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Consider this little story
Ashok "punted" on a small cap stock - he read a research report from a brokerage house that talked up the stock aggressively. He had begun learning a bit of technical analysis, and from his very limited understanding of the stock chart, he concluded that a big upside breakout is around the corner. He bought the stock. He waited. And waited. And waited. But the stock never "came to life". It just continued languishing at the same levels. A year down the road, he exited the stock - more or less at cost, in a market which delivered a 20% growth that year.
A few months later, Ashok's neighbour Rajesh told him about another "hot" stock during one of their morning walks together. Rajesh was very confident about the prospects of this stock, said he bought it just a couple of weeks ago and it was already up 10%, and is looking good to at least double in the next year, if not more. Ashok bought the stock on the basis of Rajesh's strong bullishness. Unfortunately, history repeated itself. He waited, and waited, and waited. The stock didn't go anywhere and a year down the road, he sold out in disgust, around cost. The market that year delivered a 12% return.
He felt bitter about Rajesh's hot recommendation not going anywhere. In subsequent morning walks with other friends, he would complain often, "Arre, I invested in this stock on Rajesh's advice - but look - it went nowhere. I had to sell out at cost after a year. I would have been better off even in a fixed deposit - at least I would have got 8% return!"
He was never once seen complaining about the stock he punted on, based on reading a research report and seeing a couple of charts with limited understanding of them. He never told his morning walk friends that he would have been better off investing in a fixed deposit rather than the stock he punted with his own information and insights.
Its not as if he was trying to put down his friend and hide his own failures. In the first case, he punted, it didn't work out, he exited and moved on. It didn't bother him too much. But, when he invested solely on the basis of a recommendation from his friend, and it didn't work out, he felt bad about it. He felt "let down". The fact that his purchase underperformed the market by 20% while his friend's recommendation underperformed by 12% never even crossed his mind.
Ashok continues to take an interest in stocks. He reads up reports, and occasionally "punts" in small cap stocks, hoping to catch a multi-bagger. But whenever Rajesh comes up with a stock recommendation, pat comes his reply, "Rajesh, the last time you were so confident but nothing happened. I was lucky to get out at cost!". He immediately disregards Rajesh's recommendations.
What explains this behaviour?
Does this story ring true? Can you believe that something like this happens in everyday life? We know that Ashok's behaviour is not entirely rational - but is that how most of us would behave? Have you seen something like this happening around you?
Behavioural finance specialists have conducted many experiments that came to a conclusion that given two scenarios - one where a person bets/invests money on the basis of pure chance, and the other where he bets/invests on the basis of someone's recommendation, he would normally be more averse to taking the risk based on another person's recommendation. Or, put differently, his payoff expectation is much higher when placing a bet based on someone's recommendation than on the basis of pure chance. The term coined by behavioural scientists for this human trait is betrayal aversion.
When its pure chance, you have nobody to blame for failure but luck. But, when it is an individual who makes a recommendation, you have a person to blame, should it not work out. There is somehow a greater feeling of being "let down" by an individual as opposed to being "let down" by Lady Luck. That's betrayal aversion - an aversion or dislike for getting betrayed by a person. You don't act on the person's recommendation, because you don't want to feel betrayed, should it not work out.
Implications for financial advisors
Betrayal aversion is a key risk that every financial advisor faces. As an advisor, your job is to provide investment recommendations to your clients. You take on the responsibility of picking 4-5 investment ideas out of thousands out there, and you ask clients to trust your judgement that these will be good investments, suitable investments, investments that will help achieve the outcomes your clients desire.
Often, you find clients hesitant to take that leap of faith, especially when the products you are recommending are unfamiliar to them. This is especially the case with new clients who haven't yet formed a strong personal relationship with you over the years. You are a little new to them, and your investment ideas are also new to them. They hesitate to act - betrayal aversion is very much at work.
How can you overcome betrayal aversion
Its only over time that clients start trusting you implicitly - that's because over the years they have seen you delivering value in their portfolios and their financial lives. They trust you because of the positive past experiences. But, will a new client trust you just as implicitly? Probably not. How then can you ask them to take that leap of faith in a relatively unknown advisor recommending unfamiliar products?
Its tempting to suggest that you do a "Main hoon na" number on your clients. Look straight into their eyes, give a reassuring smile and tell them "Trust me." Over the years, you have seen many of your clients developing that trust in you. You want this new client also to act on your recommendations, on the same basis.
This may however backfire. When betrayal aversion is at work, simply saying "Trust me" is not going to swing things for you. The need of the hour is to help this client understand why he can take the chance of taking a chance on you. You will need a judicious combination of the following, to help you in such situations:
Take your client through your well documented investment policy statement that clearly spells out your firm's investment philosophy and the principles which govern how you pick your investment universe Take your client through your fund research process and the objective manner in which you come up with independent fund recommendations Take your client through the portfolio review process that happens within your office as well as the regular portfolio review meetings that you will conduct with him Having demonstrated the rigourous approach that you adopt, which will also be followed for his money as well, then take him through client testimonials - which reinforce the point that you actually deliver what you claim
Trust in the initial part of developing a client relationship is built more on the basis of showcasing your competence and your track record. It is only later that the personal equation takes over.
Once you understand that a new client is likely to have a sense of betrayal aversion, rather than jumping straight into "main hoon na" or client testimonials alone, take the effort to showcase your philosophy and processes. Understand that the client has to fight betrayal aversion before going ahead with your recommendation. The best way to help him fight it is to help him understand that he is not "blindly" trusting you, but that you have the necessary competence to manage his money judiciously. And competence is not demonstrated by "main hoonna" - it is demonstrated by well documented and faithfully executed principles and processes.
All content in MasterMind is created by Wealth Forum and should not be construed as an opinion of Sundaram Mutual Fund.
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