be different?;
- If you made this investment and you were wrong about how you expected it would do, how would your life be different?; and
- Have there been things you were really certain about in the past that didn’t work out as planned?
Typically, clients will respond to these questions by acknowledging that if all things go as planned, there will be marginal (but only marginal) improvements to their situation (e.g., perhaps there will be extra vacation time or an opportunity to travel); however, if the outcome turns out badly, the consequences will be much more worse, often leading to disastrous circumstances that can involve severe losses (or even bankruptcy or divorce!). When faced with the third question, clients may realize that, while the positive outcome might sound appealing, there is a real risk of an alternative outcome having serious, potentially devastating effects, and that they can’t be ‘too confident’ about the good outcome as they recognize their own failed predictions of the past.
Often, this process is enough to help clients realize that, while the decision they are contemplating might sound like a good idea, it may not really be worth the risk involved – both the risk of a bad outcome in general and the risk that they are wrong about their ‘confident’ prediction it will turn out well.
But sometimes, a client may be too caught up in the appeal of a tempting opportunity and may want to proceed anyway. In these instances, advisors can re-connect the client’s focus to their ‘deeper yes’ – the important core values and goals they identified in their financial plan in the first place. If this approach still isn’t enough for the client to reconsider, then establishing a separate non-managed account can be an effective reminder to the client that the investment is separate from the plan, compartmentalizing the potential risk (and hopefully keeping the amount actually invested limited to a manageable minimum). On the other hand, if the client is dead set on going all in with the investment opportunity, it may simply be a signal to the advisor that it is time to part ways with the client… to avoid the ‘collateral damage’ that can, unfortunately, occur if clients harm themselves against the advisor’s advice but then still look to the advisor for someone to blame.
Ultimately, the key point is that the ‘overconfidence’ conversation is not very different from the ‘scary markets’ conversation; clients may simply need to be reminded that even though the markets may be doing well, making intentional decisions that stray from their investment strategies can throw their plans off course just as easily as a hasty decision made out of fear during bad market conditions.