CHAPTER TWO

The Psychology of Money and the Emotions of Investing

I can calculate the motion of heavenly bodies, but not the madness of people.

—Sir Isaac Newton

In Chapter One I briefly discussed why investing (making money and potentially losing it) is a highly emotional experience. I identified the powerful role that anticipation and fear play in such circumstances, and how they can light up the brain with neural activity. In this chapter we will discuss in greater depth:

• The complicated mix of emotions that investors experience, especially in times of high stakes and high stress.
• Beliefs about money and why these provide a powerful window into human nature and a basis for understanding human emotions and motivations.
• The potent power of loss, which we touched on with discussion of Kahneman and Tversky’s model of “loss aversion” in Chapter One.
• How investing takes place in a range of emotional environments, just as it takes place in a range of market conditions, from the placid lagoon to the raging seas.
• The role that we, as advisors, need to play in high-stakes situations to help our clients successfully navigate what are often rapidly changing marketplace and personal circumstances.

The Brain-Biology-Belief-Behavior Connection

To get started, let’s drill down more deeply into a discussion of emotions and how they can trigger an intense brain-biology-belief-behavior connection. In Your Money and Your Brain, Jason Zweig writes that scientists have determined that the brains of cocaine addicts who are expecting a fix have a lot in common with the brains of investors who are expecting a big payout from a risky financial move. “The similarity isn’t just striking: it’s chilling,” he says, “Lay an MRI brain scan of a cocaine addict next to one of somebody who thinks he’s about to make money, and the patterns of neurons firing in the two images” appear virtually identical.1

Love and Loss

So why does money—especially the loss or potential loss of it, have such a profound effect on us? Zweig notes that “financial losses are processed in the same areas of the brain that respond to mortal danger.”2 But there’s more to the story than that.

It’s been my observation, as I’ve worked with clients over the years, that loss is a grievous experience for people. I have certainly felt the emotional pain of financial losses myself. No money manager worth their salt would say otherwise. I believe that financial losses resonate deeply in us because of the experience of emotional losses (hurt) we have in early childhood. Remember, our emotional templates reflect conditioned responses based on early, always formative, and sometimes searing emotional experiences. Emotional losses that you or your clients might have experienced in childhood might not be obvious at first blush, but it’s my belief that one’s experience of financial loss as an adult triggers recall (almost like a flashback) of early experiences in the “emotional child” that still dwells in each of us.

So, why are these experiences so vivid? Because a child’s world is very child-centric. In the emotional and psychological drive to make sense of his or her world, a child often seeks explanations to how the world works based on what he or she did or didn’t do in a particular situation. This is foundational to the “meaning making” experience for a young psyche, trying to connect cause and effect in the world around him or her. It gets back to the issue of “object theory” that I mentioned in Chapter One.

For the investor (now a mature adult), the experience of financial loss in the market can evoke memories of past losses (and perhaps past fears) about “reality repeating itself.” And, even though the mature adult realizes that he or she is no longer an innocent and uninformed child, the experience of loss (or the expectation of it) triggers “emotional tapes” from an earlier time and place. Such emotional scars, I believe, are underneath the dynamics of loss aversion as identified by Kahneman and Tversky.

What about gains? As noted, research shows that the anticipation of a gain is actually a more intense experience than realization of a gain. Researchers have found that “anticipating a gain, and actually receiving it, are expressed in entirely different ways in the brain, helping to explain why “money does not buy happiness!’ ”3 To piggyback on that, I would argue that there is a “thrill of the chase” component to our pursuit of gains that is biologically based, and that stems from our evolution as human beings. As noted in Chapter One, researchers such as Jakk Panksepp of Bowling Green University believe we are equipped by virtue of evolution with a “seeking system” that primes us to chase opportunities when they come into our view. In prehistoric times this might have been to give chase to prey (and that night’s dinner). Today, that same impulse to give chase can come alive when we view the potential rewards of a big financial gain on the marketplace horizon.

But certainly, we’ve evolved since our days in the caves, haven’t we? Or perhaps not! It’s fascinating to see how unfulfilling the “gain side” of the financial equation is. Are we so addicted to the thrill of gain and the anticipation of gain that we strive for it again and again, without achieving ultimate satisfaction? John D. Rockefeller, one of the world’s richest men of his time, was once asked by a reporter, “How much money is enough?” To which Rockefeller responded, “Just a little bit more.”

Continental Insurance

It’s 1983. The hit TV show M*A*S*H has finally wrapped production after 11 years (and 251 episodes) on CBS. On Broadway, the hit musical Annie has been performed for the last time, after 2377 shows at the Uris Theater in New York City. Sally Ride has become the first American woman in space aboard the Shuttle Challenger.

And in the insurance industry, things are bleak.

The prices that insurance companies can charge for their policies have been stagnant for years, and consequently many insurers are suffering financially. Among the underperformers is Continental Corporation, a New York–based insurer founded in the 1850s. In 1982 it is an unprofitable, unwieldy conglomerate of many businesses with a badly beaten down balance sheet. Its market share is eroding and cash flow is strained by shareholder dividends that exceed per share earnings. But top management seems unwilling or unable to change course and has become combative with investors and Wall Street analysts, who are increasingly critical of the company’s performance.

Then, the company hires a dynamic new CEO, Jake Mascotte, an executive with no experience running a property/casualty insurer and, at 43, the youngest CEO in the industry. Soon, investors start buying up Continental stock. Acting with the impulse of sharks, they hope to cash in big-time if the company ever has a rebound from its near death experience. The chief strategist at a Wall Street brokerage firm makes a big bet on Continental, putting 2% (a significant market overweight) of his firm’s assets into Continental stock and adding it to the firm’s portfolio.

After just 19 months on the job, Mascotte hosts a meeting that is jammed with money managers and analysts. Unlike the previous CEO, Mascotte is affable and relaxed in front of the crowd. He welcomes everyone and acknowledges that, with most of his experience in life insurance (not property/casualty), he’s clearly the new kid on the block. But then he goes on to firmly declare that as CEO, he will bring a fresh approach to managing Continental’s beleaguered financials. He talks about cutting costs, rebuilding the balance sheet, and fields pointed questions with Midwestern sincerity. He beams broadly, is disarming, calls analysts by name, and impresses the attendees with his frequent use of all the buzzwords associated with corporate turnarounds.

As Mascotte speaks, a palpable excitement arises in the room. He is confident, even cocksure about his company’s future, despite its currently dismal financials. The money managers have heard what they want to hear. Indeed, a “We can do it!” attitude seems to permeate the room, and for the first time in its history, Continental seems poised to buck the industry trend and, against all odds, recover and rebound.

But one analyst in the audience, a young woman just beginning her career in finance, is bewildered. She knows that Continental’s future is troubled, even bleak. She calls her boss.

“I don’t get it,” she told him. “The people at this meeting today are all rational and logical people. But, by the end of the meeting, they’d all become very excited about Continental’s prospects and felt that the CEO could walk on water.”

Her boss chuckled. “I know; it’s not logical. But, fact is, making money is always emotional. The only thing more emotional than making money is the prospect of making it,” he told her. “Welcome to the world of emotional investing!”

Conquering Emotions: The Key to Investment Success

All of us have certain aphorisms that act as philosophical guiderails of our lives—both as human beings and wealth advisors. One of my favorites is Warren Buffett’s suggestion that we “Be fearful when others are greedy, and greedy when others are fearful.” Buffett’s remark has particular relevance to me when applied to the markets. When the market’s averages are selling at 52-week lows, it’s a clear sign that people are becoming fearful about something, and if you check the headlines you’ll probably see plenty of evidence of why the market has sold off and fear abounds. So, to agree with Buffett, that might be the very moment to put money into the markets, and look for opportunities to allocate capital to attractively priced stocks.4 When the market is at all-time highs and greed abounds, the reverse is also true, of course. Then it may be time to quietly exit and place your money in cash instead of stocks.

When Fear Takes Over

Fear can push investors and advisors to act in ways that, in hindsight, they should not have. In early 2009, as the Bush administration was ending and the Obama administration was just beginning, the government was taking over more and more businesses. Banks were forced to take on massive government loans, whether they needed them or not. The U.S. government seized control of American International Group (AIG) by taking an 80% equity stake so the company could stabilize its various businesses. AIG later became a conduit for bailing out other financial firms with government money. Lehman Brothers went bankrupt in the autumn of 2008, and bank liquidity was almost nonexistent for several days that fall. General Motors and Chrysler were taken over by the U.S. government, and shareholders’ equity was deemed worthless. These were dark days, fear was rampant, security prices fell, and it had to be the exceptional investor who did not sell but decided to buy.

The same can be said for the turbulence that briefly hit the markets in mid-August of 2015. Over concerns that China’s economic growth was slowing (and that Chinese reports of previous expansion may have been falsified or at least “puffed up”), the Dow Jones had repeated days of triple-digit declines, accentuated by a 1600-point drop at one point, and swings of as much as a 1000 points on August 24 alone.

Fear and greed drive our emotional state into what psychologist David Kantor calls “high-stakes” behavior. Much of the time we, as investors, operate in low-stakes circumstances, when the world seems rational, and we have time to be reflective and logical about the decisions we make. As the perception of market risk rises, however, and the threat of loss increases, my experience as an advisor is that the stakes for investors rise quickly. Client emotions become stronger and stronger as stakes rise, and people often feel forced into a corner: their behaviors becoming increasingly stress-affected as they perceive their options to be narrowing and their choices being increasingly critical. Rational behavior and the sense of having broad options that characterize a low-stakes situation suddenly evaporate. People become tense, fearful, anxious, and easily angered. Sleepless nights make matters seem even worse! This doesn’t always happen in such situations, but I’ve seen this scenario play itself often enough in client meetings. Not all people respond to high-stress and high-stakes situations in this way. Some people become emotionally distant in high-stakes situations. There’s no “one-size-fits all” response that all individuals have to stressful, high-stakes situations, because people have different personality types that react to stress in different ways.

To use Kantor’s taxonomy of hero types, Fixers, Survivors, and Protectors all move from operating in the “light zone” (normal, low-stakes circumstances) to a “gray zone” of intermediate stress, and from there to a “dark zone” in circumstances of high stress and high stakes. Later, we’ll explore the specific behaviors that each hero type exhibits under circumstances of high stress or high stakes.

Beliefs about Money

People bring more than just their emotional makeup to wealth advisory discussions, of course. They also bring personal belief systems about money that impact them in both subtle and obvious ways. To many people, money is bound up with notions of status, entitlement, and family lineage and legacy. Others think about it in terms of hunger, satisfaction, scarcity, ability to accomplish things, security/insecurity, and comparisons and distinctions, among other things.

Sometimes people are confused or conflicted about money. We equate its pursuit to the pursuit of love. Indeed, for some people money becomes (regrettably) a substitute for love. How many people, for example, as they approach retirement after a successful career, suddenly realize that their marriage is in shambles or their relationships with children are hostile or nonexistent? Their stock portfolio may be healthy and their net worth in the top 1%, but their spiritual cupboard is empty. An individual may have achieved everything they wanted to achieve from a financial and professional point of view, but their relationships are shallow, barren of love, or even rife with recriminations and pain. In my view, it’s no accident that the Bible counsels us that “The love of money is the root of all evil.”

Sometimes, however, this aphorism is misquoted to say that “Money is the root of all evil.” Consequently, some individuals, fearing the accumulation of money, spend everything they have in pursuit of new acquisitions or experiences rather than saving enough to retire in security and comfort. Because they see money as evil they set out to “lose” it rather than seeing its potential focus for good: as a means to provide for future generations or charitable causes.

It’s only when a client develops a balanced relationship with money that he or she can begin to relate to it in healthy ways. Sometimes the client-advisor relationship becomes the perfect venue in which that can take place. It’s one of the primary reasons why, on a regular basis, I ask clients and prospects to share with me their personal and family values surrounding money. What role do they see it playing in their lives? How do values about money influence their thinking about investment choices, portfolio planning, retirement, and their desire to pass on wealth to others, including heirs and charitable causes? Asking clients to talk about their personal and family values relative to money can also generate important insights into a client’s personality, risk tolerance, and dynamics, such as family culture. In the case of inherited wealth, for example, how has money influenced the client’s family culture, beliefs, and sibling and generational relationships among family members? Do people view wealth as an obligation, a curse, a privilege, a right, a gift?

And then, of course, it can be fascinating to see what emotions arise in individuals when they start talking about money and themselves. Did they have money when they were growing up? Or, were they the first in their family to build and acquire wealth? When I ask questions such as these, I pay close attention to people’s body language and affect. Do they feel in control of their wealth and competent to manage it? Or do they feel it controls them?

This begs a larger question, of course. Do we want money to be in charge of us? Or, do we want to be in charge of our money? Having money in charge of us means that we are constantly fretting about outcomes, wondering if we’ve accumulated enough, or not trusting that we have made sound decisions in the first place about how to earn, save, and invest. If we are dependent upon money, then we give money a powerful position in our lives. Conversely, if we salt away enough of what we earn each paycheck and invest that money wisely, we will be happier and lead a more balanced life 20 years from now. We take control of our financial circumstances and are no longer dependent upon money to meet our day-to-day needs.

Why I’m a Behavioral Finance Guy

In the world of theories explaining how the financial markets work, I’m very much in the behavioral finance camp. Behavioral finance is a relatively new field that draws on insights from behavioral and cognitive psychological theory to help explain why people sometimes make highly unpredictable or irrational decisions about investments and risk-taking.

Conventional market theory would have you believe in the idea of efficient markets and would argue that most investors are rational actors and wealth maximizers. But in my experience, nothing could be further from the truth! There are just too many instances I’ve observed where people’s psychological makeup acts as a driver of their risk-taking behavior. Their unique emotional template acts as a kind of operating system that determines how they behave both under low-stakes and high-stakes circumstances.

For us, as advisors, it’s very important to become discerning observers of human nature, because doing so enables us to adjust our own behaviors and style of interaction with clients, based on the way they “show up” in particular situations. In Chapter One I introduced the various hero types that clients can take on in high-stakes situations. As you’ll learn in future chapters, dealing effectively with a “Fixer” in the dark zone will require different skills and approaches than dealing with a “Protector” or “Survivor” in the dark zone. Your ability to “read the room” in such situations, and to intuit where your client is coming from behaviorally, will help you deal effectively with that individual under any kind of circumstance.

It’s important for all of us, as we calibrate what kind of relationship to have with money, to be aware of the potential emotional baggage we carry around about it. I know for myself, having grown up in a wealthy family, that I can never match the lifestyle my parents enjoyed. Comparisons are ever present in how I live my life. I am never “good enough” to provide for my family in the same way. My initial response to this was to run away from my family’s money to live in Vermont, and to pursue the kind of lifestyle (as a geologist and gentleman farmer) that would eventually have caused me to run out of cash. I had to make a mid-course correction to create a healthier relationship with money, where I was no longer so dependent on it. For me, establishing a healthy relationship with money meant “making peace” with my parents and the experiences of my early childhood. Money can be funny that way. Unpacking our feelings about it often proves to reveal a Rosetta stone with which we can then figure out the rest of our lives, or at least determine a new life trajectory to embark on. More than once I’ve seen clients of mine struggling with similar issues as they try to figure out their relationship with inherited wealth.

The Folklore of Finance

It’s not only clients that get caught up in the emotions and psychology of money; so too do we, as wealth advisors and investment counselors! The State Street Center for Applied Research in Boston (www.google.com/#q=state+street+center+for+applied+research) has done some intriguing research on the so-called “folklore” employed by wealth advisors in advising clients. Folklore, of course, is not necessarily fact-based, but it is often embraced by large numbers of people as reliable truth. The Center has identified three specific types of “folklore”5 that wealth advisors often employ in working with and advising clients:

• The Folklore of Time
• The Folklore of Knowledge
• The Folklore of False Comfort

All three pose potential traps for advisors and investors alike!

The Folklore of Time. Advisors who embrace the folklore of time subscribe to the belief that by examining backward-looking patterns and relationships among asset classes and industries, they can accurately forecast where future growth (and potential loss) is likely to occur. In this spirit, financial experts scramble to identify noncorrelating asset classes in order to pick and choose future asset classes and investment managers to build and manage portfolios. They employ expensive and complex software programs that delve into the history of asset classes (and outside investment managers) to build predictive models to forecast how portfolios are likely to behave under different risk scenarios, such as inflation, deflation, a strong dollar, a weak dollar, and so on. Once relationships between funds can be determined to produce low correlation, then “Presto!,” the advisor (or firm) has identified a new candidate for addition to the client’s portfolio! No matter that the analysts doing this work understand that the future is not like the past. But they can’t predict the future, so they try to do the next best thing!6

A second example of how investment advisors embrace folklore of time thinking is by focusing obsessively on quarterly results. As soon as a company announces its quarterly numbers, analysts have their research assistants adjust their earnings models incrementally and change their forecasts accordingly. After all, nobody wants to look like they weren’t prescient! If a company beats earning predictions by two cents, it means the company can then trumpet this, implying an incrementally higher growth rate in earnings per share going forward. A miss of a penny in forecasted earnings can mean just the opposite, of course.7

A good way I’ve found to deal with the market’s quarterly earnings craziness is to listen carefully to what corporate executives say to analysts during earning calls, and then to pay close attention to what a company does with its dividends. Companies hate to reduce dividends—ever! So, if after an earnings call, a company decides to increase dividends and announces it very publicly—as in, “We feel certain enough about business conditions and prospects to increase dividends by 8% this year”—it’s a very good sign that company insiders are truly bullish on the company’s growth prospects going forward. Such statements carry far more weight than whether the company just surprised Wall Street with a quarterly earnings “beat.”

The Folklore of False Comfort. This is a second area of bogus (or at least sketchy) thinking that advisors tend to embrace in their work with clients.8 The Center cites several kinds of false comfort thinking that wealth advisors and investment planning professionals embrace.

The first is the use of an ever-expanding array of ostensibly scientific indices which give wealth advisors a false sense of security about what really makes the markets work. These metrics can include measures of risk, such as value at risk (VaR), a widely used risk measure indicating the risk of loss on a specific portfolio of financial exposures, as well as fund ratings, ratings agency risk ratings, style boxes, and benchmark investment indices. At the risk of sounding conspiratorial, there is a very profitable cottage industry that has sprung up around having so many risk-related indices in the wealth management industry!9

Indices, in fact, become highly profitable products for the firms that create them and then use them to design portfolios for clients. Rating agencies, fund analytical services, and risk assessment companies all peg their own market and company assessments to these indices. A false sense of security can develop, however, if investors believe they know just how much risk is embedded in their portfolios, based on the “insights” of various indices. The integrity of these indices is generally recognized until some cardinal assumption underlying a model gets violated (e.g., “Treasuries are totally risk-free.”). Suddenly, what people always believed as gospel truth is no longer!

Although I’m generally skeptical about many of the popular, pseudo-scientific-based indices being used in the wealth management industry today, see Appendix B for information about one company, Market Profile Theorems (MPT) whose indices I do believe help illuminate the behavioral dynamics at work in the marketplace today, impacting everything from analysts’ earnings estimates to stock prices to the behaviors of key marketplace actors at various points in a market cycle.

A second kind of “false comfort” arises when firms use outside managers to invest client money.10 Many wealth management firms, to inoculate themselves against market downturns, enlist outside “experts” to handle most of their client portfolios.11 The handmaiden to this practice is using consultants to help advise and choose the outside manager(s). Consultants can be very helpful. However, in my experience as the past chair of the investment committee for a local nonprofit organization, consultants can unintentionally create distance between the organization’s investment committee, portfolio managers, and the markets. Moreover, consultants have their own agendas, so this represents a potential conflict of interest. There are also inevitable time lags between the end of the quarter when consulting firms conduct portfolio analyses and when the nonprofit’s investment committee finally meets with consultants. Recommendations can grow stale, performance becomes dated, and what might have seemed like good investment strategy one to three months before is now no longer so “crystal clear.” In the case of the nonprofit noted above, my colleagues and I normally found that the organization’s performance was in line with the index benchmark, minus the double layer of fees we paid (to the investment manager and the consultant). Ultimately, we decided it was simpler (and less expensive) to manage our organization’s money without a consultant, by allocating the funds to a group of managers we felt were well positioned to meet our organization’s needs. Moreover, rather than be solely wedded to a market benchmark, we also decided to measure performance against inflation indices. After all, it is the corrosive effect of inflation that most adversely affects investors.

Putting too much faith in regulation and disclosure practices creates another kind of “false comfort”—for investors and advisors alike.12 Investors and advisors tend to buy into the idea (perhaps subconsciously) that regulation and disclosure will effectively inoculate them against market downturns. But this clearly isn’t always the case. In my opinion, the 2008 market downturn provides a stunning example of this. The causes of the 2008 market meltdown are still in dispute. Many people argue that it was the result of large banks and insurance companies selling people products that were faulty and dangerous and that propped up poorly written mortgages. From my perspective, however, one can make a convincing case that the seeds of these bad mortgages were planted back in the early 1990s during the Clinton administration, when Andrew Cuomo, the then Secretary of Housing and Urban Development, issued guidelines requiring banks, Fannie Mae, and Freddie Mac to increase the amount of subprime mortgages they wrote. Under the plan, banks that did not comply with these requirements would face a much more stringent approval process for mergers and acquisitions.13

This policy remained in effect through the 1990s and into the early 2000s. Efforts by banks to reduce or scale back this policy were met with howls of protest from influential politicians such as Representative Barney Frank of Massachusetts. Yet, when the whole financial system began to collapse under its own weight, Frank and Senator Chris Dodd of Connecticut spearheaded passage of a massive bill (Dodd-Frank) whose regulations identified financial institutions as being at fault. The sad part of this story is that, in retrospect, I believe that the Clinton administration’s loan requirements for banks helped exacerbate banks’ problems by forcing financial institutions and mortgage investors to take on questionable debt. If you buy this premise, the idea that government regulation will protect all of us from market downturns (or worse) isn’t something we should “bank” on!

Still another way the financial services industry generates false comfort is in how it measures success, specifically by comparing what we desire (and achieve) against the performance of indices such as the S&P 500 Index. The State Street Center cites investors’ beliefs that the S&P 500 embodies a universal goal for all of us to match or beat. However, in reality, nothing could be further from the truth. The S&P 500 is an easy-to-use, but potentially inappropriate, benchmark. As investors (and advisors) we all need to do the difficult work of identifying what we personally want to achieve in terms of portfolio performance, undergirded by the identification of specific goals and benchmarks that are important to our clients. We then need to determine how best to achieve those goals and monitor performance over time.

The Folklore of Knowledge (a.k.a. the Danger of Advisor Hubris). Yet another kind of folklore the State Street Center cites as damaging to the financial services industry is the penchant of investment advisors to claim good results from their stock picks as clear evidence of unique, special, or rare knowledge and skill on their parts. As an example, the Center cites the common pattern among portfolio managers of taking credit for successes that occur, while putting blame on others when things go wrong. Both are examples of unwarranted but perhaps inevitable “self-attribution bias.”14 “Investment professionals are caught in a double bind,” notes the Center. “They need to feel conviction in their investment choices in order to reassure clients. At the same time, it is logically unreasonable to have high conviction due to the intrinsic uncertainty of investing.” To counteract this, investors tell themselves stories to explain their success and failure, according to the Center. “These narratives are so compelling—whether they’re playing the role of the hero or victim—that the story becomes the truth. And it does for their organizations and clients, as well.”15

As an advisor, I know I am prone to this tendency myself. Mind you, it’s always good to pat yourself on the back for a success. Who wouldn’t? But when things go wrong, as they often do, I, like many of my colleagues, am only too happy to point fingers and assign blame. In fact, blaming is a particularly strong suit of my personality type when stakes are high, as you will see later.

Evidence of overconfidence by both investors and their advisors is often clear for all to see. Both wealth advisors and their clients often rank their investment abilities high, when, in fact, being more modest would be more financially prudent. Still, advisors and investors alike are often quite ready to commit capital—their own or others—to investments that may be riskier than they believe them to be.

The Lesson Here: Beware of Folklore Masquerading as Actual Financial Market Knowledge!

The impact of “market folklore” masquerading as hard knowledge or professional expertise is not to be underestimated, either by advisors or investors. Indeed, there are scores of biases that influence advisor and investor attitudes and behaviors. The State Street Center notes at least 28 different biases that often influence (consciously or unconsciously) advisor and/or investor behavior.16 They include but are not limited to the following:

•  Anchoring Bias	•  Availability Bias
•  Cognitive Dissonance	•  Confirmation Bias
•  Conservatism Bias	•  Decision Fatigue
•  Disposition Effect	•  Endowment Effect
•  Emotional Quotient	•  Framing Bias
•  Gambler’s Fallacy	•  Herding Bias
•  Heuristics	•  Hindsight Bias
•  Home Bias	•  Illusion of Control Bias
•  Loss Aversion	•  Mental Accounting Bias
•  Overconfidence Bias	•  Regret Aversion
•  Representativeness Bias	•  Self-Control Bias
•  Self-Attribution Bias	•  Short-Termism
•  Status Quo Bias	•  Value Attribution

Space precludes me from providing definitions for all these terms, but as a wealth advisor you are no doubt familiar with all of them.17 Some of these biases are more easily identified in the rearview mirror once an error in judgment has occurred. All of these biases show up, depending on the personality types of investors and their advisors. Overconfidence is more common among those who are strong in “power and control.” Herding (the tendency to make decisions about investing based on what others do) and value attribution18 are things an advisor is more likely to see in clients that operate in “open and affect.” The disposition effect, in which the investor tends to hold losing positions and sell his or her winners too early, is sometimes associated with people strong in “random and meaning.”

The Responsibility of the Advisor

Besides analyzing stocks and managing portfolios, we, as advisors, need to be aware of where our professional knowledge and expertise begins and ends, and when we ourselves are prone to fall prey to financial markets and financial industry folklore, both in guiding and advising our clients, and investing for ourselves. The psychology of money—our opinions and embedded beliefs about it—is always at play—in some way, shape or form—in every interaction we have with clients.19

So what counsel do I offer here? In building and nurturing client relationships, it’s important to keep the client’s interests, priorities, and needs continually in mind. The relationship you have with a client ideally will be a co-created partnership in which the two of you work together to chart and draft an investment plan, determine strategy, and outline specific investment goals and objectives.

Early in any new client relationship, you need to take time to build rapport, chemistry, and understanding with individuals. Early “contracting” with clients—identifying client goals, expectations, personal and family values, and ways of working together—can help put a firm foundation of trust in place to help carry both you and the client through times of marketplace volatility when it’s likely that the two of you will be having high-stakes conversations. (For more, see Chapter Nine.)

Become an astute observer of your clients. Understand what motivates and energizes them, what concerns them, and what makes them fearful and nervous. With knowledge of the client as a psychological “system,” you’ll be able to manage crucial conversations while maintaining and building trust, even in the most difficult of marketplace situations.

In chapters to come, I’ll have much more to say about how to handle the psychological dynamics and emotions of money that are always present in client-advisor relationships, and which can become especially problematic in times of stress and high stakes. This is when it’s important for you to remain grounded and to be confident in your ability to handle difficult conversations in ways that lead to productive and optimal outcomes.