Playing on emotional responses

Wealth Management and emotional vs rational decision-making

Many investors make wealth management decisions based on emotion; usually either greed – they want very high returns – or fear – they are afraid of losses.

But making investment decisions will be more successful if it is a rational process, where your adviser determines not only the most-likely return, but also estimates the downside and upside returns. Financial advisors should assign probabilities to each case and thereby calculate the investment Expected Monetary Value (EMV).

Using EMV as a yardstick will give you a rational comparison of alternative strategies, as opposed to a decision based on emotion  - fear or greed - which is unlikely to be successful. However a number of products are prescribed and sold by financial advisors and promoters that appeal to people’s emotions and ignore EMV and opportunity cost.

Capital Guaranteed Investments – an emotion-based product

One example of wealth management products that appeal to emotions are capital guaranteed investments. These products suit people whose main focus is avoiding losses (working from fear).

However, a rational analysis may show capital guaranteed products have lower most-likely and upside case returns than equivalent products, invested in the same sectors, without a capital guarantee. The capital guaranteed product may forgo some returns by capping the upside and paying higher interest rates. Capital guaranteed products may have a lower EMV than equivalent non-protected products. We note there are situations where capital guaranteed products have a legitimate use where the focus is not on getting a good return but solely on avoiding a bad return.

Ask your financial adviser to quantify the EMV difference between a capital guaranteed product and an equivalent non-guaranteed product, and think twice if they can’t do this.  This EMV difference is the price you pay for security in protecting against the downside result. It may be a higher price than many realise! (There are no free lunches in the investment world…)