Kerry Johnson, MBA, Ph.D.
In the 1930’s depression, much like the downturn of 2008, market technician Ralph Nelson Elliott made an interesting discovery. He noticed equity markets move in similar and replicating patterns with degrees of trend. This new field called Socionomics explained market movements response to social mood, both euphoria and discouragement, optimism and pessimism. In fact, Robert Prechter, who recently popularized this area, warned of a top in the market in 2000 based on past patterns of market movement, in turn based on social mood. This major mood swing called a grand supercycle portends the magnitude of what may happen in a future framework, while not predicting week by week changes. This is almost like a TV meteorologist is able warn of storms a week from now because of low pressure areas, as they may not be able to tell you what day next week it will occur. One economist at a conference I spoke at suggested since baby boomers were retiring in such vast numbers from 2000-2020, all an Advisor had to do was dig a hole in front of where the herd was moving. Good strategy, but if the herd makes a detour, your hole will be empty. A more important part of this ‘grand market movement’ is how your clients emotionally respond to these seismic financial changes, here are 5 mistakes to help them avoid.
Dumb Mistake #1: I want to stay with my Advisor (even though I have lost 42% of my life savings over the last year).
This stupid investment mistake is called Status Quo Bias. William Samuelson of Boston University showed clients three investment options. One stock with a 50% chance of staying the same. Another stock with 40% of staying the same. A U.S. treasury with a 9% return and municipal Bond with 6% tax free return. Which to choose? 47% of those who were told they already owned an investment ignore their selection and remain with the investment they already had. This study showed that people are inclined to stay with what they have, no matter how bad the performance. This also explains why some investors will stay with a bad Advisor.
Tell your prospects about this research and tell them a story about a client who realized this mistake and how well they did by working with you.
Dumb Mistake #2: I want to keep my money where it is. If I sell now, I will ink those losses.
This stupid investment mistake is called Sunk Cost Fallacy – Throwing good money after bad.
These investors believe their portfolio is still OK until they cash in. You cannot make changes to the portfolio because it will ink your loss instead of taking the money out and moving into a more suitable investment. In the last decade, The ‘Big Dig’ in Boston linking the city to Logan airport was fifteen billion dollars over budget. The administrators would not fire the contractor and start over because of all the money they have sunk in the project already. Yet even after completion, a tile fell off the ceiling of a tunnel and killed a woman causing the project to incur even more expense. The US Government gave seventy billion dollars to General Motors (GM) in 2008. GM asked for thirty billion more in March of 2009. Both the Bush and Obama administrations fell into this trap believing it was too big to fail. But the ensuing GM default was the biggest sunk cost mistake in US history. If GM had restructured in September of 2008, they could have saved the company billions in cost and the U.S. taxpayer nearly one hundred billion. Because of the inability to recognize sunk cost fallacy, currently every citizen in America now owes six hundred dollars per person on behalf of that one company. That is a sunk cost sinkhole.
Ask your client if they did not already own their investment, would they buy it again? That will bring them back to reality quickly.
Dumb Mistake #3: I am going to keep my money in the market. It is moving up and I want to recover my losses
This Stupid investment mistake is called Confirmation Bias. There is a great tendency for investors to look for information that confirms their beliefs, rather than data that falsifies it. Cornell Marketing professor Ed Russo did a project with students evaluating restaurants. They rated restaurants on a one to ten scale, ten being the most positive. The ratings were based on menus and photos. But when the differences were mentioned one at time with photos of problem areas like rips in the booths and dirty kitchens, the students stayed with the initial ratings. They discounted information that did not fit with their first impressions.
Dick Winnick and Rahul Guah of Cornerstone Research in Boston noted that when consumers bought the same car every three to five years, they paid a premium over those who chose a different brand. They paid an extra $1500 with Buicks. Mercedes owners paid an extra $7500 because of Confirmation Bias. These car owners tended to be less skeptical and less willing to negotiate a deal with a car brand they have owned for the last twenty years.
During the U.S. presidential election of 2008, shock jock Howard Stern asked voters in New York City who they would vote for. If the answer was Obama, the next question that was asked was if the voter liked his running mate, Sarah Palin. The Obama supporters agreed it was time for a female VP. Stern employees also asked what the Obama supporters thought of his pro-life stance. They again mentioned their support of a child’s right to life. Kind of makes you wonder how voters make decisions in the first place.
Tell your clients about Confirmation Bias and talk about information that refutes their views, then produce stories about other clients who came to you with the wrong ideas and succeeded as a result of following your advice.
Dumb Mistake #4: I don’t like totally safe investments right now, I am getting back in. Look at how much the market has gained!
This Stupid investment mistake is called Short Term Memory Syndrome. We soon forget what happened last quarter in favor of what happened last week. The stock market lost 42% over the last 6 months and came back 25% in the last 6 weeks. The downturn must be over and boom times are here again. The stock market is based on earnings and GDP expansion. Everything else is sensitive to emotion and subject to volatility. This is also called ‘Chasing Returns.’ There is a strong tendency for your prospects and clients to respond to news reports that taut something that happened today or this week while ignoring a longer term perspective.
Talk to your investors about the rule of 100. Discuss the level of volatility over the last two recessions if they had been fully invested without regard to their retirement horizon. Tell stories about investors you have helped to weather the last few storms.
Dumb Mistake #5: Losses are only paper, it’ll eventually be fine. I don’t really care about losses right now.
This Stupid investment mistake is called Mental Accounting. The money you have is worth the same no matter how you make it. It is not true that some dollars are worth less than others and thus don’t matter. The notion is that my earned income is worth more than the money I make or lose from investing. This is where the idea of ‘found money’ came from.
One new husband while waiting for his wife to dress, before dinner he decided to try his luck with $10 at a Las Vegas casino roulette table. $10 turned into $100. That became $1000 and soon parlayed into $10,000. He lost it all on his last roll. On the way back to his hotel room, he noticed $5 still left in his pocket. His wife asked about his luck, he said, “Not bad, I only lost $5.” Casinos always make money. Las Vegas hotel mogul Steve Wynn once said he has never seen a gambler make money over the long term.
Take out a $10 bill and give it to your prospect. Let them keep it long enough to feel like they own it. Then ask for $10 out of their wallet and tear it up. Ask which $10 was a gift and which was earned. Your point will soon be made (you might want to give them another $10).
It is widely thought that we are in a secular bear market due to the levels of debt raked up by the current U.S. administration. This treasury debt is competing with private debt dampening the ability of private capital to influence future investment growth. Yet many investors believe we are in a bull market recovery. Even if that were so, it will be a very shallow recovery with a great deal of volatility in the short term. If your clients are caught on the wrong side of that volatility, it will greatly impact their retirement lifestyle. The five major cognitive traps described here are common for investors, and they may find themselves using them without the benefit of your financial guidance and counsel. As you hear each of the above objections and concerns from your clients and prospects, let them know first what the concept is, and if possible, tell stories about other clients who have mistakenly believed similar notions and how you helped them.
Kerry Johnson, MBA, Ph.D. is a best-selling author and frequent speaker at financial planning and insurance conferences across Canada. Peak Performance Coaching (his one on one coaching program) promises to increase your business by 80% in 8 weeks. To see if you are a candidate for this fast track system, click on www.KerryJohnson.com/coaching and take a free evaluation test. You will learn about your strengths and what is holding you back. Or call 800-883-8787 for more information