Foundation — Emotions in goal setting, and the first four client behaviours

A mother who wants her son to eat fewer sweets has two choices. She can stand beside him at every meal and say no — which works while she is standing there and fails the moment she leaves. Or she can buy a smaller packet once a week and put nothing else in the house.

The second approach is what the workbook means by making behaviours SELF-LIMITING, and it is the design principle behind everything in this chapter: an adviser's role lies in understanding these impulses and PROVIDING WAYS TO MAKE SURE THAT SUCH BEHAVIOURS ARE SELF-LIMITING.

For retail therapy the device is a separate account where the budgeted amount is kept, spent only through a debit card or by withdrawing cash. The workbook states the principle exactly: the important thing is to have a SELF-IMPOSED BRAKE on the behaviour which comes from an IN-BUILT EXPENSE LIMIT.

Why this works and lectures do not: willpower is weakest at the exact moment it is needed. A person under stress at 11 p.m. on a shopping app is not going to recall a conversation about budgeting. But if the account has Rs 400 left in it, the transaction simply fails — and no willpower was required at all.

The same logic explains the workbook's hostility to credit cards: credit cards INDUCE IMPULSIVE SPENDING precisely because they are the opposite of an in-built limit. They remove the brake and post the bill to a future self who is not in the room.

Watch anyone waiting for a lift. Within twenty seconds someone will press the already-lit button again. It changes nothing. The lift is coming at its own speed. But pressing it feels better than standing still.

That is ACTION BIAS — the NEED TO DO SOMETHING — and the workbook sets it directly against what investing actually requires: LONG TERM CONSISTENCY AND LONG YEARS OF PATIENCE.

In a portfolio the lift button is the trading screen. A client watching a falling market feels an almost physical need to do something, and the only somethings available are buying and selling. So they buy and sell. The workbook names the result exactly: too frequent and too many transactions, WHICH HAS THE IMPACT OF TURNING AN INVESTMENT ACTIVITY INTO A TRADING ACTIVITY.

Paul Samuelson, the Economics Nobel laureate, put the cure in a sentence worth memorising: "INVESTING SHOULD BE DULL. IT SHOULDN'T BE EXCITING. INVESTING SHOULD BE MORE LIKE WATCHING PAINT DRY OR GRASS GROW. IF YOU WANT EXCITEMENT, TAKE USD 800 AND GO TO LAS VEGAS."

And note how the workbook says the cure must be applied: the ONLY way to induce the client to curb such a tendency is to PRIME THEM IN ADVANCE with the benefits of patience and long term investing. In advance — because a client in the middle of a 15 per cent fall cannot be taught patience; they can only be reminded of it.

The workbook supplies its own image and it cannot be improved on: INVESTING BASED ON PAST PERFORMANCE IS LIKE DRIVING A CAR BY LOOKING IN THE REAR VIEW MIRROR. IT IS BOUND TO CRASH AT SOME POINT OR THE OTHER.

Think about what the mirror actually shows. It is perfectly accurate — that is the trap. Every twist of the road you have already travelled is displayed in sharp detail. The information is real, it is verifiable, and it is completely useless for the corner ahead.

So it is with a one-year return table. The numbers are audited and correct. Gold was up 30 per cent last year. That is a fact. And it tells you almost nothing about gold this year, because most asset classes have a CYCLE OF GROWTH AND DECLINE and there is an INEVITABLE REVERSAL TO THE MEAN.

The workbook's example is the client who invests in Gold when Gold goes up and shifts to Equities when equity markets rise — always arriving after the move, always leaving before the recovery.

The remedy is structural, not persuasive: a pre-decided asset allocation policy that has UPPER LIMITS FOR EACH ASSET CLASS, plus a MAXIMUM EXPOSURE LIMIT WITHIN a given asset class for a specific security. The limit argues with the client so the adviser does not have to — and, better still, the limit was agreed by the client when they were calm.

A family in Pune eats out twice a week and has done so for fifteen years, always within four streets of home. They know the owners, they know the kitchens, they know which place is clean. They are not being foolish — familiarity really does reduce a certain kind of risk.

But if a water shortage closes every kitchen on those four streets on the same evening, they have nowhere to go. Their comfort and their exposure came from the same source.

That is HOME COUNTRY BIAS: investors prefer home securities due to FAMILIARITY with the markets, the companies involved as well as the REGULATORY ENVIRONMENT, and thereby lose the benefits of diversification which come from investing into asset classes WHICH DO NOT MOVE IN TANDEM with the local securities.

Read that last phrase carefully, because it is the whole justification. The point of global investing is not that foreign markets return more. It is that they do not move in tandem — so when the local market has a bad year, the portfolio is not entirely at its mercy.

The workbook lists five further reasons beyond comfort: lack of knowledge; home country laws; lack of access and high cost; compliance with foreign tax and other laws that may conflict with local laws; and lack of expert advice because THE ADVISERS THEMSELVES ARE NOT WELL VERSED.

And in India two doors have opened: the Liberalised Remittance Scheme, under which a resident may remit up to USD 250 thousand, and Indian mutual fund schemes that invest overseas — including S&P 500 and Nasdaq 100 funds available in rupees, which need no remittance at all.

A man goes to buy an umbrella in May. The shopkeeper shows him two. One is large, plain and strong. The other is small, pretty and matches his bag. He buys the pretty one because it matches.

In June it rains, and he gets wet.

He did not buy a bad umbrella by accident. He bought it on the wrong criterion — and the criterion he used had nothing to do with rain.

The workbook is blunt about the Indian version: AT LEAST 3 GENERATIONS OF INDIANS HAVE GROWN UP ON A DIET OF BUYING INSURANCE FOR TAX SAVING ALONE. AS A RESULT, THEY END UP BUYING THE WRONG KIND OF INSURANCE AND/OR COMPLETELY INADEQUATE INSURANCE.

Both failures, and they are different. Wrong kind — an endowment policy where term cover was needed. Inadequate — a Rs 5 lakh sum assured protecting a family that needs Rs 1 crore. A person choosing by Section 80C limit will stop at Rs 1,50,000 of premium, because that is where the tax benefit stops. The family's actual need does not stop there.

The workbook restores the correct order: appropriate and adequate insurance is the FIRST STEP of any good financial plan. TAX SAVING THROUGH THE INSURANCE PREMIUM JUST REDUCES THE COST of a good insurance plan.

And it states the comparison plainly: the ultimate return from investing the same sum of money into buying a TERM POLICY PLUS INVESTING IN PUBLIC PROVIDENT FUND will INVARIABLY BEAT the ultimate return from buying an ENDOWMENT life insurance product for the same amount of investment.

A man worried about a limited diet orders four thalis from four different restaurants. He now has four plates of dal, rice, two vegetables and roti. He has four times the quantity and exactly the same variety.

The workbook describes the portfolio version exactly: if the investor buys 2 LARGE CAP FUNDS, 4 MID-CAP FUNDS AND 6 SMALL CAP FUNDS for diversifying his risk, HE CAN ACHIEVE SIMILAR DIVERSIFICATION BY SIMPLY BUYING A TOP 500 SHARES INDEX FUND.

Twelve funds. Hundreds of underlying stocks, mostly the same stocks. Twelve sets of statements, twelve sets of capital gains computations at redemption, twelve decisions at every review — and the diversification of one index fund.

The principle is stated in one line: DIVERSIFICATION DOES NOT COME FROM BUYING MANY SECURITIES. It comes from owning things that behave differently. Buying more of the same thing under twelve different names is duplication wearing the costume of diversification.

The workbook is careful to name the opposite error in the same breath: conversely, some investors will have their ENTIRE INVESTMENT PORTFOLIO IN A COUPLE OF SPECIFIC SECURITIES OR INVESTMENT WITHOUT ADEQUATE DIVERSIFICATION across asset classes or within an asset class.

So the adviser is not pushing in one direction. The task is to find THE GOLDEN MEAN for an appropriately diversified investment portfolio, BASED ON THE CLIENTS' RISK PROFILE, AVAILABLE RESOURCES AND TIME FRAME FOR GOALS — three inputs, and the right number of holdings falls out of them rather than being a target in itself.

The workbook offers a test anyone can run. Survey the employees in a workplace and ask which percentile of relative performance they place themselves in.

MOST EMPLOYEES WILL PUT THEMSELVES ANYWHERE AROUND 60-75 PERCENTILE, WITH A RARE INDIVIDUAL CLAIMING TO BE BELOW THE 50 PERCENTILE.

Now count. By definition, exactly half of any group is below the fiftieth percentile. If almost nobody places themselves there, the answers cannot all be true. The workbook says so in a phrase worth remembering: THE AGGREGATE OF THESE EMPLOYEE PERCEPTIONS IS AN ARITHMETICAL IMPOSSIBILITY. THUS, THE TRUTH IS INDIVIDUALS CONSIDER THEMSELVES AS BETTER THAN THEY REALLY ARE.

This is a beautiful piece of reasoning because it proves the bias without examining a single individual. No one employee can be shown to be wrong. The distribution can.

In investing it appears as attributing skill to bets that have come off. The workbook's example: the client made a small bet on an individual stock that became a 5X in 3 months. THIS MAY ONLY PARTLY BE DUE TO SKILL AND MOSTLY BE LUCK. IN ANY CASE, EVEN IF IT IS SKILL, IT IS DOUBTFUL IF IT IS CONSISTENTLY REPEATABLE.

Note the two-stage argument — it is more careful than a simple accusation of luck. Stage one: it was probably luck. Stage two: even if it was skill, can it be repeated? A client can dispute stage one forever. Stage two is much harder to answer, and it is the question that actually matters for the next investment.

The danger that follows is concrete: the client may be tempted to OVER-INVEST in an asset class or security and MODIFY THE EXISTING ASSET ALLOCATION. And the workbook gives the adviser their finest sentence: in times like these, THE INVESTMENT ADVISER'S INFLUENCE CAN STAND BETWEEN THE CLIENT AND HER BIG MISTAKE.

A widow with a daughter in class twelve has Rs 42 lakh. Her daughter's engineering degree abroad will cost roughly Rs 40 lakh. Her own retirement is nineteen years away.

Ask her and there is no contest. "My daughter's education first. My retirement can wait." She is not being irrational — she is being a mother.

The workbook describes this exact situation: the client is emotional about making sure her daughter gets the best possible education EVEN IF IT MEANS COMPROMISING WITH HER RETIREMENT, which may be some distance away, and hence is not that important for her immediately.

Notice the two things making retirement lose: it is distant, and it is therefore felt as not important. Neither is a statement about how much money she will need at 62.

The adviser's job here is not to argue that education matters less. It is to do two things the workbook names: point out THE EXTENT OF THE COMPROMISE that is being done for a vital goal like retirement, and point out ALTERNATIVES LIKE PARTIAL EDUCATION LOAN for the higher education WHICH CAN THEN BE PAID BY THE DAUGHTER FROM HER EARNINGS after completion of the education course.

The second point is the one that dissolves the conflict. The mother framed it as a choice between her daughter and herself. It was never that choice. A partial loan, serviced later by a working engineer earning well, funds the degree without emptying the retirement corpus — and spares the daughter a future in which she must support a mother who has no pension.

The workbook's summary is the professional standard: this kind of OBJECTIVE ROLE played by the Investment Adviser is crucial in assisting the clients to TAKE THE RIGHT DECISIONS EVEN AS THEY ARE HIGHLY EMOTIONAL.