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Why do clients, who have been riding along with investments for the long term, suddenly proclaim that they were not willing to take any risk when the markets and their investments have turned south?
Have you ever heard a client say "I told the broker I did not want any risk?" I bet those of you involved in dispute resolution have in mediation, arbitration, deposition or trial. Even under oath they say it.
We know that brokerage firms do not (cannot- not even cash has no risk) sell anything that has "no risk" so most people might just be dubious about that client statement actually occurring. Are they then intentionally making a false statement (under oath)? Probably not, at the time they later say they told the broker "they didn't want any risk" (add the phrase to their principle or leave it out - it doesn't matter) they may very well believe that they had in fact said just that.
How then do we explain the discrepancy?
The answer may lie in what behavioral economists call “Myopic Loss Aversion” (as opposed to ordinary Loss Aversion). Loss Aversion tells us that people are twice as upset about a potential loss of a certain size (say for example $10,000) than they are happy about a potential gain of the same size. When an unrealized loss becomes material, clients obsess - get a myopic view - myopically focusing in on a short term time horizon, thus, you guessed it, myopically defining the "heretofore expressed" range (as in none) of permissible investment outcomes. The larger the loss relative to their view of their net worth the more powerful this myopia becomes. This myopia not only causes clients to focus on the immediate term but also to disregard other facts no longer deemed salient (such as what actually occurred during the conversation in question).
In other words when there is a material unrealized loss in a portfolio or investment, this phenomenon can cause folks to reverse their time horizon from long term to short (as in "immediate") term despite the fact that nothing in their lives would dictate that change objectively. This investment time horizon inversion is largely subconscious and compulsive.
You may wish to consider this as an investor.
If you are a financial services professional you may wish to improve your level of client communication especially when one of your clients has a material unrealized loss in their portfolio.
If you are in the dispute resolution business you may wish to reexamine the underlying facts with this phenomenon in mind.
On a somewhat analogous point, Financial Advisors can influence their clients without meaning to:
Investors given shorter term historical return data to review in connection with an investment portfolio discussion adopt more conservative investment strategies than Investors given longer term historical return data ( and vice versa).
Financial Advisors may wish to make sure that the term of the historical return data given to a client matches the real time horizon under consideration. Here are some links to professional papers:
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