During initial discussions with a new financial adviser, a client describes herself as a long-term investor, willing to tolerate market tumbles for what she hopes are the eventual larger returns in equity markets.
But in practice, she panics when the market does go down and bails out of positions at a substantial loss.
Should the adviser have done more to ferret out her true risk tolerance? Should the client have done a better job of describing herself to the adviser?
In many cases, the answer to both questions is yes–a clear failure to communicate.
But the larger problem may go deeper.
Investors may believe they control their behavior with a rational set of principles, but often they are dead wrong about what those beliefs really are, said Richard Peterson, a San Francisco psychiatrist and managing partner of a consulting firm specializing in market psychology.
Peterson recently posted a Financial Values self-test on his firm’s Web site (www.marketpsych.com) that asks more than 50 questions designed to better understand a client’s money motives. The test is in a free trial now, but it will cost $100 next year.
The questions look at a person’s earliest financial memories and family influences on money behavior. They also probe investment styles and risk tolerance, as well as general life goals.
Answers are then tallied and a report spits back some general feedback on your emotional relationship with money (how you feel about scarcity and abundance, for example), your investing style and your asset-management habits. Open-ended questions aren’t evaluated, but are put in context with the scored answers in the report.
My own pass through the quiz revealed that I am a slow-and-steady investor, but also one who seeks excitement and can be paralyzed by losses. Not a great combination.
Thus far, about three dozen people have taken the quiz, Peterson said, expressing unmet life goals ranging from making a difference in people’s lives to having 14 percent less body fat.
“I’m hoping [the quiz] helps people understand their deeper beliefs and values, and that it helps planners understand clients better,” Peterson said.
Clearly, there is a need.
Through September, more than 1,500 investors in 2005 had filed actions against their brokers claiming their money was placed into investments that were unsuitable to their risk profiles, according to the NASD, a securities industry self-regulatory group.
By starting to understand our most prominent money emotions, Peterson believes, we will uncover useful patterns in our actions and be better able to communicate our financial styles.
“People tend to cluster their responses into certain areas. Those who score high in financial stress also tend to score lower in trust, for example,” he said.
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But getting down to the root of an investor’s decision-making pattern is extremely difficult, especially in an online quiz, said Matthew Spiegel, a Yale School of Management professor and principal with Alpha Investment Opportunities LLC in Birmingham, Ala.
Simply changing the phrasing of a question can lead to wildly different answers, he said. “Most people would turn down a random gamble, but if you phrase it as an investment, suddenly the rate of acceptance goes way up,” he said.
Knowing thyself as an investor is a lofty goal, and asking the probing questions can be a rewarding experience. But sometimes, flipping a coin can help too, Spiegel said.
He and a colleague once asked a group of business students to play a coin-flipping game designed to replicate stock market gyrations. Each time students flipped a coin, if it landed on heads they would be up $1.01. If it was tails, they would lose a dollar.
When the students got behind they started to panic and get out of the game, while in the long run staying the course would have paid off, he said.
“Eventually they started to see that in the long run they have to get used to the risks, and the downturns started to immunize them from total panic,” he said.
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E-mail Janet Kidd Stewart at [email protected].