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One common investor bias is loss aversion, when the pain of losing money hurts more than gaining it, which can lead to panic selling.pcess609/iStockPhoto / Getty Images

For financial advisors, the value of behavioural economics in helping clients stick to their long-term financial plans is being put to the test amid the stock market volatility resulting from the COVID-19 public health crisis.

Behavioural economics is the study of cognitive and other biases that shape our decision making – and it has become a growing part of the wealth-management business as advisors aim to understand what makes investors tick.

One common investor bias is loss aversion, when the pain of losing money hurts more than gaining it, which can lead to panic selling. There’s also herd mentality, when investors follow the pack and buy into hot stocks or sectors, or sell because others do, even when the moves could harm their long-term investment goals.

The recent stock market rout has exacerbated these and other cognitive biases, making the job of keeping clients focused on their financial plans even more challenging.

“It’s one thing to say, ‘I have a sensitivity to market noise,’ when it’s a bull market, versus the noise in a very different market today,” says Dave Kelly, senior vice president, private wealth management and financial planning at TD Wealth. “It gets harder to stay committed to a plan that will evolve over the next 20 years.”

TD Wealth has been reinforcing its behavioural economics training with advisors in recent weeks to help investors find their “financial blind spots.”

“We’re trying to help people focus on what really matters,” Mr. Kelly says. “These are hard conversations. They are high emotion. People are under stress. It’s natural, it’s expected. It’s our job to help clients get through this period of time.”

Mr. Kelly says using behavioural economics as a guide helps advisors have more connected conversations with clients. “People want to make sense of why they feel the way they feel.”

Clients have also been using the tool kits that TD Wealth provides to do self-checks, like if they’re thinking about selling a stock out of fear and panic.

“It helps heighten self-awareness for the clients, too,” he says.

Catherine Milum, head of wealth sales, retail markets, at Manulife Investment Management, says some investors can become irrational during a market downturn.

“When people become irrational, they tend to not want to take advice,” says Ms. Milum, whose company is working with BEworks, a Toronto-based consulting firm focused on behavioural science, to help educate its advisors on how to spot and work with investors on cognitive biases.

She points to BEworks research that Manulife Investment Management plans to publish soon, which shows that applying behavioural economics can help increase how well investors follow advice.

“It helps advisors have real conversations with their clients. ... They’re getting ahead of it. The charts and graphs don’t work very well during market volatility,” she says, adding the focus should be more on human emotion and behaviour.

Ms. Milum says behavioural economics promotes conversations that are less about the markets and more about how clients are feeling and may react.

“When people are able to acknowledge a negative emotion, or they’re aware of it, they’re better able to deal with it,” she says. “It means their estimate of the future will be more tempered. They don’t think the future will be all negative.”

ATB Wealth, the wealth-management division of ATB Financial in Alberta, has been coaching its advisors for a few years now about how to talk to clients about their emotional reactions to money and investing.

“Looking at what’s happening in the world today, are we ever grateful we’ve prepared for this and trained [our advisors] ... to help clients manage through it,” says Sherri Wright-Schwietz, ATB Wealth’s vice-president of client and advisor solutions.

One cognitive bias she says many investors are experiencing right now is an urge to take action as the market rises and falls. ATB Wealth advisors are talking to clients about what they can and can’t control in this market – and reminding them that doing nothing is an action, too.

“Action doesn’t mean you have to go to cash or trade something,” Ms. Wright-Schwietz says. “It can also mean looking at your financial picture … and staying the course.”

She says advisors need to validate their clients’ emotions and be human, too, perhaps by acknowledging they’re also feeling the pain when markets fall.

“You have to lead with your heart first before the data make sense or come to life for a client,” Ms. Wright-Schwietz says.

Advisors know behavioural science is working when a client becomes more knowledgeable about their relationship with money, she says.

“Behavioural economics isn’t some secret, behind-the-scenes work. It’s about us trying to give clients the most knowledge and personal power about their money, their relationship with it and understanding how they react to it,” Ms. Wright-Schwietz says.

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