Behavioral Investing: Why Smart Seniors Make Stupid Mistakes with Their Money

In the Great Depression of the1930s, much like the severe economic downturn of 2008, market technician Ralph Nelson Elliott made an interesting discovery. He noticed equity markets move in similar and replicating patterns with degrees of trend. This new field, called Socionomics, explained market movements’ response to the prevailing social mood: euphoria and discouragement, optimism and pessimism. In fact, Robert Prechter, who recently popularized this area, warned of a top in the market in 2000 based on past patterns of market movement, in turn based on social mood. This major mood swing, called a Grand Supercycle, portends the magnitude of what may happen in a future framework without predicting week-by-week changes. This concept can be likened to a TV meteorologist who is able to warn of incoming storms a week from now based on his or her assessment of low-pressure areas, yet they may not be able to pinpoint the precise day next week the storm will occur.

A more important part of this grand market movement is how your clients emotionally respond to these seismic financial changes. It is widely thought that we are in a secular bear market due to the levels of debt incurred by the current administration. This treasury debt is competing with private debt, dampening the ability of private capital to influence future investment growth. Yet despite this evidence, many seniors believe we are in a bull market recovery. Even in that were true, it would be a very shallow recovery with a great deal of volatility in the short term. If your clients are caught on the wrong side of that volatility, it will greatly impact their retirement lifestyles. Here are a few of the traps your senior clients may find themselves in without the benefit of your financial guidance and counsel. As you read each of these objections and concerns from your clients and prospects, let them know first what the concept is and, if possible, relate anecdotes about other clients who have mistakenly believed similar notions and how you helped them.

The Objection: “I want to stay with my current advisor (even though I have lost 42 percent of my life savings over the last year).

This stupid investment mistake is called status quo bias.

To illustrate this mistake, consider an experiment performed by William Samuelson of Boston University. He showed clients three investment options: one stock with a 50 percent chance of staying the same, another stock with a 40 percent chance of staying the same, and finally, a U.S. treasury with a 9 percent return combined with and municipal bond with a 6 percent tax-free return. Which to choose? Forty-seven percent of those who were told they already owned an investment ignored their selection and remained with the investment they already had. This study showed that people are inclined to stay with what they have no matter how bad the performance. This also explains why some seniors will stay with a bad advisor.

The Fix: Tell your prospects about this research and also relate a story about a client who realized this mistake and how well they did by working with you.

The Objection: “I want to keep my money where it is. If I sell now, I will ink those losses.”

This stupid investment mistake is known as the sunk-cost fallacy — essentially throwing good money after bad.

These seniors believe their portfolio is still OK until they cash in. You can’t make changes to the portfolio because it will ink your loss instead of taking the money out and moving into a more sound investment. In the last decade, the Big Dig in Boston linking the city to Logan Airport was $15 billion over budget. The administrators wouldn’t fire the contractor and start over because of all the money they had already sunk into the project. Yet even after completion, a tile fell off the ceiling of a tunnel and killed a woman, causing the project to incur even more expense.

Similarly, the U.S. government gave $70 billion to General Motors in 2008. GM asked for $30 billion more in March of 2009. Both the Bush and Obama administrations fell into the trap of believing the company was too big to fail, but the ensuing GM default was the biggest sunk-cost mistake in U.S. history. If GM had restructured in September of 2008, they could have saved the company billions in costs and spared the U.S. taxpayer nearly $100 billion. Yet because of the inability to recognize sunk-cost fallacy, every citizen in America currently owes $600 per person on behalf of that one company. That is a sunk-cost sinkhole!

The Fix: Ask your client if they didn’t already own their investment, would they buy it again? A bold question like that typically will bring them back to reality quickly.

The Objection: “I am going to keep my money in the market. It is moving up and I want to recover my losses.”

This stupid investment mistake is called confirmation bias.

Seniors have a great tendency to look for information that confirms their beliefs, rather than data that falsifies it. To wit, consider Cornell marketing professor Ed Russo’s project of having students evaluate restaurants. They rated restaurants on a scale of one to 10, with 10 being the most positive. The ratings were based on menus and photos, but when the differences were mentioned one at time with photos of problem areas like rips in the booths and dirty kitchens, the students stayed with the initial ratings. They discounted information that didn’t fit with their first impressions.

Yet another example to share with your senior clients: Dick Winnick and Rahul Guah of Cornerstone Research in Boston noted that when consumers bought the same make of car every three to five years, they paid a premium over those who chose a different brand. Buick lovers paid an extra $1,500 and Mercedes owners paid an extra $7,500 due to the confirmation bias. Ultimately, these car owners tended to be less skeptical about and less willing to negotiate a deal with a brand of car they have owned for the last 20 years.

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Kerry Johnson

About Kerry Johnson

Kerry Johnson, MBA, Ph.D. is the best-selling author of seven books including his newest, “Behavioral Investing: Why smart people make dumb mistakes with their money (available at Peak Performance Coaching (his one-on-one coaching program) promises to increase your business by 80 percent in eight weeks. To see if you are a candidate for this fast-track system, click on
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