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Advising a Too-Conservative Retiree Using Behavioral Investor Types

Michael Pompian's first case study features a high-spending retiree with a cautiously positioned portfolio.

This is the fifth article in a series focusing on behavioral investor types and intended to help advisors strengthen their relationships with their clients by helping them better understanding clients' financial personalities. Once advisors understand the various investor types at play, they can adjust their advisory approach for each type. 

We have reached the point in this series where you will practice applying your learning of behavioral finance using a fictional client case study. The key questions to be answered are:

  • What personal biases might drive the client's behavior and decision-making?
  • What is the client's behavioral investor type?
  • How might the client's personal biases affect the investment strategy and solution decision?
  • How should the advisor approach the client to moderate or adapt the impact of these biases?
  • What is the best investment strategy and solution for the client?

For the case study, assume today's market environment. That is, the U.S. stock market is fairly valued, not terribly overvalued or undervalued. Interest rates are rising. Volatility is present in the market.

As you read the case, try to identify any biases based on the fact pattern.  When solving for the investment strategy, for simplicity’s sake, assume that all client portfolio allocations will be divided between three asset classes: stocks, bonds, and cash. 

When thinking about the case, remember that every advisory relationship is unique, and there is no absolute way to understand and respond to client behavior and biases. Keep this in mind while reading and thinking about how you might handle similar situations in your own way with clients. Focus most on applying methods of behavioral analysis, investment strategy and solution proposal, and tailor your advisory approach to the given market and client situation.

Case Study: Situation
Mrs. Gina Fleming is a single, 70-year-old retiree living an exclusive lifestyle. Her annual living expenses are approximately $400,000 (including taxes). However, her only income is generated by her $5 million investment portfolio at about a 2% annual rate. Her spending rate is 8%, so she is spending down her principal. You have known her for three years. Mrs. Fleming's primary investment goal is for her assets to sufficiently support her for the rest of her life (perhaps 20 years more), and she has a low tolerance for risk. She also has a goal of donating $2 million to a charity for animals if possible.

Although she is not that interested in the details of how her money is managed, she has told you many times that she does not, under any circumstances, want to lose money, because she recalls that her relatives lost money in the crash of 1987. You have noticed that she feels the pain of losing money more acutely than the pleasure of generating returns from her portfolio.

You have also recognized that Mrs. Fleming is stubborn and inflexible in her thinking, especially when it comes to financial markets. She likes to keep things as they are, even if the world around her is changing. Although she is not an expert in financial markets, she periodically studies the markets and uses current trends and market levels as benchmarks for predicting the future. When markets are falling, she says that she would be "crazy to invest now, because the markets are going down"; when they are up she says, "Have we missed it?"

In your review of Mrs. Fleming's portfolio, you realize that, despite your recommendations, she has never changed her portfolio structure. She has a big part of her portfolio (50%) in Treasury bonds and high-grade municipal bonds. Most of Mrs. Fleming's equity (10%) is in a large concentrated position in Exxon stock. She inherited this stock from her late husband who passed away in 2011, keeping the certificate in her safe deposit box at her local bank. The dividends are set up for automatic dividend reinvestment to buy more shares. This is how her late husband had arranged it, and she didn't want to disturb the plans that he had made for her. The rest of her portfolio is in cash (40%). 

You are concerned that Mrs. Fleming's conservative allocation will not support her lifestyle nor allow her to reach her financial goals. You suspect her discomfort at the prospect of re-allocating her portfolio is due to one or more behavioral biases.

Case Study: Analysis
Assume you are Mrs. Flemings advisor. Your job is to advise her on the best allocation you believe is appropriate for her given her unique circumstances and her behavioral profile. You are trying to ensure that she feel comfortable enough with your investment solution that she will not decide to change it six months from now.

To help further analyze her situation and devise a plan, answer the following questions. In next month's article, we will review the answers to these questions and provide a suggested solution.

  1. What behavioral biases might drive Mrs. Fleming's behavior and decision-making? What specific evidence leads you to this diagnosis?
  2. What is her behavioral investor type?
  3. How might Mrs. Fleming's personal biases affect the asset allocation decision?
  4. How should the advisor approach the client to moderate or adapt the impact of these biases?
  5. What is a reasonable allocation recommendation for Mrs. Fleming? 
  6. How should you as the advisor facilitate the client conversation so that the client makes a good and thoughtful investment decision and shows more consistent investor behavior?

Michael M. Pompian, CFA, CAIA, CFP, is the founder and chief investment officer of Sunpointe Investments, an investment advisor to family offices based in St. Louis, Missouri.  His book, Behavioral Finance and Wealth Management, is helping thousands of financial advisors globally build better relationships with their clients. Contact Michael at michael@sunpointeinvestments.com.

The author is a freelance contributor to Morningstar.com. The views expressed in this article may or may not reflect the views of Morningstar.