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By David GordonDirector, Eaton Vance Advisor Institute

Chances are you have family and friends who consider themselves good drivers when in actuality they are not. In fact, according to a 2018 AAA survey, nearly three-quarters (73%) of U.S. drivers believe they too are better-than-average drivers.1 This is an excellent illustration of the behavioral bias known as overconfidence — people tending to overestimate their own skills and abilities.

Overconfidence also colors investor behavior. Investments and Wealth Institute, in its report "2021: Investor Behavior in a Market Crisis," notes two important observations for advisors:

  • "Clients may not make the best decisions if they are not fully informed. The data shows that investor knowledge is both imperfect and, at times, overstated."2 
  • "Advisors may not provide the support clients need if they do not understand client perceptions. The data shows a disconnect between advisor and client perceptions."2 

We caution advisors against applying broad-brush solutions. However, advisors may well seek help to bridge a knowledge gap and reduce client overconfidence. Our suggested approach employs the 3 Dynamics of Chasing Positivity®:

  1. Communicate empathically. Start by asking them, 'How's your driving?" as an amusing way to point out that overconfidence affects many areas of our daily lives, including investing. You can foster openness by offering that you too, are prone to overconfidence in some areas of life.
  2. Collaborate consciously. Offer to set up a rules-based investment policy to help reduce the impact of emotion. You could include counter-emotional triggers, such as using market declines as buying opportunities, or institute a policy of quickly reinvesting the proceeds of a loss sale. This makes you and your client allies in combating overconfidence, without pointing fingers at anyone.
  3. Inspire action. Be more proactive, not less, during market crises. Call your clients and ask thoughtful questions to ensure the policies you put in place are still appropriate. Even if your rules-based plan calls for doing nothing, agreeing on this with the client makes it a conscious choice rather than an absence of action.

Bottom line: How you communicate before and during market crises can lead to better investor decision-making and improved confidence.