Lisa Gray

ContactLisa Gray has been a wealth writer since 2001. She has been involved in the wealth management industry since 1988. She is the author of two bestselling books—The New Family Office and Generational Wealth Management.
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graymatter Strategies LLC

Case Study: Using Generational And Behavioral Biases To Translate Personal Goals Into A Financial Language, Part I edit
Friday, May 11, 2012 08:17

Tags: asset allocation | investing | investment strategies | investor behavior

Why do we need behavioral finance? Because traditional models based on institutional clients’ needs do not account for the tax liability, multiple goals, life stages, and unexpected events invariably faced by individuals.

 
So how do you translate the needs of individuals into a goals-based asset allocation that makes sense from a portfolio management perspective and individual client perspective? There are tools to help us do that. Llook at a case study to see how they work.

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The first tool is actually a skill you must possess. It takes practice to develop. The good news is it's pretty intuitive. It's the ability to recognize generational and behavioral biases in your clients. Here’s an example of how you would do it.
 
Travel back to June of 2008. A "silent generation" patriarch says at his family meeting (where you are present) that he wants to invest in GM stock because, he says:
  1. GM is a solid “blue chip” company the government would never allow to fail
  2. The stock is making new highs
  3. The company just announced it is closing four plants
  4. He feels the position would be a good long-term, conservative choice
  5. He feels the family has taken too much risk in years past.
In the late 1990s, the family sold its then current position in GM and added a position in Amazon.
 
Generational biases present:
  • This silent generation member feels investing in GM is like investing in America.
  • Amazon is an online, dot com company with a business model this man does not understand.
  • The man inherited the original position from his father, who fought in WWII
  • GM was a company that led the country back to prosperity after the war.
  • The man lives below his means and he is afraid of running out of money, even though his portfolio has a double seven-figure value.
  • He feels his Boomer children (who outvoted him on the Amazon purchase) live an extravagant lifestyle and take too much risk with the family money.
Analysis: The patriarch’s feelings about his father, America, and the war are clues about the values he wishes to pass on to his children. They also signify the hopes he has for his children, grandchildren, and the legacy he will leave them.
 
Identifying these biases will lead you to the client’s real (authentic) goals. They are very much within the Silent generation’s view of the world.
 
Behavioral biases present:
 
Overconfidence Bias: The man was certain of the investment prospects of GM and he looked at the facts he wished to see to support his assessment. He ignored other facts like the condition of GM’s pension plans and the sales records of some of its brands.
 
Hindsight Bias: He was regretful the family had sold the original position for several reasons and felt the portfolio would have performed better if it had not been sold, even though the Amazon position had performed well.
 
He had also seen many of his friends lose their life savings in dot com companies after making above market returns. He lumped Amazon in with the entire dot com group.
 
Framing Bias:  Because of his generational view of the world, he saw the GM position as a better fit. It matched the values he held dear and it was tied to what he deemed was a valuable and wise gift from his father.
 
End Result: In June 2008, GM stock was trading at $35. By June 2009, the company had filed for bankruptcy protection.
 
In Part II, we’ll see how a second set of tools helps us educate this man on both sets of biases and how they are influencing his investment decisions.
 
Then, we’ll implement the tools to translate his authentic goals into an investment strategy directly designed for their achievement.

 

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