Monday Morning: Advisers should take a cue from physicians

Financial planners should consider themselves financial physicians and pattern their services on those of doctors, according to Meir Statman, professor of finance at Santa Clara (Calif.) University.

Speaking at possibly the most interesting session at Charles Schwab & Co. Inc.’s IMPACT Conference in San Francisco last month, Mr. Statman told more than 200 financial planners and advisers that physicians promote more than health; they also promote well-being. They must manage patients’ aspirations, hopes and fears.

He noted that doctors ask, listen and empathize. Then they diagnose, treat and educate.

That sounds like a great model for financial planners, the best of whom, whether they realize it or not, probably do all of the above.

Reframing the Issues

The first three steps are crucial: ask, listen and empathize. The trouble is, it isn’t easy to discern what people are saying – even when we listen carefully – because investors often send mixed messages.

According to Mr. Statman, investors have aspirations that may conflict. They want to be secure, and they may also want to be rich.

They have conflicting emotions: hope, fear, regret and self-control. And they have ideas, some of which are wrong.

At times, being rich may be more important to the client than being secure. At other times, for example, after a bear market, being secure may be more important than being rich.

Younger clients are likely to be more interested in being rich than in being secure, while older clients usually consider being secure most important.

Sometimes hope will overwhelm fear and regret. At other times, fear and regret will be the strongest emotions.

Financial advisers must empathize with their clients as they wrestle with these conflicting aspirations and emotions.

Then, according to Mr. Statman, they can help clients deal with the conflicts by framing the issues differently and educating them.

For example, from the end of August 2000 to the end of August 2003, an indexed stock investor would have had a -30.5% compound annual return. That is enough to make any investor fear for his or her financial future.

But if the financial adviser shows the client that from the end of December 1986 to the end of August 2003, the same portfolio had an 11.6% compound annual return, the client’s concerns will be alleviated. That is reframing.

Prediction addiction

In the same session, Jason Zweig, the Money Magazine senior writer, and editor of the latest edition of Benjamin Graham’s “The Intelligent Investor” (HarperBusiness Essentials, 2003), cited research at the University of Iowa showing that brain chemistry affects financial decision-making.

For example, the research shows that the brain of an investor who correctly predicts investment gains resembles the brain of a person who is high on drugs or sex, according to Mr. Zweig. As a result, investors can become addicted to predicting and hence to moving in and out of the market or individual stocks.

That would likely have come as no surprise to Mr. Graham, he noted, because Mr. Graham in 1972 declared that “the investor’s chief problem – and even his worst enemy – is likely to be himself.”

Mr. Zweig recommends that advisers offer to track and report clients’ trades. They should also keep an “emotional registry” that can be used to remind clients, in their own words, how they felt at key times.

Advisers should also record their own forecasts and the clients’ forecasts, and present data from different angles, he said.

These steps will help advisers educate the clients about themselves, and how their aspirations and emotions affect their financial decision-making.

Over time, this should lead clients to make better decisions.

One other step advisers should take, especially with clients who show a tendency toward “prediction addiction,” is to give them a copy of Mr. Graham’s “The Intelligent Investor” as a holiday gift, preferably the latest edition, edited by Mr. Zweig. The latter’s revisions in light of the latest research make this an invaluable book for serious investors.

Consider it a financial physician’s desk reference.

Mike Clowes is the editorial director of InvestmentNews and sister publication Pensions & Investments.