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This is a great time to be regrouping with your management team and aiding them in adding valuable context to their roles as leaders in the organization. As their direct reports struggle with increasingly turbulent and uncertain capital markets, your leaders have an opportunity to help them connect the dots between their client’s and prospect’s behavioral characteristics like performance under pressure and predictable irrationality and their own. An emerging area of study called Behavioral Finance can be explored with your management team in the context of helping them gain perspective on why they and their customers approach the current environment in predictable ways.
“I’d be a bum on the street with a tin cup if the markets were always efficient.” - Warren Buffet
In spite of compelling evidence that our financial markets are highly efficient, there have been many studies that have shown several phenomena in securities markets that contradict the efficient market hypothesis. Such phenomena are often referred to as stock market anomalies.
Behavioral Finance is a branch within the field of finance which explores psychology-based theories to explain such irregularities. Within the Behavioral Finance realm it is assumed that the emotional characteristics of market participants and the flow of information amongst them systematically influence investment decisions as well as market outcomes.
Because emotions underlie so much of thought, behavior, and perception, and because they are largely unconscious, emotions are key to understanding behavioral finance. Emotions are subjective feelings that serve as easy shortcuts (or heuristics) for our brains. Specifically, emotions tell us how one is doing related to specific financial goals and threats. On one hand, the emotion of excitement indicates that one has identified an opportunity. Excitement propels increased risk seeking and exploratory behavior. Conversely, the emotion of fear notifies of potential danger. Fear gives rise to behaviors of risk aversion and withdrawal.
Behavioral Finance is one of the most important aspects of financial advisory as it centers on the ability to control emotions, think rationally and not be fearful when you should be greedy or greedy when you should be fearful. Making choices about money is among the most significant and emotional activities in which humans engage. It is critical for understanding why we do what we do and when we do it. In its simplest form, managing wealth has several fundamental aspects, including, but not limited to: entering and exiting the market, stops, asset allocation, risk and reward, investment planning, control of emotions, preservation of psychological and physical capital, including mitigation of stress, understanding why markets move the way they do and how to profit from the emotional overreactions of others. For financial advisors, the brain is at the root of all of this and is, without question, our most powerful tool. Helping clients to use logic and minimize emotion is the advisor’s greatest challenge and opportunity.
While emerging areas such as Neuro Finance and Neuro Economics are helpful in many ways, few definitive research studies have been conducted to help predict business behaviors. The best we can do is assess The Big 5 Personality Variables and learn how to manage them for ourselves and our clients. The Big 5 as they relate to financial advisory clients are:
· Optimistic vs. Pessimistic— reflects extroverted and gregarious leadership type behaviors vs. a nervous and often scattered approach
· Emotionally stable vs. Nervous—reflects calm, cool, steady, self-confident behaviors vs. anxious, worried, and insecure behaviors.
· Conscientious vs. Impulsive—refects self disciplined, persevering, gratification-delaying, and rule following behaviors vs. irresponsible, undependable and disorganized behaviors.
· Agreeable vs. Self Interested—reflects cooperative, sympathetic, warm, and good natured behaviors vs. aloof, distant and suspicious behaviors.
· Innovative vs. Traditional —reflects imaginative, broad minded, and curious behaviors vs. conventional, concrete, practical, and status quo behaviors.
Recognizing and learning to communicate with our clients emphasizing one or more of these personality traits is a key success factor in good and bad economic times. Co-developing expectations around these Big 5 factors allow for a highly effective and efficient financial advisory experience for our clients
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