Performance figures for each account are calculated using time weighted rate of returns on a daily basis. The Composite returns are calculated based on the asset-weighted monthly composite constituents based on beginning of month asset mix and include the reinvestment of all earnings as of the payment date. Composite returns are as follows:

Advisors look to manage investor biases as stock markets shift

By Brenda Bouw

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The surging stock market valuations experienced during 2021 are creating a new set of concerns for financial advisors as some investors are getting overconfident in their ability to keep racking up double-digit returns.

This psychological trait, in which people put more focus on short-term performance than long-term results, is known as recency bias. The sentiment is much different from the spring of 2020, when loss aversion, a preference to put avoiding losses ahead of achieving gains, forced many investors to panic sell as stocks were sinking.

It’s cognitive biases like these that advisors are continuously trying to manage to prevent clients from making short-term decisions that could impact their long-term financial plans.

“Just like a car has a blind spot … humans have blind spots as well,” says David Terry, vice-president and head at TD Wealth Financial Planning in Toronto. “That’s not a good or bad thing. That’s just what it is to be human.”

Advisors are paying closer attention to psychological biases as part of the field of behavioural finance, which looks at why people make certain financial choices that affect not only their portfolios but the broader markets.

“There’s a growing awareness … that people aren’t wired to make decisions on a purely rational basis or that decision-making can be impacted by a whole number of factors, including emotions, personality traits and the context [in which] the decision is being made,” Mr. Terry says.

TD Wealth has been coaching its advisors for years on how to use behavioural finance to spot issues that might cause investors to make irrational decisions, he says.

“Creating awareness of these blind spots helps [clients] to get through some of the challenging situations that they might find in the market,” Mr. Terry says.

The ability to keep investors from making emotion-driven investment decisions provides the greatest value to the advisor-client relationship, according to Russell Investments Canada Ltd.’s 2021 Value of an Advisor Study.

The sixth-annual study shows advisors added an overall value of 3.95 per cent, up from 2.88 per cent last year. Behavioural coaching ranked as the highest source of value at 2 per cent, followed by 0.66 per cent for tax-efficient planning, 0.63 for offering a customized client experience, 0.62 per cent for product alignment and 0.04 per cent for active rebalancing.

Advisors add value when they’re in touch with their clients’ emotions and identify the difference between an investment preference and an emotional preference, says Sophie Antal-Gilbert, head of business solutions at Russell Investments’ North America advisor and intermediary solutions business in Seattle.

“What you’re trying to do as an advisor is to help the client slow down and become aware of their emotions and their bias. It’s like mindfulness in some ways,” Ms. Antal-Gilbert says.

She says advisors should ask a client three questions when making an investment decision: What would the outcome of this decision look like? What would the worst-case scenario be? Have you ever made a quick decision and been wrong?

“The answers the client provides don’t even really matter,” Ms. Antal-Gilbert says. “You’re just trying to get them to talk … to slow down the emotions.”

Having a goal-based financial plan with a professional advisor can prevent investors from making risky decisions when markets swing, according to TD Wealth Behavioural Finance Industry Report 2021 released in May.

“The role of an experienced advisor who goes the extra mile to understand the psychological and behavioural factors of a client’s individual risk tolerance can be equally as important as the awareness of their risk capacity,” states the report from researchers at the bank and the University of Toronto’s Behavioural Economics in Action Research Centre at Rotman.

The report also states that clients who believe they have greater investment knowledge and experience may also take more investment risks, and that their career choices could also lead to riskier behaviour. For example, people who work in volatile industries or have an unsteady income were more likely to select a volatile portfolio and be highly reactive.

“Overconfident, highly extroverted investors could prove to be challenging as they may state they are very willing to embark on highly volatile investment but have neither the capacity nor tolerance to do so,” the TD Wealth report states, while recommending advisors provide the reality check.

“Advisors may want to remind these clients that while these risky investments have potential upside, they may also hold future downsides. Gaining a full understanding of the client’s risk tolerance using evaluative techniques or risk questionnaires may help minimize the chances that the client is holding a portfolio that is outside of their risk tolerance.”

The TD Wealth report also says half of Canadians studied with investible assets of more than $100,000 didn’t have a financial plan. Those who had a financial plan in place with an advisor were 34 per cent more likely to be very satisfied with their retirement readiness than those with no financial plan.

Behavioural finance should be part of every advisor’s practice, especially in today’s environment given how technology has supercharged the sharing of financial information, says Ben Jang, portfolio manager at Nicola Wealth Management Ltd. in Vancouver.

Often, the rapid flow of information makes investors feel like they too need to make quick decisions in their portfolios, which is rarely the case, especially for those with longer-term financial plans, he says.

“Part of our job [as advisors] is to understand how clients are thinking about their decisions,” Mr. Jang says. “We guide them to focus on a process for coming up to their conclusion because even though we … manage assets for clients … at the end of the day, the clients make the final decision.”

The goal is to try to help clients avoid mixing money and emotions, which is a big risk for investors, he says.

“When you look at risk, most people think about traditional market and asset risks,” he says. “But investor behaviour and cognitive biases, while less tangible, also create risks to achieving solid returns. So, to acknowledge them is obviously a step in the right direction.”