Getting on top of the 3Es

All financial advisers need to manage their clients' emotions, expectations and economics - the 3Es. Once the 3Es are managed, the rest will fall into place.

An investor needs their financial adviser most when the market is volatile, when they're emotionally vulnerable, because they will be inclined to let the 3Es dictate their decisions.

All financial advisers need to manage their clients' emotions, expectations and economics - the 3Es. Once the 3Es are managed, the rest will fall into place.

An investor needs their financial adviser most when the market is volatile, when they're emotionally vulnerable, because they will be inclined to let the 3Es dictate their decisions.

Managing the 3Es is even more crucial with the new breed of investor. These new part-time traders have only recently experienced the bittersweet taste of direct share ownership. In fact, according to the latest statistics from the Austra-lian Stock Exchange, nearly one in three Australians is a direct shareholder, so it's likely some of your new clients fit into this category. These are the customers most in need of 3E financial advice.

Inexperienced clients can react to their investments on an emotional level. Sen-sational newspaper headlines such as "shares soar", appearing one day and "shares dive" the next, can induce fear and encourage investors to break one of the golden rules of share investing - "don't try to time the market". Nervous investors can react irrationally, often to the point of delaying investing new monies, or redeeming existing investments at exactly the wrong time. These in-vestors end up buying high and then selling low with the result that their port-folios are hit with a double whammy.

According to the Psychology of Investing by Kahneman and Tversky (1979), a loss has two and a half times the impact on an investor than a gain of the same mag-nitude. Most investors would rather lose $8000 than have an 80 per cent chance of losing $10000. This is becoming known as "loss aversion", and a key role for today's financial adviser is to be empathetic to, and help allay, their clients' fears about loss.

A financial adviser's challenge is to encourage customers to stay fully invested continually and make recommendations for further investment to help clients achieve their long term financial goals. One key component in achieving this is to painstakingly alert clients to financial market volatility, in particular, share and bond volatility. A long term client will evolve if the financial ad-viser sets the right expectation from the outset.

Many investors' first experience of direct share ownership is through high pro-file floats. The market has largely been kind to them. However, as many Tel-stra 2 (T2) or technology stock investors are now discovering, the sharemarket also falls. How many of your customers who have invested in either direct shares or managed funds, want to sell, instead of riding out the short term fluctuations in favour of the long term gains? Managing your clients' response to fluctuating markets is central to keeping them invested for the longer term. The most common mistakes that investors make are in response to market volatil-ity. Some of these mistakes are known as Recency, Anchoring and Getting-Even.

Recency is where investors give new information far too much weight in forming their expectation about the future. They are overly optimistic about recent win-ners, and overly pessimistic about losers - Newscorp and AMP being two recent examples. Negative and positive one-off isolated events can send unnecessary and irrational shockwaves through the market.

Anchoring Investors often get anchored on certain investment returns or price levels. These numbers seem to represent good value and they use them as inherent benchmarks. The 2500 level of the All Ords was considered a major anchor by many investors and professional market analysts. In fact, one prominent dealer group in Australia recommended that all its clients sell down their exposure to the Australian stockmarket simply because the 2500 level had been reached. This was a very high risk strategy - and many of their clients forfeited huge re-turns. Anchoring can apply to individual stocks as well as market benchmarks.

Getting even is pretty simple. Many investors will not sell anything at a loss as they don't want to give up the hope of getting a return on a particular in-vestment, or they want to get even before the sell. The 'getting even' disease has probably wrought more destruction on investment portfolios than anything else. Nick Leeson is the best example of 'getting even', trading to get back his losses, and finally losing over $1.4bn, taking the oldest bank in the world down with him. To avoid 'getting even' requires discipline on the part of the investor and this responsibility rests with the financial adviser.

Bull markets influence investors' decisions, and internet stocks have been a key catalyst. When the stock market is roaring, as it has done through most of the 1990s, investors can become blinded by their euphoria over their returns. In-vestors usually hope for bull markets and double-digit returns, but unfortu-nately this blinds their memories of bear markets.

Once your clients start saying things like "This time it's different", then it's time for you to really earn your money, by resetting and managing their expecta-tions and emotions and bringing the economic reality back into focus.

Paul J van Rooyen is head of business development with

Westpac Financial Services