How to ensure a client is happy- an article for the financial advisor

What is Behavioural Finance?

Would you agree on these two things?

  1. Clients are emotional about their money and assets and
  2. Financial advisors (FAs) when establishing the client – advisor relationships, stay focused on the economic aspect of a client’s financial health.

Humans naturally get emotional about money and the things they own. Would you give some stranger your watch? Look at how emotional South Africans have got about land. Think about when you say no to a child, how they react. How do you feel when you cannot afford an item you really want and then someone roars past in a Ferrari?

Often money matters land couples in divorce courts or results in bitter family arguments.. Debt can result in a lack of money, as does the loss of a job, sickness and death. For most people the assets they own are dependent on their next pay check.

It is unfortunate that FAs do not get trained to recognise the client may not be rational when talking about money and the assets they have accumulated. Quite often this inability to fully comprehend money as an emotional subject leads to a failure of the advisor –client relationship.

In order to help us we will have a brief look at the subject which is called Behavioral finance.

The fields of behavioural finance, financial psychology, and financial therapy are developing in the area of money and the related behaviours people have with it. Behavioural finance is the application of cognitive psychology to financial behaviour. When we say “cognitive” it is how we act through the process of thinking, reasoning, or remembering, in other words how we know something. Behavioural finance is based on scientific attempts to understand normal human behaviours and attitudes in the financial settings of spending, saving, and investing.

Behavioural finance concepts fall into three major categories: 

  • cognitive biases: this means people inadvertently make errors in their thinking as a result of learning they possess
  • heuristics: rules of thumb or how people act on their gut feelings when making decisions about items such as: 
    • current income; 
    • current wealth; or 
    • future income. 
  • choice architecture: how changing the way a problem is presented can lead individuals to make different choices about things that are essentially the same.

We use behavioural finance in looking at both the personal (client focused) market focused areas of financial decision-making. Behavioural finance does not replace traditional forecasting or economic measuring methods. For further information on market focused behavioural finance it is suggested you read chapter 23 of 2018 version of the South African Financial Planning Handbook. In this course we look at how a FA can use client based behavioural finance methods.

Six steps of financial planning

To illustrate how we can use behavioural finance as FAs with our clients we will use the six steps of financial planning. ISO standard ISO 22222 and the Financial Planning Institute of South Africa suggest every FA uses these methods for doing a financial analysis on a client. This six step framework focuses on financial data-gathering and financial goals, and does not necessarily include the emotional, cognitive, and behavioural aspects of a client’s money-related issues. To help with the behavioural finance aspect we will show you examples of how to include it at each step of the process.

Decision making

When using the six step process we have to use a decision making process. This is where we look at the problem by gathering our data in step 1, 2 and 3 of our six step process. We then generate alternatives and evaluate each alternative in step 4 and implement the decisions in step 5. Step 6 is where we continuously evaluate these decisions and monitor them. This can be illustrated in the diagram below.

Step 1: Establish and Define the Relationship with the Client

Before we can work with a client we must define the mutual relationship or contract we will develop and hopefully in so doing also establish rapport with the client. In step 1, we should not only disclose our conflicts of interest and compensation structures but we should develop our view of the client as a “financial personality”.  Responsibilities of each party must also be determined along with the estimated duration of engagement.

In all our steps we will use plain language at the level the client can comprehend to get our ideas about the way the client thinks about money. The FA can search for information by using open ended questions such as:

“What is it that concerns you most about your financial situation today?”

“What will show you that our financial relationship has been successful?”

“What should I know about you and the family?”

“Where do you want to be in five years financially?”

Truly listening should be where you repeat only what the client says and do not put your own interpretation into the conversation. For example:

“I hear you say that both family and education is important to you- how would success be measured in these areas?” The FA then uses reflective statements, by repeating exactly what the client has said. Repeating these statements make clients feel they have been heard and understood and encourage sharing.

In all these conversations be alert to how they deal with the pain of regret. While we all hate to admit we made a bad decision and/or took an unwise action, some people start again or freeze and refuse to go forward.This will impact on the financial co-operation you can expect.

Step 2: Gathering client data and determining goals and expectations

It can be taken as a given that most people want to maximize their economic abilities as a general rule. This desire leads us to look at changing jobs or even studying further.

The FA could get the clients to reflect upon their thoughts and feelings about situations and their assets to determine if any bias are present. For example use questions such as:

“What would be your ideal retirement?”

“What do you think may happen to your assets after death?”

Questions the FA would need to answer at this point would include:

Is this person and their family rational and risk adverse?  For example do they overestimate their predictive skills or assume more knowledge then they have?

Do they have an accurate conception of possible returns, i.e., do the probability beliefs of the investors match the true distribution of returns. You need to exam if the person’s beliefs and preferences are reasonable, but whether they are internally consistent. They may say they like risk but do they accept loss?

Ask further exploratory questions such as:

How would they feel successful?

How would they feel they have failed?

Be aware of any difficulties of self-control. Try and be positive in such cases. For example, if a client set up a budget but has not followed it- praise them for the setting up of the budget and help them to see the next step to point the behaviour in the desired direction. Always end with a positive statement about the issue.

Step 3: Analysing and evaluating the financial status of the client

Most companies give risk questionnaires to determine the clients risk needs at this point. However risk questionnaires have been called into question as to their accuracy. In 2012, the Financial Advisory and Intermediary Services Ombud, Noluntu Bam, stated that risk questionnaires do not necessarily produce an accurate assessment of the client’s risk tolerance n her annual report.  The FA needs to look at how the client views money. People run imbedded programs about money and these are referred to as money scripts in behavioural finance studies. It

Klontz ((Klontz, Britt, Mentzer, and Klontz 2011)) developed a Money Script. There are currently four identified money scripts by Klontz and Britt 2012; Lawson et al. 2015:

  1. Money avoidance; Money is bad syndrome and should not be discussed.
  2. Money worship; Money is the key to happiness
  3. Money status; Keeping up with the Jones syndrome
  4. Money vigilance; keeping an eye on the money

It is important to take time to discover the clients’ attitudes about money that are formed early in their lives– ask your clients how money was handled in their families while they were growing up. For example clients of 65 and older whose parents struggled through the depression years might be overly conservative, while a 24 year old may be over optimistic on the inheritance they think they will receive and as a result spending  rather than saving is a priority.

Clients also want their savings and investments to work for them. How they judge this is by using certain methods. One of these is “Narrow framing”. Narrow Framing is where clients look at investments in isolation from their entire portfolio and can be determined by having the client provide a list their assets and allocation. In narrow framing client will have developed portfolios such as personal, retirement, education and so forth. While they may be personally they will not look at taking assets from another area to maximise the growth and may have relatively small accounts attracting multiple administration fees.

Financial anxiety is another aspect of behavioural finance which needs to be explored in this step. The Financial Anxiety Scale (FAS) (Archuleta, Dale, and Spann 2013) has been used as a tool in this area. A person who is anxious about money will often find it hard to make decisions on it. In addition high anxiety levels can indicate counselling may be needed in this matter, to prevent further health situations from developing.

It is most important in this step to look at the client’s personal obligations with regard to other family members in both the short and long term to get a full picture of the way they approach reality.  The personal needs additionally will include the client’s retirement age, life expectancy, income needs, risk factors, family responsibilities, time horizon, and any other special considerations specific to the client. Economic considerations include assumptions about the inflation rate and investment returns, taking into account the expected tax rates that the client will pay.

A bias to be alert to is called mental accounting. Mental accounting outcomes are perceived and experienced, and result in how decisions are made and subsequently evaluated. A second component of mental accounting involves the assignment of activities to specific situations or accounts which may include the source of the money and the intended use for each account. For instance, some people keep a special fund set aside for a vacation that earns no interest but carry a large credit card debt.

Advice for dealing with the mental accounting bias will be looked at in step five.

Step 4: Develop and Present the Financial Planning Recommendation and/or alternatives

This is possibly the most important step the FA has to look at and certainly the most complex.

When taking the solutions to a client the FA may find clients place undue weight for making decisions on the most available information they have. We call this Availability bias. To fight this availability biaswhen there is extreme optimism or pessimism you will need to stop and consider how you decide on an investment, to ensure that you and your clients do not choose investments just because it receives the most press coverage, or because they follow the herd instinct.  Following the Herd is a behaviour pattern which can affect the client’s financial well-being as they base their decisions on other people’s behaviours. Often a pack leader may be followed. This si very common in the field of politics, when sensible people emotionally bond to leaders that are not ethical or sensible.

For example, John has made a fortune in network marketing, does not mean Jane will also make a fortune by following John’s example. Behavioural Finance tells us the FA should not argue for the change or discuss why the change is so important to make, in such cases, as this will get the client to become defensive. The FA should rather ask them why they would want to follow John and what they would need to do to become successful like John, highlighting any areas of discrepancy.

When the FA discusses the recommendations with the client, you need to listen to client concerns and revise recommendations as appropriate to allow the client to make informed decision. This decision should be documented in the Record of Advice.

Most FAs can tell you that when advising clients about retirement, their mental accounting bias makes them discount life expectancy- as a result they might just outlive their money if they do not take on a little riskier portfolio. To change a client’s mind we need to understand both the framing bias and mental framing. Framing bias or mental framing can be described as the tendency to respond differently to various situations depending on the context in which the choice is presented. For example investors will sell an investment that has made a gain more readily than one that makes a loss.

Advice for dealing with the framing bias[1]

  • Ask the right questions and make sure you understand the client’s answers. Ensurethat you are on the same page and that your client understands what the investment is and what it is not.
  • Propose your solutions to them by focusing on the strategy, the end goal and not the price and product. This will frame the success over the entire period in terms of the goals.
  • When presenting solutions to clients, present facts and choices neutrally and objectively.

The role of the financial planner is to understand their clients’ goals and then to assist them to reach their goals, sometimes in spite of themselves.

Step Five: Implementing the financial planning recommendations

At this point in the servicing, the client should make the final decisions and your need is to ensure that the client understands their commitment and the product/s chosen. The client must accept the conditions and requirements to maintain the product. The FA and the client agree on how recommendations and implementations will be carried out.

Clients may exhibit a bias toward the status quo when they prefer to do nothing or keep what they currently have. The FA may have to carry out the recommendations for the client or serve as a coach coordinating the process with the client and other professionals such as brokers, Financial Services providers, attorneys or investment houses. The FA may assign client tasks to help the client in this matter, such as writing up their wills or creating a living will or simply drawing up a budget.

When presented with new information, some clients tend to be slow to change. It is a common human tendency to rely too heavily, or ‘anchor’, on one trait or piece of information when making decisions.Anchoring also occurs when people develop attachments to things. People who anchor tend to be slow to change. To deal with anchoring in a client do not give too much weight and attention to historical results as opposed to more salient information regarding the current holdings in their portfolio and the rational reasons for the specific holding. Steer clear from any focus on short-term performance figures and make affirmative statements.

We previously discussed mental accounting and we need some techniques to deal with this bias as well as helping the client move toward change.[2]

  • Educate your client regarding correlations that might exist between investment “buckets”– show your client that having the same investment type in different mental accounts can be risky for their wealth creation. Show your client the benefits of sufficient diversification to encourage them to at least use the mean-variance algorithm to find their portfolio’s overall expected return and standard deviation by way of placing their mental accounts as an overlay over actual accounts.
  • Warn clients that theyare more inclined to take on risk as their total wealth increases. People do not value money that accumulated on investments as being equal to the value of the initial investment. Continuously make these clients aware of the risk of their chosen investments and that R100 equals R100 at all times.
  • Advise clients not to hang on to investments that made money in the past but are losing money at present – some clients find it hard to close a mental account by selling an investment. They only have a paper gain or loss until they close the mental account by selling the investment. By selling an investment, a paper loss becomes an actual loss and it is difficult to close an account at a loss. Mental accounting favours selling winners and keeping losing accounts open.

Another component of mental accounting concerns the frequency with which accounts are evaluated and ‘choice bracketing’ in which decisions are made in isolation (narrow bracketing) or together (broad bracketing). Broad bracketing allows people to take into account all the consequences of their actions, and it generally leads to better choices being made.

An example of using knowledge from a Behavioural finance perspective:

When the FA shows the client the investment they should consider, they illustrate the following criteria:

  • The performance relative to similar sized and styled investments available in the market
  • How long the current managers  have been at the fund or company
  • That the fund managers are well known and highly regarded
  •  The fund’s one-, three-, five- and ten-year returns all exceed market averages

The FA duties include scrutinising all the product providers’ marketing material for subjectivity and narrow framing – in other words take care when putting your marketing material together to be as objective as possible and focus on the big picture. Ensure that marketing material from product providers contains all the relevant information. Ask them for any omitted detail.

  • Educate your client continuously[3] – educating your client regarding the benefits of diversification, the danger of different biases to rational decision making and proper financial or portfolio management will help to neutralise biases.

Step six: Monitoring the financial planning recommendations

In terms of the Code of Conduct (BN80 of 2003) of the FAIS act, you have to show contact with any client you have an on-going relationship with, at least once a year. In this phase of the financial planning process certain behaviours may also be found.

Irrational Market behaviour is apparent when the price movements of the financial instrument in question do not follow the fundamentals of that instrument. Stocks are the financial instrument most prone to irrational market behaviour.

In the client irrational investor behaviour can be found by them holding on too long when a stock is falling, or getting out too soon when a stock is rising, or expecting to get back the cost price. These are common mistakes that tend to get repeated by the irrational investor. This irrational investor behaviour can be corrected through awareness and experience.

Loss aversion is another important psychological concept. Loss Aversion is where the investor is a risk-seeker when faced with the prospect of losses, but is risk-averse when faced with the prospects of enjoying gains. An investor suffering from loss aversion will insist in locking in losses and reducing the upside potential of their portfolios. Another area of concern is gambler’s fallacy. In the gambler’s fallacy, an individual erroneously believes that the onset of a certain random event is less likely to happen following an event or situation and will refuse to correct a situation that can or will lead to financial loss. This in effect is saying “if I toss a coin I will get heads if the coin gave me tails on the toss before”. In truth a single event or happening needs to be weighed against many other factors such as the market itself and the organisations ability to innovate in a tight market.

When clients tell you that “this time it will be different” this can also indicate loss or regret aversion or the investors’ desire to avoid pain of regret arising from a poor investment decision. This aversion encourages investors to hold poorly performing investments by avoiding their sale. Regret aversion creates a tax inefficient investment strategy because investors can reduce their taxable income by realising capital losses.

Step 6 may be the point when you need to warn your client not to become caught up in fads – hot information invariably means that overreaction has already set and overheating occurs when markets start to climb rapidly. This overheating can result in an economic bubble or asset bubble (sometimes also referred to as a speculative bubble, a market bubble, a price bubble, a financial bubble, a speculative mania, or a balloon developing. Bubbles and balloons happen when trade in an asset is at a price or price range that strongly exceeds the asset’s intrinsic value. Be alert to herding behaviour which often accompanies fads and bubbles.Herding behaviour is where many people want a product such as happened with bitcoin. When a client comes to you and asks for an investment because he knows someone else who made it and thinks it is a good investment, refer the client back to their planned goals and strategies rather than looking to obtain differing opinions or outside information to confirm a single aspect of their belief (confirmation bias).

Methods to deal with biases and bubbles

Advise the client to put the past behind them and to base their current decisions on the current strengths, weaknesses, costs and benefits of the specific investment. On your portfolio review date, you should consider each product in the client portfolio the same way you would consider a brand new investment you consider for the first time. Ask yourself should the client buy it today or will you as the FA advise against it? If there is no benefit in buying the investment, there is no reason to keep it in a portfolio. In an investment portfolio it can be wise to decide when to buy an investment as well as  on which price you will sell it when it start to lose money, in other words, predefine when to apply a stop-loss rule.

To continue the trust between the client and the FA, the FA should monitor that the FSP delivers the product or service it has promised and keep an easily obtainable record system. Files should contain ongoing review and servicing records.

There are many other aspects to the study of behavioural finance, in this course we have given you only a small selection to show how using Behavioural finance as a science in the financial process the FA can add considerable value to their clients by helping them make the most rational decisions and  achieving the goals and objectives.


Philipp Erik Otto: Cognitive Finance: January 2007: Behavioural Strategies of Spending, Saving, and Investing: UMI Number: U592281

Lawson, Derek R., and Bradley T. Klontz. 2017. “Integrating Behavioral Finance, Financial Psychology, and Financial Therapy into the 6-Step Financial Planning Process.” Journal of Financial Planning 30 (7): 48-55. 13/08/2018

 Brian Goodall  Lee RossiniMarius Botha Walter Geach Laura du Preez Paul Rabenowitz  The South African Financial Planning Handbook: 2018: Chapter 23

[1]  Brian Goodall  Lee RossiniMarius Botha Walter Geach Laura du Preez Paul Rabenowitz  The South African Financial Planning Handbook: 2018: Chapter 23

[2]  Brian Goodall  Lee RossiniMarius Botha Walter Geach Laura du Preez Paul Rabenowitz  The South African Financial Planning Handbook: 2018: Chapter 23

[3]  Brian Goodall  Lee RossiniMarius Botha Walter Geach Laura du Preez Paul Rabenowitz  The South African Financial Planning Handbook: 2018: Chapter 23