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Dan's new book for millennials, Wealthier: A Field Guide to Financial Freedom, will be published in April 2024 and available on Amazon.
A groundbreaking study by Chaoran Chen et al., titled "Mediating Role of Optimism Bias and Risk Perception Between Emotional Intelligence and Decision-Making: A Serial Mediation Model," has shifted the spotlight from data and numbers to a softer skill: emotional intelligence (EQ).
While the study examined investor behavior in the commodity market, the findings are more generally applicable.
The primary findings
The study's primary findings relate to optimism bias and how emotional intelligence impacts investment decisions.
Optimism bias causes investors to believe they are less likely than others to experience negative events. Investors with optimism bias tend to underestimate the likelihood of adverse occurrences while overestimating the probability of positive outcomes.
The study found EQ impacts how optimistic a person tends to be regarding the outcome of their investments. People with higher EQ might better manage their optimism, ensuring that unrealistic expectations of positive outcomes do not overly influence their investment decisions.
How to use these findings
The findings of this study suggest the importance of understanding your clients' EQ and determining if they suffer from optimism bias.
Wealthier:
A Field Guide to Financial Freedom
Why have so many financial advisors agreed to review an advance copy of Wealthier: A Field Guide to Financial Freedom? It empowers millennials to be responsible DIY investors and financial planners. You can see some of their reviews here.
Wealthier will be published in April 2024.
Here’s what one advisor said: "Saplings grow into trees. We need to help the next generation of investors get to where they need our services."
For more information, visit the website for Wealthier:
To review Wealthier send an e-mail to: [email protected]
As a practical matter, how do you do this?
Here are some suggestions.
Measuring EQ
Self-assessment questionnaires
Tools like the Emotional Quotient Inventory (EQ-i) or the Mayer-Salovey-Caruso Emotional Intelligence Test (MSCEIT) can assess clients' self-perceived EQ. These questionnaires evaluate different aspects of EQ, like self-awareness, empathy, and social skills. Some clients may find taking these tests off-putting, so use your discretion before suggesting them.
Behavioral observations
You can observe clients' behaviors and reactions during meetings and discussions. How they handle stress, their ability to listen and empathize, and their capacity to manage emotions can provide insights into their EQ.
Feedback from others
Collecting input from family members or close associates can offer an external perspective on the client's EQ.
Scenario-based assessments
Presenting hypothetical investment scenarios and observing clients' responses can help assess their emotional reasoning and decision-making skills.
Determining optimism bias
Review past investment decisions
Analyzing clients' investment decisions can help advisors identify patterns of overly optimistic expectations.
Discuss expectations
Open conversations about clients' expectations from their investments can reveal signs of optimism bias. If clients consistently expect higher returns with little consideration for potential risks, they may have optimism bias.
How to overcome optimism bias
Once optimism bias is identified, you can help clients overcome it through:
Education
Discussing optimism bias and its potential impact on investment decisions is a crucial first step. Providing information about historical market trends and the importance of realistic expectations can help clients recalibrate their outlook.
Risk management strategies
Work with clients to develop risk management strategies that align with their financial goals while addressing their optimism bias. This may involve adjusting their portfolio, setting realistic return expectations, and establishing clear risk parameters.
Regular reviews and feedback
Regularly reviewing clients' portfolios and providing feedback on their investment decisions can help them stay grounded and make more informed choices.
Behavioral coaching
Employ behavioral coaching techniques to help clients recognize and manage their emotional responses to market fluctuations. Suggest the client pause and reflect before making decisions, encourage them to consider a range of outcomes, and help them develop a long-term perspective.
By measuring clients' EQ, identifying optimism bias, and providing the necessary support and education, you can help your clients make more informed and rational investment decisions.
Dan coaches evidence-based financial advisors on how to convert more prospects into clients. His digital marketing firm is a leading provider of SEO, website design, branding, content marketing, and video production services to financial advisors worldwide.
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Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives.
Here’s what one advisor said: "Saplings grow into trees. We need to help the next generation of investors get to where they need our services."