Advisors can spend hours explaining a great solution to their clients, only to have those clients not act on the solution.

There’s no magic bullet. But sometimes clients appreciate it when their advisor helps them identify what’s making the decision hard. 

What makes a decision difficult?

 Decision analysts have found four main things that make a decision difficult:

1. Uncertainty
2. Conflicting Values
3. Complexity
4. High Stakes

In this post, we examine each one of these to see how and why each factor can hinder a client’s decision-making.

Uncertainty

Many people hate uncertainty. Some actually fear it.[1] Studies have shown that people would rather be certain that bad news is coming than be left not knowing whether they’ll receive a good or a bad outcome.[2]

Making decisions about the future requires people to consider many kinds of uncertainty. 

For example, consider a client who owns $7 million of Nvidia, out of a total net worth of $9.5 million. The client knows that that he’s taking excess risk. Even if Nvidia is not overvalued (at the time of this writing Nvidia’s market cap is greater than the market cap of the Chinese stock market[3]), the decision presents issues of uncertainty.

Will Nvidia continue to outperform, making the client even wealthier? Will Nvidia perform at the market, will it lag, or will it even collapse?

There’s no way of knowing. What appears to be the most important factor – the future price of Nvidia – is inherently uncertain and unknowable.

But that uncertainty is an excuse, not a reason, to avoid a decision.

Complexity

Relatively few people have much training or experience handling decision complexity in a logical manner. The decision analysis literature provides extensive, logical, and implementable tools for making rational decisions in the face of complexity. But that literature is itself complex, and the tools (mainly a quantitative technique called decision analysis) are generally the subject of graduate study.

Other decision researchers have identified simpler, more useful, methods of making decisions in the face of complexity.

One of the best of these researchers, Gerd Gigerenzer, has studied these rules of thumb. For example, one is called the “recognition heuristic.”[4] This is a decision technique in which people choose something they recognize over something they don’t recognize, merely because they recognize one option instead of the other.[5] For example, when Gigerenzer and his colleague Daniel Goldstein asked participants to choose from a list of cities and decide which cities were the most populous, participants chose the cities that they recognized over the cities they didn’t, merely because they recognized the cities.

But when people use the recognition heuristic to decide what to invest in, that can get them in trouble. For example, if people want to stay invested in a stock position just because they’ve heard about that company and because their friends own it, that can cause people to make unwise investments, or to stay invested in companies that aren’t actually in their best financial interest.

Another heuristic, which Gigerenzer calls “take the best” might better help clients make decisions.

The “take the best” heuristic requires the decision maker to identify only the most important variable, and then make the decision that optimizes that one key variable.

Analysis Paralysis

Complexity too often instead results in “analysis paralysis” in which the decision-maker feels overwhelmed by the various factors underlying a decision and makes “no decision” which too often is a decision to keep doing what the person was already doing (e.g. holding Nvidia) even if that’s actually likely the worst possible decision.

Conflicting values

In making financial decisions such as portfolio allocations, or whether to hold or sell an important asset, some people fail to clarify their values. This lack of clarity about what they’re trying to accomplish makes a decision feel impossible.

And because of this lack of clarity about values, a person might attach great importance to a “factor” that is or ought to be irrelevant.

For example, suppose a client, Tracey, holds a concentrated stock position in Apple stock because her father gifted it to her when she was a child. She’s held the position for the last twenty years. Her father gave her $5,000 of Apple stock in a tax-deferred account, and it’s now worth about $2.6 million.  Apple has made her rich – but it won’t necessarily keep her rich, and Tracey’s advisor suggests that she diversify.

Tracey hasn’t been shown the three major values that are (for most people) competing in this situation. So she feels overwhelmed, and falls back on the emotional crutch of daddy’s decision twenty years ago.

The Three Essential Values that Might Conflict

In financial situations involving high net worth clients and decisions, the true values conflicts usually involve two or more of the following desires:

1. To avoid regret
2. To maximize future net worth
3. To minimize risk

That’s it. Everything else, including emotional attachments, are really just excuses to “avoid” a decision. And of course, by failing to make an active decision, clients often end up making a de-facto decision.

High stakes

Most high net worth people, despite their high net worth, do not have a great deal of experience of making large financial decisions.

For example, most business owners sell a business only once. Most people who are fortunate enough to own a ton of Apple only have one such huge investing success in their lives.

As a result, many high net worth individuals don’t have much experience making single decisions about numbers that are large to them.

So, even when there is little objective risk to the decision, many people will hesitate.

For example, consider a typical high net worth client who (somehow) comes into possession of $10 million, which is 50% or more of his net worth. And suppose that person is deciding between temporarily investing that money in one-year treasuries, or in a similar FDIC insured one year bank deposit program (there are such programs, even up to $10 million). Chances are, that person will hesitate, even though the two alternatives are both about equal in terms of risk and expected return. It’s a tough decision because so much money is at stake.

In most real-world cases, high stakes are on top of one or more of the other considerations.

What to Do

There is no surefire solution for getting clients over their decision paralysis. But one approach that can be successful is to help them clarify the heart of their indecision. More often than not, that is a lack of clarity on their values. In particular, advisors can help their clients clarify which of the following three Decision Criteria is most important.

Those criteria are:

1.Wealth maximization

A high net worth client whose top priority is to maximize his or her wealth should, logically, make investment decisions that provide for maximum expected return, consistent with taking no more risk than necessary to obtain that maximum expected return. For people who actually have this preference, the logical inference is to be maximally exposed to a highly diversified equity portfolio, such as the S&P 500 or the total world index.

2.Risk Minimization

Risk minimization can make a great deal of sense for a high net worth investor. The simple logic is that if a person or family already has more than they’re likely to ever spend, the risk is all to the downside. Making more money won’t improve their lives materially, but losing money could in theory cause them to reduce their material standard of living.

3.Regret Minimization

We find that among high net worth investors, the real top value is often regret minimization. That is, they don’t want to look back and feel they made the “wrong” decision. And too often, this means they make “no decision” which in fact is often the wrong decision they’re trying to avoid.

Consider the case of the person at the beginning who owns $7 million of Nvidia. She fears that if she sells it, and it doubles, she’ll feel stupid for having sold. Objectively, it is true that no one can know what Nvidia (or any other stock) will do. But because her Nvidia has done so well, she has a “secret” belief that it will continue to do well.

The real question shouldn’t be will Nvidia go up or down. The real question should be:

1. On the one hand, suppose you sell and Nvidia’s value increases by $3.5 million, how much will you regret your decision to sell?
2. And on the other hand, suppose you hold and Nvidia drops in half by $3.5 million, how much will you regret your decision to hold?

This pair of questions encapsulates all the complexity and uncertainty into a single comparison. All the client needs to do to make an actual decision is to anticipate how he or she would feel in either scenario. The client then chooses the decision – hold or sell – in which he or she would feel least bad if the bad outcome occurs.

Most people would find the loss of $3.5 million much more painful than the pleasure they would get from a gain of $3.5 million.[6]

Taxes

When high net worth investors are unable (or unwilling) to “make a decision,” taxes are often a convenient excuse. But excuse is all that taxes are.

For clients facing a large capital gains tax when they sell an asset, there are solutions. Sterling offers free advisor guides for the three largest asset classes that can result in big capital gains taxes. These are real estate, closely held businesses, and large stock holdings. Click here to request the following advisor guides:

• Advisor Guide to Real Estate Shelter Trust
• Advisor Guide to Stock Diversification Trust
• Advisor Guide to Business Owner Trust

We’re here to help

We help advisors grow their businesses and increase AUM. We’ve found that walking clients through decision-making using frameworks like the above can be helpful, as well as empathizing with clients. To talk to us more about decision making, call 703 437 9720 and ask for Connor or Katherine. Or, click here to request a chapter on The Value that Financial Advisors Add from our forthcoming book, “The Investor’s Dilemma Decoded.”

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[1] Arthur Brooks, “The Art of Happiness: Fear of Failure” podcast

[2] https://www.forbes.com/sites/alicegwalton/2016/03/29/uncertainty-about-the-future-is-more-stressful-than-knowing-that-the-future-is-going-to-suck/?sh=66da5220646a

[3] https://finance.yahoo.com/news/nvidia-now-worth-much-whole-010315545.html

[4] The word “heuristic” comes from the Greek word εὑρίσκω, meaning “I find.” This is the same word from which Archimedes’ famous exclamation, “Eureka!” is derived.

[5] https://thedecisionlab.com/thinkers/psychology/gerd-gigerenzer

[6] This phenomenon was described more fully in Daniel Kahneman and Amos Tversky’s 1979 paper “Prospect Theory.”