How to Analyze the Independent Investor Type
Here are some strategies for overcoming this behavioral investor type's biases.
This is the 10th article in a series focusing on behavioral investor types, and it is intended to help advisors strengthen their relationships with their clients by helping them better understand financial personalities. Once advisors understand the various investor types at play, they can adjust their advisory approach for each type.
In last month's article, we reviewed the case of the Masters family, a high-net-worth couple. By way of refresher, here are some of the salient points about the case:
This case involves a married couple. However, while analyzing the case, treat them as a single client; try to identify biases and the behavioral investor type as if they were a single individual. To better understand their situation, we are going to answer the following questions and then will provide a suggested solution to their situation.
1) What is their behavioral investor type?
2) What behavioral biases might drive their behavior and decision-making? What specific evidence leads you to this diagnosis?
3) How might the Masters' 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 the Masters?
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?
Case Study: Answers to Questions
The Masters' biases are very consistent with an independent behavioral investor type. We know that they are independent because, based on the descriptions in the case study, they exhibit the following cognitive biases:
The independent behavioral investor type profile leads to a clear allocation preference for risk; typically, independents are risk-tolerant. In the case of the Masters, however, their availability bias (thinking that another crisis is near) coupled with conservatism bias (making a forecast and clinging to that forecast irrationally) have caused them to be more risk-averse. In addition, confirmation bias is reinforcing these views and preventing them from taking on a riskier allocation.
It is up to you to decide how to prepare a recommendation for the Masters. You have been working with them for a long time and know them well. You reflect on when you started--back then, you prepared a financial plan recommending an asset allocation of 70% equities, 25% bonds, and 5% cash. They chose a more conservative allocation of 40% equities, 40% bonds, and 20% cash. They never did get to your target. You decide to "meet them near the middle" with an asset-allocation plan that takes into account the Masters' financial goals while at the same time accounts for their biases. Therefore, you decide that a reasonable allocation is 60% equities, 35% bonds, 10% cash.
When meeting with the Masters, you decide that you will accomplish the following as it relates to explaining your recommendations and their reactions to them:
Previous installments in the series:
Advising a Couple That Fears a Financial Crisis
Why You Need to Understand Behavioral Investor Types
The Four Behavioral Investor Types
How Advisors Can Help Preservers and Followers Succeed
How Advisors Can Help Independents and Accumulators Succeed
Advising a Too-Conservative Retiree Using Behavioral Investor Types
How to Advise Preservers
Advising a High-Earning, Risk-Taking Pre-Retiree Using Behavioral Investor Types
How to Advise the Accumulator Investor Type
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. His book, Behavioral Finance and Wealth Management, is helping thousands of financial advisors globally build better relationships with their clients. Contact Michael at firstname.lastname@example.org.
The author is a freelance contributor to Morningstar.com. The views expressed in this article may or may not reflect the views of Morningstar.