Even at the best of times, clients exhibit pronounced psychological biases that can cloud their judgment. At these the worst of times, these biases become more pronounced, says Lisa Kramer, an associate professor of finance at the University of Toronto’s Rotman School of Management, undermining clients’ investment decisions.

By understanding these biases, Kramer, a specialist in behavioural finance, told advisors attending the Top Advisor Summit, you can help clients avoid making decisions that jeopardize their future and help them stick to their financial plans.

“It’s easier to make a case for behavioural finance right now because people are seeing so much evidence of its influence,” she says. “We’re seeing people hoarding cash because they’re nervous, and avoiding stocks because they believe stocks are too risky.”

Yet a period of slumping markets presents an opportunity for advi-sors to demonstrate their value. “It’s pretty easy for clients to deviate from an optimal investment strategy when they are not running their choices by an advi-sor,” Kramer says. “So, advisors can capitalize on their expertise by reminding clients that advisors can help them stick to sound investment principles.”

In order to guide clients through this difficult time, understanding the biases that influence their judgment is helpful. The following are common behavioural biases:

> Seasonality. Kramer’s research has indicated that market cycles are in sync with the seasons. Many people experience some degree of seasonal depression — the fall and winter blahs — making them generally more risk-averse in the fall and winter and influencing their investment decisions.

“People who suffer extremely become chronically depressed,” Kramer says. “But all of us probably suffer to some degree from some risk aversion associated with a dampened mood during those seasons.

“What we see in markets is less inclination to hold risky stocks and more inclination to hold safe securities, such as treasury bonds or even cash,” she continues. “This is something that’s going on all the time to some degree. During times of extreme market volatility or market risk, however, it seems to happen even more.”

Kramer points out that the current market crisis hit in the fall, at a time when a large segment of the population was growing depressed. While seasonal risk aversion didn’t cause the crisis, she says, it did exacerbate it. Now, with the arrival of spring and more daylight hours, the market’s new resilience doesn’t surprise Kramer — inves-tors are once again becoming more risk-tolerant.

So, if you know about seasonal biases, Kramer says, you can work around them to ensure clients are making optimal decisions: “I encourage people to do financial planning during the spring or summer, when they’re less likely to be influenced by these considerations.”

She advises scheduling client portfolio review meetings in the spring or summer, when clients are more likely to accept an appropriate amount of risk.

For Kramer’s research, go to www.lisakramer.com.

> Disposition Effect. When clients hold on to poorly performing stocks too long, they are usually under the influence of the “disposition effect.” What underlies this tendency, Kramer says, is our very human unwillingness to come to terms with our mistakes.

“The remedy to that one is to have parameters or goals as to how long you are willing to hold on to a stock,” she says. “Once it has gone beyond those bounds, let it go rather than be fixated on the notion that it’s eventually going to bounce back.”

If the parameters are set beforehand, the client won’t have to make that decision while the stock is tanking, which can be a stressful period.

> Endowment Effect. Similar to the disposition effect, the “endowment effect” refers to the tendency to overvalue what you already possess. As a result, clients hold on to a stock longer than is advisable. Again, setting parameters in advance can ensure clients sell their holdings at an appropriate time.

> Overconfidence. The overconfident bias is the work of Bard Barber and Terrance Odean, professors at the University of California at Davis. This bias afflicts investors who believe they are better than others at picking stocks and can consistently beat the market. They usually trade more frequently than other investors and are more often men than women.

Although some overconfident investors may show better growth performance than their buy-and-hold counterparts, their gains are usually negated by transaction fees.

@page_break@“I don’t want to say that there aren’t people out there who have superior skills or superior information,” Kramer allows. “But a lot more of us think we have superior skills or superior information than possibly could.” IE