Coaching clients through fear

These are the times you train for as an adviser. These are the days when your leadership, poise and perspective can help clients overcome the forces of emotion that cloud their judgment. Your help and coaching can now make a long-term difference in the lives of your clients if you know how to recognize and minimize the effects of emotion on judgment.

In the best of times, investors are prone to mistakes of judgment as a result of biases and mental shortcuts. When crises strike, we have even a greater risk of making mistakes because the natural emotional responses to crisis amplify problematic thinking. In these times, we need our minds to be flexible and open to new information so that we can problem-solve and think clearly. Unfortunately, time pressure, negative emotions, exhaustion and other stressors amplify cognitive rigidity, a closed and inflexible state of mind. While you can’t remove emotions from the picture, you can help mitigate the impact emotions have on clients’ decisions.

The many faces of fear

People have very strong and very different responses to fear. I’ll describe three main reactions, what to listen for and how to coach clients through these difficult emotions.

Risk aversion

Some respond by becoming more risk-averse. This is rooted in a strong desire to reduce uncertainty at all costs – even if it means locking in major losses to avoid the chance of more bad news. For some people, the emotional benefit of having their money "safe" in the present moment can feel more important than the idea of recouping losses in the future. The stress hormone, cortisol, has been shown to increase risk aversion in experimental studies, so people who were calm when volatility was low can become extremely risk-averse under stress.

To spot heightened risk aversion, listen for catastrophizing, "what-if" scenarios, and the word "safe." The deep desire here is to avoid harm and minimize uncertainty.

When coaching clients through heightened risk aversion, it is often helpful to ask about regret. For example, when a client feels compelled to sell at a major loss, there are two possible worst-case scenarios in play. First, there is the possibility that they move their money to "safety" only to have the markets recover quickly, causing them to miss out. In that case, they guaranteed themselves a loss that was unnecessary. On the other hand, if they don't move their money and the markets remain weak, they stand to lose more, and possibly face a long recovery time. Choosing one of the two worst-case scenarios is a technique called the "least-worst," described by Gerd Gigerenzer and Peter Todd, and it can help clients minimize future regret.

Risk-seeking

Cortisol is a powerful motivator, but so is adrenaline. This can motivate some investors to treat fear as a reason to gamble. “If so much is lost already,” they figure, “then why not double down?” Adrenaline increases risk-seeking behavior and overconfidence, driving some investors to pour funds into hot stock tips and long-shot gambles in an effort to capitalize on the opportunities that a bear market presents. While bear markets can be a good time to buy, helping risk-seeking clients to avoid costly purchases is just as important as helping risk-averse clients avoid panic selling.

To spot risk-seeking, listen for hunger and urgency in clients’ tone. Does an otherwise hands-off client suddenly want to scoop up shares in some hot biotech firm they read about on the internet yesterday? This is risk-seeking and overconfidence at work. To help, rather than dismissing the suggestion, try tempering the adrenaline rush with a bit of broader context. You might say, “So, you want to add some biotech to your portfolio. Great!. Let’s talk that through, and I can help you find some good opportunities that fit with our long-term strategy.” This allows them to use the adrenaline to their advantage while not turning to a completely speculative strategy.

[More: Client behavior is a better benchmark for measuring success]

Avoidance

For some, fear triggers a freeze response. In this case, investors feel paralyzed. On the surface, this may seem like an advantage because at least those who are avoiding their investments will not sell in a panic. However, the freeze response can cause people to avoid even good opportunities. Clients who have cash on hand for seizing opportunities may find themselves unable to decide how to invest, since fear paralyzes their ability to think clearly.

To spot avoidance, listen for reticence, conspicuous silence from otherwise in-touch clients, or a general sense of resistance to even justified investment opportunities. When working with clients who freeze, it may help to walk them through the possible outcomes of action versus inaction. Helping them to picture a future where their courage to act pays off can sometimes break the spell of indecision.

Rumination

Lastly, fear and stress can lead some to ruminate. This is problem-solving on overdrive. When we ruminate, we get stuck in repetitive, negative patterns of thought that not only fail to solve the problem, but the act of ruminating exhausts and stresses us more. Rumination amplifies present-bias and loss aversion, and leaves people prone to making myopic decisions that hurt more than help in the long run.

To spot rumination, listen for indications that the person feels powerless, is going in circles or feels generally unable to handle the situation. When coaching someone who is stuck in a ruminating mindset, it may be helpful to ask them about their emotional support network. It may sound strange, but there is some evidence to suggest that just thinking about the people who have supported us in the past (emotional support, not necessarily financial) can help us break out of ruminating thought patterns and think more clearly about the task at hand.

Summing up

When clients are afraid. they may respond in many different ways. Some will seek stability, even at a loss. Some will run into the fray trying to make a bundle, and others will be paralyzed by avoidance or rumination. You can’t keep clients from feeling fear, but you can help them avoid costly mistakes made in the throes of this powerful emotion.

Help the anxious minimize regret. Help the daredevils hedge their bets. Help the paralyzed see their opportunity, and help those who ruminate remember that they are not alone.

[More: Fear sells, but excitement buys]

Sarah Newcomb is a behavioral economist at Morningstar Inc.