What’s Going On In Clients’ Heads? Don’t Ask AI

AI your mind.

In good times and bad (mostly bad) advisors have to reassure clients that sticking to their financial plan will keep them on track. Client risk aversion shifts constantly, and advisors must navigate those changes, all while AI becomes more prominent in investment management. As technology takes over more technical tasks, clients will expect human advisors to understand them on a deeper, more emotional level, even in ways they may not fully understand themselves. That means behavioral finance will likely play a much larger role in wealth management in the years to come.

“I absolutely believe the behavioral piece is going to get more important, and concurrently, maybe paradoxically, the technical pieces,” Investments & Wealth Institute CEO Sean Walters told Advisor Upside during last week’s IWI conference in New York City. “Advisors are going to need to be smarter than AI.”

Risk On, Risk Off

It’s not just general market volatility that affects a client’s risk profile, but also their own experiences, said Chris Geczy, adjunct professor of finance at the Wharton School. Investors who have lived through periods of low returns often shy away from future risk. “If we had a crash yesterday, guess what? Today, it’s harder to invest,” Geczy said during a panel discussion at the conference. “And yet, when we look at the greatest investors of all time, they may literally invest on the day of the crash.”

Market losses can leave long-lasting psychological marks, like millennials’ hesitancy to buy homes, for example. While today’s housing market is expensive, many still carry the emotional trauma of the 2008 financial crisis. “Five or six decades ago, people were buying homes in their 20s and 30s,” Geczy said. “Now the average age, depending on the part of the country, is in the 40s or 50s.”

But risk aversion can “echo” across generations, too. Someone whose family struggled during the Great Depression may adopt conservative habits, saving diligently and avoiding risk even if they never experienced hardship firsthand. “You don’t necessarily have to have a depression or a market crash to have this affect your life,” Geczy noted.

On the other end of the spectrum are clients whose risk tolerance is too high. These investors are prone to FOMO, a response triggered in the anterior cingulate cortex near the brain’s pain center, Geczy said. “You don’t necessarily feel it on your skin, but you can feel the risk,” he said. “It causes an urgency. You feel stressed.”

Inner Machinations: So, what’s an advisor to do? Communication remains essential. Geczy recommends grouping clients not only by profitability, but also by personality. For more risk-averse clients, he suggests starting with the bucket model, separating assets into short-, medium- and long-term allocations. “If you can get your clients into a situation where they feel safe, they can then make a decision about growth, and then make a decision about higher levels of risk,” he said.