How to handle Legacy Holdings of Client Portfolios?

Emotions and psychological biases are an integral part of investment management. Sometimes it is as important a part, or even more important, than hard facts and analysis. Here we will discuss one such issue: when the client is psychologically biased towards an investment that has been bequeathed to him/her and does not want to dispose of it.

Experts in behavioral finance have propounded a theory called ‘endowment bias’, which means when somebody holds ownership rights on an asset, he/she values it more. Ownership of an asset  “endows” the asset with some added value. Endowment bias can affect attitudes toward items owned over long periods of time or can crop up immediately as the item is acquired. In an experiment, a researcher made two groups of participants. In the first group, the participants were given a coffee mug.  They were then asked to complete a questionnaire, after which they were shown some candy bars. It had been determined earlier that the 76 participants were about evenly divided over whether they generally preferred candy bars or coffee mugs if given a choice. But when told that they could substitute a candy bar for the coffee mug they had been given, 89 percent chose to keep the coffee mug. The second group consisted of 87 participants. Again, about 50 percent preferred candy bars, and 50 percent preferred coffee mugs. The second group participated in the same exercise as the first group, except this time, the candy bars were the endowment good and the coffee mugs were offered subsequently as substitutes. In the second group, 90 percent declined to trade their endowed candy bars.

Now let us relate this emotional phenomenon to investments and financial planning. When someone inherits an investment, there tends to be an emotional connect or “endowment bias” for that asset. Many a time, people are reluctant to sell securities that are bequeathed by earlier generations; there is a feeling of ‘disloyalty’ in selling it. As a financial planner, you have to approach it sensitively. Let’s take a case. An old widow inherits an equity-heavy portfolio from her deceased husband. Obviously, this is not appropriate for her risk-return profile and horizon. However, in this case, it is advisable to not take the usual approach of explaining the optimal asset allocation and need to re-allocate the portfolio. She may have an undue attachment to those equity stocks as a memento of her deceased husband and straightforward advice to sell may not work. You have to take a discreet approach like asking her “if your husband left you as much cash as these shares are worth, how many of these shares would you buy?” Assuming she is not conversant with the equity market, she would probably say that she would buy none of these as she is not into the equity market. Another approach could be to tell her, maybe your husband did not want to hold these shares per se, but he was himself a participant in the equity market and he did not convert the holdings into cash as nobody knows when the last day is coming.

A similar ownership bias may be there in case of securities purchased by your client, of the type “I know better”. In this case also, instead of telling bluntly that the choice of securities was poor, it is better to say something like, “if you had to convert your current holdings in these securities into cash and then allocate that cash, would you buy these same stocks?” Or you may try “What do you hope to accomplish by holding these securities, and how is this helping to you achieve your financial goals?” Often, as in the case of inherited securities, the client will see the light. Stressing a long-term view in financial goals can often persuade clients to be more receptive to facts.

Given the importance of emotional aspects in investments, as financial planners, we have to step into the shoes of the client and understand the perspective. The logic given may be not just the portfolio allocation argument. For example, the client may have investments across well-performing equity funds. Amidst the India growth story, he/she may have a valid reason to hold on to those funds. Your persuasion to exit one or two of those funds has to touch the emotional chord: “Sir, with advancing age, your doctor is advising you to cut down on salt and sugar. You can no longer eat like your younger days. If that be the case, you should not hold on to as much equity as your younger days, and let go of one or two equity funds though we all believe in the India growth story”.

Your client has to perceive you as his/her friend, not just about giving the right investment advice but understanding where he/she is coming from.

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