Executive Summary
When market conditions become volatile and scared clients are on the verge of panic about the potential to lose even more money, financial advisors are faced with the challenge of talking their clients “off the ledge” from making a potentially disastrous investment choice to leap out of the market near the bottom and risk missing the recovery. Getting clients to actually stay the course, though, is easier said than done, as simply telling clients “don’t panic” doesn’t necessarily help them to do so!
Alternately, when the pendulum swings the other direction and markets are ramping upwards, clients can become overconfident and as natural greed begins to kick in… often asking for even more of their top-performing investments (regardless of the additional risk), and less of the poorly performing ones in their portfolios (that may have simply been the conservative diversifiers). Which introduces yet another challenging conversation, as telling clients “don’t be greedy” in the heat of the moment isn’t necessarily any more effective, either!
In our 25th episode of Kitces & Carl, Michael Kitces and financial advisor communication expert Carl Richards revisit their earlier podcast discussion about how to talk clients off the ledge from ‘scary’ markets and then explore the flip side of the situation and how to keep clients from making bad decisions in the midst of a raging bull market.
Advisors can structure these ‘overconfidence’ conversations using a three-question framework, asking the following questions:
- If you proceed with this decision and it works out as expected, how would your life be different?;
- If you made this investment and you were wrong about how you expected it would do, how would your life be different?; and
- Have there been things you were really certain about in the past that didn’t work out as planned?
Typically, clients will respond to these questions by acknowledging that if all things go as planned, there will be marginal (but only marginal) improvements to their situation (e.g., perhaps there will be extra vacation time or an opportunity to travel); however, if the outcome turns out badly, the consequences will be much more worse, often leading to disastrous circumstances that can involve severe losses (or even bankruptcy or divorce!). When faced with the third question, clients may realize that, while the positive outcome might sound appealing, there is a real risk of an alternative outcome having serious, potentially devastating effects, and that they can’t be ‘too confident’ about the good outcome as they recognize their own failed predictions of the past.
Often, this process is enough to help clients realize that, while the decision they are contemplating might sound like a good idea, it may not really be worth the risk involved – both the risk of a bad outcome in general and the risk that they are wrong about their ‘confident’ prediction it will turn out well.
But sometimes, a client may be too caught up in the appeal of a tempting opportunity and may want to proceed anyway. In these instances, advisors can re-connect the client’s focus to their ‘deeper yes’ – the important core values and goals they identified their financial plan in the first place. If this approach still isn’t enough for the client to reconsider, then establishing a separate non-managed account can be an effective reminder to the client that the investment is separate from the plan, compartmentalizing the potential risk (and hopefully keeping the amount actually invested limited to a manageable minimum). On the other hand, if the client is dead set on going all in with the investment opportunity, it may simply be a signal to the advisor that it is time to part ways with the client… to avoid the ‘collateral damage’ that can, unfortunately, occur if clients harm themselves against the advisor’s advice but then still look to the advisor for someone to blame.
Ultimately, the key point is that the ‘overconfidence’ conversation is not very different from the ‘scary markets’ conversation; clients may simply need to be reminded that even though the markets may be doing well, making intentional decisions that stray from their investment strategies can throw their plans off course just as easily as a hasty decision made out of fear during bad market conditions.
Authors:
***Editor’s Note: Can’t get enough of Kitces & Carl? Neither can we, which is why we’ve released it as a podcast as well! Check it out on all the usual podcast platforms, including Apple Podcasts (iTunes), Spotify, and Stitcher.
Show Notes
Kitces & Carl Podcast Transcript
Michael: Welcome, Carl.
Carl: Greetings, Michael. Super excited to talk. This is going to be fun.
Michael: I’m looking forward to today’s conversation. So, I was looking back over the podcast episodes we’ve done for the past few months and I guess there’s no great surprise that, looking back, one of the most popular episodes that we’ve done was the ‘duo’ set of Episode 17 and Episode 18 around how to talk your clients off the scary ledge when bad stuff’s happening and how to actually get them reoriented back to where they should be focused.
These were really popular episodes, but I got a lot of questions (at least on our end; I would imagine you got some of these as well). They were like, “Hey, cool conversation, but my problem right now isn’t that the market’s crashing, my problem right now is like, it’s gone up for 10 straight years, and I’ve got clients that want to go all-in now, because we’re 10 years into a bull market and so it’s got to keep going.
The challenge is not, “I need to talk my client off of the ledge of selling out at a bear market bottom”, it’s, “I’ve got to talk my client off the ledge because they want to go all-in because markets keep going up.” They’re like on opposite end of the spectrum. And I don’t know if you have the same conversation to talk someone back from being too enthusiastic as you do when they’re being too negative, or what you do to handle those kinds of situations.
Carl: Yeah, that’s really fun. So the name I gave this conversation years ago was the “scary markets conversation”. We actually worked on this for a while – we haven’t released it anywhere yet, but I’ve recorded all the videos for it and it’s called the “Happy Markets Conversation”. It’s the same thing. Rather than rehashing that specifically, I would just say to go back and listen to that episode and realize that you can absolutely use those same tools.
Like, if a client quickly says, “I want to move all my money to Bitcoin!” I’m not picking on Bitcoin, I’m just picking on something, right? So this is not about Bitcoin. I don’t need any emails, please.
So the client says, “I want to move all my money to Bitcoin!” We can do the exact same thing, like, absorb with empathy, right? Even though what we want to say is, “Are you kidding me?” But don’t. “I understand, especially if I read some stuff, I understand why you may want to do that.” We absorb with empathy.
We also use the police-hold method; we get the touchstone document – I like to think of it as a one-page plan, but whatever you use – your investment policy statement. We absorb with empathy. We talk about it. We circle back to values, we talk about goals, and we talk about process. We talk about product and we say, “Okay, great, let’s stay the course.” We can do the same thing. We use the same tools for happy markets. So go back and review; that would be my suggestion.
Having The Overconfidence Conversation With Clients [00:03:57]
But if you think it would be helpful, there’s another conversation called the “Overconfidence Conversation”, which is really more powerful. It’s tricky and fun, but really powerful, especially for specific moves. Like, “I want to move all my money to…” or “I’ve got a chance to buy equity in my company,” or it could be Bitcoin, or whatever. “So should we buy that a little bit?”
Michael: Yeah, “I’ve got this thing, I made a bunch of money in it, and now I want to put all my money in it.” Those kinds of scenarios. Like, maybe that would be a little Bitcoin I bought on the side and went up. Maybe that’s my company stock, because that always goes up, so we’ve got to put more in it, or even just in the portfolio, right?
We all have that experience. You put a statement in front of a client with all the individual line items of what you own in their portfolio and everybody does the same thing. They find the line item that did the worst and said, “Why don’t we own less of this?” And they find the line item that did the best and like, “Why don’t we own everything in this?” So we always get that. Whatever’s working, why can’t we just go all-in on this thing? It’s working.
Carl: Totally. Let’s talk about that. But before we do, let’s talk about the thing that is really interesting for us to remember, that idea that the definition of a diversified portfolio would be that there’s something that’s working, there’s a bunch of stuff that’s okay, and there’s some things that are absolutely not working, and they rotate, right? That’s the definition. And so remember, especially for entrepreneurs and business owners, when they want to fire the stuff that’s doing poorly and put more in of the stuff that’s working, that makes total sense in their minds.
Michael: Right, because in a business context, that’s what you do as a business owner. Hey, we’re selling this product or service or strategy. People are buying more of it. There’s demand and it’s profitable. So you make more of that thing. You do more of that. And if you’re selling the thing that no one’s buying, you stop that activity.
Carl: Totally, right? You’ve got two divisions, one’s doing awesome, one’s doing terrible, you kill the one that’s doing terrible, you reallocate the resources of the one that’s doing well. So that makes total sense. It makes total sense to hire a basketball coach that way, right? To hire somebody who remodels your kitchen, it would be reasonable for you to look at the last couple of remodels they did and expect them to be as good if not better, right?
So I just think that’s another place where we need to have empathy. Especially with business owners and entrepreneurs, they don’t get it…although they do once we explain, once we talk through it, but their first reaction is a human reaction, “Yeah, get rid of the things doing terrible, get more of the things doing well.” So that’s important to understand. Just a little bit of empathy, that feels human. And some humans particularly are wired for that mistake. But most of them so.
Michael: So then how are you talking people back from that mistake? So, “Yep, I totally see why you’re doing that, but that’s dumb.” You just can’t say it that way.
Carl: Totally. Obviously, the longer discussion around just describing asset allocation… how I normally start it is something like, “Hey, you know what? It makes perfect sense that you would feel that way. In fact…” And then I would give the basketball coach example, and then I would give the kitchen remodel example and I’d say, “But here, this is a little different. There’s this thing called buy low and sell high.” And sort of introduce that idea. Then that light goes off and they’re like, “Oh, yeah, of course, with investments, you want to buy low and sell high.”
So that’s a discussion. But what I think we want to talk about is how do you prevent somebody from making a big mistake? A happy big mistake. Like, on the greed side.
Michael: Yeah, absolutely, it’s the greed side, right? We talked about how to walk back someone that’s on the fear ledge. So how do you walk back someone that’s on the greed ledge?
Carl: Okay. So I’ll tell you a story. This is where this was developed. So this conversation is tricky. It takes some skill to determine the proper dosage for this conversation.
Michael: Oh, so like, we’re going heavy sarcasm here?
Carl: Yeah. Sometimes it needs to be an empathetic hug and other times you need to punch somebody in the face. Metaphorically. Don’t send me emails about that, too. It’s just a metaphor. I got some emails about using punch as a metaphor. So let me walk you through it and you’ll see what I mean.
Michael: Okay.
Carl: So this was developed with a client of mine and Rick was his actual name. And there are enough Ricks in the world (oh, but now I can’t tell you what the stock was, though). So Rick had options in a company that you would all recognize if you were in this space in ’99, 2000, 2001, 2002. Covers of magazines, that sort of company that went completely gone, like bankrupt gone. He had options in that company and he lost all of his money. And it represented like 80% of his net worth at the time. Now, Rick’s a highly paid guy, and he had no problem getting another job.
So fast forward like eight years later, he’s rebuilt everything. It’s amazing. And he’s got…he’s coming to me. I wasn’t around, I wasn’t involved. I started working with him long after that happened, to be clear, but he had told me the story. And his wife had definitely told me the story. Which is a whole other subject, right?
So now, fast forward again and he’s working at another company with another chance to do this thing. And not only that, but there’s an employee stock purchase plan. So that’s what we were talking about. He was getting all these grants, and that’s awesome. But he wanted to take some of the money and buy more. And this is a guy that just lost everything five years ago, right? It’s human nature. We’re all this way. We tend to forget painful experiences really quickly.
Helping Clients Assess the Upside and Downside of Risky Decisions [00:10:05]
So I sat down with Rick and we had the overconfidence conversation. It’s three questions. Question number one is, if you do this thing and it works out as you think, for example, why do you want to buy this? “Oh, it’s going to double in the next year.” Okay. If we do this thing and you’re right, how would your life be different?
Now, normally, this isn’t like taking your entire life savings; normally the answer to that question – I’ve actually never had it be any different than this – is normally something like, “Oh, it’d be a little better, maybe I’d retire a little earlier. We might go on more vacations.” It’s nothing like, “I’m going to go from having $1 million to an island.”
Michael: Okay. Right. So the extreme, “Oh, my life actually would be completely different” doesn’t trot out of this conversation. This is more the like…
Carl: No, I think it would still work, it’s just not…the gap isn’t as big, but it would still work. You’d have to really dose heavily on the third question. I’ll explain that in a minute. So yeah, let’s pretend that you said it would be amazing, but most clients that have been through this say something like, “It’d be better around the edges. Maybe I’d retire a little earlier, maybe we’d go on a trip. We’d buy a different house, whatever. I’d buy a new car.” It’s not massive.
And this is partially because we’re massively loss averse, typically. So, if you did this thing and it worked out as you think it would, how would you like to be better? The way I ask that is, “If you made this investment or made this change you’re thinking about making and you were right, how would your life be different?” That’s question one.
Question number two: If you made this investment and you were wrong, let’s just say, and you were wrong to the tune of like 50% lower, or 0. Like in Rick’s case I could say, “Or zero like you did before.”
Michael: Yeah, like last time.
Carl: But I didn’t have to, I just said, “If it didn’t work out and there were some elbows being thrown by somebody else.” So, “If you did this thing and it didn’t work, how would your life be different?” What do you think the answer would be to that question, relative to the first question I would normally get? How would you answer that question?
Michael: Oh, man, all the loss aversion starts cropping up. Like, this would be a disaster. Boy, after I lost our life savings the first time around, if I do it again, I’m pretty sure my wife’s going to divorce me this time. That may be joking. That may even actually be serious for some couples. Yeah, it’s not hard for most people to come up with some pretty genuine disaster scenarios if something really bad happens.
Using Loss Aversion To Help Clients Gain Perspective [00:12:53]
Carl: Yeah. So this feels a little bit to me like a righteous trick. It’s not a bait-and-switch – righteous tricks are always in the service of the client. A bait-and-switch, or sneaky stuff, is in service of the advisor. We don’t do those. None of the people who watch or listen to this do those. But we do pull righteous tricks.
And I think this is a righteous trick because we’re playing chess here. We’re using loss aversion for the benefit of a good decision. That’s exactly what happens – most people will say, “Okay, if you were wrong and this thing goes to zero or let’s just say it gets cut in half, how would your life be different?” Almost universally the answer is like, “Oh, geez, that would be bad. I’d have to work for 10 more years,” or, “I’d have to…”
Michael: And because of that good old loss aversion, the Kahneman and Tversky funky line, like, we amplify our losses and the pain of our losses more than the benefits of our gains. You literally pull that straight out of the conversation with the first two questions because you’re starting with the happy one.
Like, what would happen if this goes well? And you essentially emotionally identify what gains look like. And then you ask them to think about the losses, and they mostly identify with what the losses look like, which virtually always are going to be more severe than the gains.
Carl: Totally. And I didn’t know to start with that – I didn’t know. It was after I shared this conversation with somebody else. They said, “Well, yeah, of course, that’s because of loss aversion.” I was like, “Oh, yeah, yeah, of course, that was my plan all along.”
So then question number three is where things get tricky. I’ll just tell you the question an
d we can talk about it. Question number three is, “Have you ever been wrong before?” And that’s where things get…
Michael: Whoah…
Carl: Yeah. So with Rick, it needed to be like, “Hey, I don’t want to point at anything; please don’t take this personally. You may fire me for the question I’m about to ask, but you should definitely fire me if I don’t. Have you ever been wrong before?”
For somebody else it could be more like, “Hey, so for question number three, let’s just play a little thought experiment. Have there been things that you were really certain about that didn’t work out?” That could be the softer version of question three.
Okay. We’ve identified that your life would be marginally better if it goes well. We’ve identified that your life would be way worse, at least in your mind, if it goes poorly. And we’ve identified…
Michael: Right. And then inevitably, I come back and say, “Yeah, but I’m going to get the good one and not the bad one?” Right? That’s what we’re queuing up, right? I wouldn’t have been doing this if I thought it was going to go badly. Of course, I’m going to get the winning scenario.
Carl: In the whatever number of times I’ve gone through that conversation in real life with clients, I’ve actually not had anybody go, “Yeah, yeah, that was cute, Carl. I’m still going to double down or double up.” Most people are like, “Oh, yeah, yeah.”
But I think if you do, the conversation needs to go straight into, “Let’s just revisit this plan that we built. You told me time with your kids mainly outside and serving in the community was the most important thing, and we’re putting all of that at risk here. What if we did that with a smaller piece?” You can start playing other righteous tricks.
You can either be Nick Murray and say, “If you do that, tell me where to send the money.” That’s a fine approach, and it totally works for some people. Or you can play chess and say, “All right, I see how important this is to you, but can we isolate the damage? Like, if there was damage, is there a way for us to contain it?” And so we just sort of…we’re just deciding what level of chess we want to play. And in some cases in chess, you lose a pawn to win the game or win the match ultimately, right?
Michael: Yeah. So if your client is that insistent, you can say, “Hey, okay, can we just experiment with just a portion? And then at least if this actually goes badly, we have compartmentalized the damage.”
I guess the only risk which you can’t entirely avoid would be if, heaven forbid, they do it with a portion and then the thing actually does work out and goes up, they just keep doubling down.
But I suppose at the end of the day, that’s human nature. You’re only ever going to talk them off the ledge so far if they have the great unlucky misfortune of actually being lucky several times in a row.
Carl: Yeah. I think we run into these people and I think there is definitely a line. I can think of a couple of situations in my career where I had to be really clear and say, “Look, that was lucky. That was not skill. Do you want to make another bet on luck?” Right? This is exactly what you do in a casino, it’s not what you do with your fate. I’ve had to be that direct. And I always preface those direct conversations with, “Listen, John, you may fire me for what I’m about to tell you, but you should definitely fire me if I don’t.”
So this overconfidence conversation applies to the same situation of:
“I really want to trade a couple of individual stocks.”
“That violates a fundamental principle of how we invest money here.”
“But I really want to trade.”
Like, there’s this tension. The overconfidence conversation reconnects clients to think, “You know what? I get that, but it kills me. I’m a doctor and I get to see all the new drugs, so I want to buy this pharmaceutical company.”
So that’s it. I’ve had a couple written plans that included a separate account held somewhere else. I always made a point to like, “Okay, go open that somewhere else. I don’t want it on our stuff.” And we always had a rebalancing rule around that account. Like we said, “Look, you’re going to have X dollars in there. What would you agree to? And if it goes well, you’re going to send some of that money back. If it goes poorly, we can have another discussion about whether or not we want to fund it again.”
The Power of Connecting Clients To Their Deeper “Yes” [00:19:07]
So those are some of the tools that I’ve used, and I’ve just found that it’s tricky to understand like, if the only shot you have is if there’s a deeper “yes” that you’ve uncovered. That’s the only shot. Saying no to that thing that they want to do, the only way for them to say no is if you can connect them with a deeper yes. If you can’t connect them with a deeper yes, it’s like, there’s only so much you can do before you have to tell them to hit the road. Like, “Sorry, this isn’t a good place for you.”
Michael: Wait, what’s my deeper yes here?
Carl: The deeper yes would have to be reconnecting me to a set of values and goals that I identified when I was thinking clearly with the benefit of my family, my spouse, like you, right?
Michael: So pulling them back to what’s in the plan. What are the goals? What are the underlying values? Why are we doing all this in the first place? You want to spend more time with your kids, so does putting all your money in Bitcoin really actually get you to this goal?
Carl: Especially if it goes wrong. So it’s if all the stuff from the earlier podcasts we listened to just slipped. And now you’ve just got the added tool in your tool belt, the overconfidence conversation to be used with caution and care.
Michael: Yeah. I like the discussion and just that core three-question framework. Like, “If you do this and it works out, how would your life be different? If you make this investment and it doesn’t work out, how would your life be different in the other way?” And let most people’s natural loss aversion kick in.
When they inevitably say or start thinking to themselves like, “Yeah, but I’m going for the first scenario when it’s good and not the second scenario when it’s bad,” get them thinking with the third question, which is, “Have you ever been wrong before?” And then queue them up to realize, “Oh, I guess I actually can’t ignore scenario two because I’ve got to own the fact that this went badly once before or more.”
Carl: Totally. I think about this a lot, especially when we’re talking about the market. If there’s a specific stock option or other specific thing, those discussions would be a subset of the discussion which we’ve just had. But for the market in general, to me, that conversation is all about reminding, right? “Hey, remember how you felt in 2007, 2008, and 2009? We would not be having this discussion in 2008 or 2009, I promise you.”
So it’s all about “Remember, remember.” It’s about our tendency to indefinitely project, it’s recency bias, right? Project the recent past. We’ve got to elongate the definition of the recent past by reminding them of what they felt here. And I used to actually keep these tools in a client’s folder – I would have people write letters when we were in the middle of those sorts of moments.
If they came to see me in 2008 or 2009 and wanted to sell out of something, we had the whole scary-markets conversation and we agreed to not make any decisions to jump in the water while we were in the lifeboat. Like, “I want to get more conservative.” “Okay, great. I hear you. Totally.” Boom, scary markets.
And then when we’re back on the ship, we’ll talk about that again. Now, we all know that when we’re back on the ship, the market’s going to be doing well and they’re going to say, “What risk?” And so I always tried to have people write notes to themselves in my office; I would say, “Here, here’s a piece of paper, write a note to yourself of how you feel right now, and we will label it ‘open when back on ship.’” And if you have those notes 10 years later, you can go, “Hey, remember, this is how you felt. I’m not saying it can’t change, but just remember.” Right?
So I think remembering and elongating the definition of recency, pointing out the recent past, getting people to remember how they felt, reconnecting with why, those are the only tools we’ve got in this box to get this job done. And if those don’t work – and I’ve had those scenarios; I can remember two of them – if those don’t work, then we’ve got to hit the road. It’s not a good place for you.
Michael: Yeah. Well, at some point, you don’t want to be the advisor on site if the client truly manages to implode themselves, because most people don’t like to accept their own blame. So if they’re looking for someone to blame, it’s not good to be standing near the implosion at some point.
Carl: Yeah, totally. And in addition, it’s like, look, if you’re not going to take my advice…
Michael: Then why are you paying me for it?
Carl: You should probably go do this. And if you’re going to cut your own fingers off, you may as well do it someplace where it’s cheap and fast.
Michael: Yeah. Well, on that wonderfully happy note, thank you for the conversation today, Carl.
Carl: Yeah, super fun, Michael. Thank you.
Michael: Absolutel
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