Morningstar Advisor - October/November 2009 - 37

Many Passive Preservers focus on taking care of family members and future generations, especially by funding life-enhancing experiences such as education and home ownership. As age and wealth increase, clients may exhibit more Passive Preservers tendencies. Biases Anchoring (Cognitive) Passive Preservers cling to purchase points and arbitrary price levels. They have a price in mind when buying or selling an investment and will stick to it, often to their detriment. Mental Accounting (Cognitive) allocation. They are hands-on and want to be involved in investment decision-making. They are optimistic that their investments will do well, even if that optimism is irrational. Some Active Accumulators need to be monitored for excess spending. Biases Passive Preserver biases tend to be emotional: endowment, loss aversion, status quo, and regret. They also exhibit the cognitive biases of anchoring and mental accounting. Endowment (Emotional) Passive Preservers often compartmentalize their money. They segregate their assets into “buckets” representing an investment goal without regard for correlations connecting investments across buckets, leading to a suboptimal asset allocation. Solution Active Accumulator biases are overconfidence, self-control, optimism, and illusion of control. Overconfidence (Emotional) Passive Preservers, especially those that inherit wealth, tend to assign a greater value to an investment they already own (such as a piece of real estate or an inherited stock position) than they would if they don’t possess the investment but had the potential to acquire it. Loss Aversion (Emotional) Passive Preservers feel the pain of losses much more than the pleasure of gains. They will not unload bad investments even when there is little prospect of a turnaround. They strongly want to get back to even. Status Quo (Emotional) Passive Preservers often prefer to keep their investments (and other parts of their life, for that matter) at the status quo. They don’t like change; when faced with choices, they opt for what “feels the same.” Thus, Passive Preservers often hold investments inappropriate to their risk/reward profile and will resist changing to a more suitable portfolio. Regret (Emotional) Passive Preservers are difficult to advise because they are driven mainly by emotion. But they greatly are in need of good financial advice. Passive Preservers need “big picture” advice; advisors shouldn’t dwell on quantitative details such as standard deviations, Sharpe ratios, and charts. If they do, they will lose their clients’ attention. Instead, advisors should talk about how clients’ investment decisions affect emotional aspects of their lives, such as their legacy, their heirs, or their lifestyle. Once Passive Preservers feel comfortable discussing these emotional issues with their advisor, they will take action. After a period of time, Passive Preservers are likely to become an advisor’s best clients because they value professionalism, expertise, and objectivity. Active Accumulators overestimate the quality of their judgment. They believe that they have special decision-making powers and an above-average aptitude for selecting investments. Therefore, they tend to trade excessively. Self-Control (Emotional) Active Accumulators tend to consume today at the expense of saving for tomorrow. Advisors must be on guard for clients with a high risk tolerance who spend wildly. In a declining market, an Active Accumulator might be forced to sell solid long-term investments to meet current expenses. Optimism (Emotional) Active Accumulator Active Accumulators are the most aggressive type of investors. They are often entrepreneurial and the first generation in their family to create wealth. They are strong willed and confident, and they believe that they can control their investment outcome. They want to alter their portfolios as market conditions change, which often puts a drag on investment performance. They are quick decision-makers; they may chase high-risk investments that their friends or associates recommend. Some Active Accumulators don’t believe in basic investment principles such as diversification and asset Many Active Accumulators are overly optimistic investors who believe that bad investments will not happen to them. Such an illusion can damage portfolios because Active Accumulators fail to mindfully acknowledge the potential for adverse consequences in the investment decisions they make. Illusion of Control (Cognitive) Passive Preservers avoid taking decisive actions because they fear that, in hindsight, whatever course they select will prove to be a mistake. “I’ve been burned before, and I don’t want that to happen again.” Regret aversion causes Passive Preservers to hold portfolios that are too conservative because they are timid in their investment choices. Active Accumulators have convinced themselves that they possess more control over the outcome of their investments than they actually do because they are “pulling the trigger” on each decision. They believe that the best way to manage an investment portfolio is to constantly adjust it. Solution Aggressive clients are the most difficult to manage, particularly those who have experienced MorningstarAdvisor.com 37

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Morningstar Advisor - October/November 2009

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