Teaching clients to embrace risk
We like to think we make rational decisions based on the information available. But in truth, our brains use cognitive biases — psychologists call them “heuristics”— to make decisions more efficiently. And while we try to consider all the information available to us, we tend to employ the information we can easily recall.
The above quote is from RetireOne CEO and co-founder David Stone’s recent article in FinancialPlanning, “Fearful clients? Teach them to embrace risk.” We all like to think we’re rational, that our decisions are based on logic and sound reasoning. As David explains in the article, though, that’s mostly an illusion.
Which isn’t to say that we’re always prone to making bad decisions, but we are prone to making emotional decisions, especially when we’re dealing with a lot of stress and anxiety.
Given current market performance and world events, stress and anxiety have become far more common than most of us are comfortable with, and that’s caused many to become risk averse. While understandable, risk isn’t the enemy. David explains:
It’s natural that clients should feel risk-averse right now, but risk avoidance itself can be risky if it stunts a portfolio’s growth in the run-up to retirement. When clients call in a panic, it’s the advisor’s responsibility to get them to take a deep breath and help them figure out what they’re actually afraid of. A client’s sudden desire to move their investments to cash, for instance, could be motivated by the wish for control in the face of geopolitical destabilization and other uncontrollable uncertainties. That’s when selling low can occur — sometimes to harmful effect.
Risk is intrinsically linked to reward. Wouldn’t it be ideal, then, to wrap risk within an income guarantee (like portfolio income insurance) rather than avoiding it?