The Gorilla in Your Client's Portfolio: Unmasking Hidden Biases

Welcome to Client-Centric Advice! I'm Fraser, co-founder of Lyfeguard. Through my conversations with advisers and my work building Lyfeguard's client management solution, I've seen great strategies and gained insights into how advisers are deepening client relationships – and I'm excited to share them with you in this newsletter.

A bat and a ball cost ￡1.10 in total. The bat costs ￡1.00 more than the ball. How much does the ball cost?

Think you have the answer?

Most people instinctively answer 10p (myself included). However, the correct answer is 5p. This simple question highlights behavioural economics in action, and in this case, our tendency to rely on attribute substitution. Instead of tackling the complex calculation, our brain substitutes it with an easier, more intuitive one.

Before we dive deeper, watch this classic experiment that reveals something fascinating about how our brains work.

Did you notice anything unusual in the video?

You might be surprised to learn that a gorilla walks across the screen! This experiment highlights a phenomenon called inattentional blindness.

These two simple examples reveal a powerful truth: our brains are wired to take shortcuts, and these shortcuts can sometimes lead to surprising oversights and flawed judgments.

Just as we miss the gorilla or instinctively jump to the incorrect answer, your clients may also make intuitive judgments about their finances that aren't always in their best interest.

This is where understanding the human side of investing becomes crucial. Behavioural finance can help you to decode the hidden biases and emotions that influence your clients' decisions, even when logic points in a different direction.

Why Emotions Matter

Our brains are wired for survival, not necessarily for sound investing.

Evolution has equipped us with mental shortcuts (heuristics) that helped us make quick decisions in life-or-death situations. While these shortcuts served us well in the past, they can lead to irrational choices when it comes to money.

“Identical information can lead to opposite conclusions based on relative perceptions of its receivers.” — Naved Abdali

Unmasking the Biases

The human mind is a fascinating and complex machine, but it's not without its quirks. Here are five biases that can affect how your clients perceive and manage their finances:

• Loss Aversion: The pain of a loss is felt more intensely than the pleasure of an equivalent gain. This leads investors to avoid potential losses, even if it means missing out on greater gains. For example, a client might hold onto a losing investment hoping it will recover, even when the odds are stacked against them.
• Confirmation Bias: We tend to favour information that confirms our existing beliefs, even if it means ignoring contradictory evidence. This can lead investors to make biased investment decisions based on incomplete or inaccurate information.
• Herd Mentality: The recent meme stock frenzy is a prime example of herd mentality in action. Investors, fueled by FOMO and social media hype, piled into stocks like GameStop and AMC, disregarding fundamental analysis and risk management.
• Anchoring Bias: This is the tendency to over-rely on the first piece of information received (the "anchor") even when it's not relevant or accurate. In investing, this can lead to fixating on a stock's purchase price or a past market high, hindering rational decision-making.

• Availability Bias: This bias causes people to overestimate the likelihood of events that are easily recalled, often due to their vividness or recent occurrence. This can lead to irrational fears or overly optimistic expectations based on limited information.

“Human beings are poor examiners, subject to superstition, bias, prejudice, and a profound tendency to see what they want to see rather than what is really there.” — M. Scott Peck

Overcoming Biases in Client Interactions

Everyone is susceptible to these biases, including yourself and your clients. Recognising this is the crucial first step towards building stronger, more informed client relationships.

Develop your "behavioural finance radar" by actively listening to your clients' language, observing their decision-making patterns, and asking insightful questions. For example, a client consistently focusing on short-term market fluctuations might be exhibiting loss aversion, while dismissing information that contradicts their investment choices could signal confirmation bias.

With this awareness, consider how these underlying biases might be subtly influencing your client interactions. How might you reframe a conversation with a loss-averse client to shift their focus from potential losses to potential gains? Or, when confirmation bias is at play, how could you encourage a more balanced perspective and critical evaluation of information?

Think about how you might guide clients influenced by herd mentality to embrace independent thinking, or how you could help those anchored to past prices to focus on future potential. When recent events cloud judgment, how can you provide historical context and emphasise long-term trends to foster a more objective outlook?

Remember, grasping behavioural finance is about helping clients to understand their psychological drivers and building trust by acknowledging their emotions and biases. How can you cultivate deeper empathy and tailor your approach to resonate with each client's unique psychological landscape? How can you leverage tools and technology to gather data, track biases, and personalise your advice in a way that empowers clients to make more informed decisions?

Final Thoughts

This is just a glimpse into the complex world of behavioural finance. The key takeaway is this: be aware that biases are constantly influencing our decisions, and by recognising them, we can take steps to mitigate their impact and make more rational choices.

Thanks for being a part of the Client-Centric Advice community! I'm always looking for ways to make this newsletter even more valuable. If you're an adviser with unique perspectives or would like to contribute to a future edition, please reach out – I'd love to hear from you.

Until next time,

Fraser