Behavioral Economics and Investing
At Boston Financial Management, Abby Psyhogeos helps clients stay the course
When Wealth Manager Abby Psyhogeos graduated from Bowdoin College with a degree in economics, she had no idea what she wanted to do. A job with a start-up registered investment advisor in Boston proved fortuitous; it launched her into the industry where she has happily and successfully spent her 30-plus year career. Now a managing director of Boston Financial Management, Psyhogeos brings her broad and deep experience to lead the firm’s Portland office, which opened last spring. In a stylish, serene, and comfortable space in the Old Port, she and her team focus on service, stewardship, and the understanding of behavioral economics to help clients meet their long-term goals. “The best value I can provide to clients is to equip them with a process-driven investment plan, and also to help them stay the course and mitigate stress and emotional decision making,” says Psyhogeos.
Q. What is behavioral economics, and how does it apply to wealth management?
A. Behavioral economics studies the effects of psychological, social, cognitive, and emotional factors on the economic decisions of individuals and institutions. It applies to wealth management in numerous ways because making decisions around one’s wealth evokes emotion. In 2017 economist Richard Thaler received a Nobel Memorial Prize in economic sciences for his work in establishing that people are predictably irrational in ways that defy economic theory. One often hears about fear and greed leading individuals to sell low and buy high.
Q. What happens when investors trade excessively?
A. Historically, it is overconfident investors who trade excessively; they believe that they can outsmart markets. When people become emotional, they may want to take action rather than “stay the course.” Turnover, which is measured by the percentage of buys and sales in a portfolio, has an inverse relationship with returns. The higher the turnover, the lower the portfolio returns. This doesn’t mean to never sell, but both purchases and sales should be made based on sound fundamental work of an investment, rather than emotions around politics or other “noise.” Many studies support this conclusion. Carl Richards coined the phrase “The Behavior Gap,” which is the difference between investment return and investor return. According to a Lipper/DALBAR 20-year study in 2014, the difference between the S&P annual rate of return of 9.9 percent and the average equity investor return of 5.2 percent is a negative annual 4.75 percent! This “Behavior Gap” is for one year, but the compounding effect results in thousands, if not millions, of dollars lost annually for individuals.
Q. What steps do you take to develop the right plan for your clients?
A. We begin by spending time with individuals to understand their financial and personal goals and how we can help them meet those goals with the assets we have been trusted to manage. We explain risk and evaluate their risk tolerance; time horizon, cash flow, and how making or losing money makes one feel all play into this exercise. It’s important to understand where the money came from and what the purpose is for the funds—both now and after the client is gone. Time is always a factor. For example, do they need funds over the next several years for education, retirement, or new homes? I try to get to know the people and talk to them about how they will feel when markets go down and they lose money, even it if is “paper loss.” That helps me determine the best asset allocation. In all circumstances we develop an investment policy statement for each account, and we generally invest over time using a combination of time and market opportunities.
Q. How are you uniquely positioned to help clients avoid emotional decision making in the market?
A. When you become a client of Boston Financial Management, you give discretion to our firm to make investments in the accounts that are being managed. This is different than the old days of a broker calling the client and selling them on a single stock idea. Before we begin, we agree on a well thought-out plan that includes asset allocation and portfolio construction. It’s my job to make sure the client understands the plan to include the risks. Again by investing over time, we mitigate the chance of emotions taking over and someone wanting to “bail” at the wrong time. Ongoing open and transparent communication helps us understand our clients’ worries and fears that can drive emotional decision making. By taking the time and really getting to know and understand each of our clients, we are better able to help them tune out some of the “noise,” stick to the plan, and avoid emotion-driven decision making.