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Fearful or Forward-Looking? What Financial Advisors Must Understand About Investors

Mirtha Kastrapeli | State Street Center for Applied Research

June 27,2017

When you're driving a car, what motivates you to obey traffic laws?

Is it the fear that you might be stopped by a police officer and ticketed for speeding? Or is it the goal of arriving safely to your destination?

If you lean toward the former, you may exhibit what's known as greater behavioral inhibition system (BIS) sensitivity — a tendency to respond more strongly to potential punishment. If you prefer the latter, you may have higher behavioral activation system (BAS) sensitivity — a tendency to be motivated by rewards. The BIS and BAS models, developed by the British psychologist Jeffrey Alan Gray, have been used for decades to analyze the personalities of everyone from adolescents to inmates. But there's another group of people who also benefit from BIS/BAS assessments: investors.

At State Street's Center for Applied Research, we recently sought to understand investor motivation by surveying more than 3,600 individual investors to determine their sensitivities to BIS and BAS as well as to gauge their investing habits and savvy. What we found was, in some ways, intuitive: Investors with higher sensitivity to BAS — that is, those focused on achieving long-term goals — were more likely to avoid excessive trading. With a distant horizon in sight, it seems, they weren't as vulnerable to being spooked by market volatility or sudden declines that might scare other investors into making unwise decisions, like selling low and locking in losses. BAS-sensitive investors also exhibited other savvy traits: They were more likely to use financial advisors, more likely to know what investment-related fees they were paying and more likely to consider environmental, social and governance (ESG) factors in their investing decisions.

Technology is needed to serve the human elements but it cannot replace them.

In contrast, investors with higher BIS sensitivities — those motivated primarily by fear — were vulnerable to several mistakes related to personal finance and investing: They were prone to spend more than they saved, they were more likely to buy investments that had already gained significant value (buy high), and they were more likely to sell investments after major losses (sell low). Earlier research informs our understanding of such fear-driven investors. For instance, those who exhibit what's known as financial anxiety, defined as "holding an unhealthy attitude about one's financial situation," are less likely to seek the help of a financial advisor, according to a 2014 study1 published in The Journal of Financial Therapy. Such anxious investors, apparently, would rather avoid addressing financial matters than seeking out help. Those who judge themselves to be lagging behind others in terms of achieving financial success, meanwhile, may be victims of their own pessimism:  A 2015 study2 published in The Journal of Finance showed that when provided information about their peers' retirement savings habits, workers were more likely to lower their own savings rates — reactions tantamount to "throwing in the towel."

When faced with fear-driven investors, what are financial institutions and advisors to do? Well here's one thing they shouldn't do: Try to change their personalities. Attempting to change an individual's personality is a foolhardy task for a psychologist, let alone a financial professional. But what advisors can do is change the environment around investors to one that encourages goal-setting. That means, for instance, skipping presentations that emphasize how much their wealthiest age peers are socking away into their retirement accounts — as research has shown, such information will only discourage them. Instead, it's better to encourage investors to, as the old adage goes, run their own race. Advisors should help investors set tailored, manageable goals...and when investors take responsible steps toward those goals, advisors should celebrate their successes.

As US President Franklin D. Roosevelt said in his famous 1933 inaugural address3, "the only thing we have to fear is fear itself—nameless, unreasoning, unjustified terror which paralyzes needed efforts to convert retreat into advance." With the right guidance at their disposal, fear-driven investors need not be paralyzed. Rather they can join their goal-oriented peers in advancing toward a healthy financial future. As for banks and financial advisors? It's time they brush up on BIS and BAS. For their clients, that's what's best.

1. Grable, J., Heo, W., & Rabbani, A. (2015). Financial Anxiety, Physiological Arousal, and Planning Intention. Journal of Financial Therapy, 5 (2) 2.

2. Beshears, J., Choi, J. J., Laibson, D., Madrian, B. C. And Milkman, K. L. (2015), The Effect of Providing Peer Information on Retirement Savings Decisions. The Journal of Finance, 70: 1161–1201. doi:10.1111/jofi.12258   

3. Franklin D. Roosevelt: "Inaugural Address," March 4, 1933. Online by Gerhard Peters and John T. Woolley, The American Presidency Project.

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Topics: Investment Approach

Mirtha Kastrapeli | State Street Center for Applied Research

Mirtha Kastrapeli is the Global Head of State Street's Center for Applied Research. She has more than 13 years of experience in the private and public sectors, analyzing capital markets and helping shape public policy. Mirtha is currently listening to sustainable investment trends.