Advisers Urged to Focus on Psychology

Advisers Urged to Focus on Psychology

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A currency trader watches monitors near the screens showing the foreign exchange rates at the foreign exchange dealing room in Seoul, South Korea, Friday, June 2, 2017. Asian stock markets rallied on Friday as investor sentiment was boosted by signs of continued improvement in the U.S. job market. Tokyo stocks jumped to the highest level in nearly two years. South Korea’s Kospi rose 0.8 percent to 2,363.89. (AP Photo/Lee Jin-man)
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With the rise of robo-advice, financial regulation and DIY investment, it often seems as if the traditional role of the adviser is under threat.

But behavioural scientists at Morningstar believe that advisers are in an excellent position to capitalise on these changes by building on longstanding skills and roles. Being a good adviser has always been more than selecting investments and managing portfolios. Psychology is an essential part of working with clients.

As investors, we all have behavioural biases, such as overconfidence and loss aversion, that lead us astray when making financial decisions. Good advisers, however, can help their clients overcome these. As the investment landscape changes, advisers need to serve as behavioural coaches and help clients navigate their biases and make more rational decisions. Advisers help investors cultivate good financial habits, stick to their investment plans, and avoid emotional responses to market volatility.

Social changes also make investment advice more challenging. With the rise of auto-enrolment for pensions, younger people are now being made aware of retirement provision much earlier than previous generations.

Millennials interact very differently with their finances than do older generations. With easy access to more information online, and a tendency to look to it for guidance, younger investors are more likely to form their own strong opinions about the “right” investment strategy, separate from their adviser, for good or for ill.

Coaching Emotions for Better Investing

Despite these changes, what remains unchanged is the psychology of investing: the common behavioural obstacles that investors face due to the quirks of the mind. These biases can’t be regulated away or completely solved by technology. But they can be coached and managed. The role of the adviser as a behavioural coach is one of the most valuable contributions advisers can bring today to the adviser-client relationship.

Although more industry professionals are beginning to appreciate the value of behavioural finance, investors rarely have the same level of expertise. Most investors do not seem to understand the impact their biases can have on their finances, nor do they have practical ways to counteract the effects. Without the guidance of a behavioural coach, many investors are at the mercy of their own emotions.

According to the research, our brains have two relatively distinct modes of thinking, the reactive, which involves following daily routines such as commuting to work, to the deliberative, which involves a higher level of thinking – such as buying a house. As behavioural teachers, advisers help clients to nudge them toward making more deliberate decisions.

Market volatility is part and parcel of investing. Yet during market fluctuations, some investors panic and liquidate investments, causing them to veer off course, as described by Morningstar’s head of behavioural finance, Stephen Wendel. This panic, in part, is derived from their behavioural biases.

During these emotional periods, investors might believe that what has just happened is going to continue to happen in the future. This arises from what is known as recency bias. In their minds, market volatility turns into long-term capital loss. During trying times like these, advisers help clients manage their emotions and stay focused on long-term goals.

Source: morningstar

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