Coach’s Corner

Often, deeply held biases inhibit rational decision-making and lead to an unwillingness to diversify. Understanding common biases you may encounter and asking the right questions can help you move the concentration conversation toward diversification.

Overconfidence

Overconfidence is our irrational tendency to overestimate the probability of positive personal events and underestimate the likelihood of negative events. We tend to be overconfident about our own success and see bad fortune as reserved for others. This bias is particularly common with senior corporate executives who feel their contributions to the company will ensure its lasting success.

Listen for: Overwhelming certainty in the future without sufficient grounding in the data.

Ask: "Suppose for a minute that things don't go as you imagine. How might a different outcome impact your decision?"

Sentimental Attachment

Founders and early-stage employees can be understandably reluctant to diversify away from a position in which they invested much of their personal time and energy. Sentimental attachment can also be an issue with inherited or gifted shares, particularly when the company in question played an important role in the family's wealth creation.

Listen for: Narratives involving "feeling words" and accounts of personal benefit resulting from holding the stock. "I can't imagine selling after all my hard work."

Ask: "This stock clearly means a lot to you. Can you tell me more?"

Perceived Familial Pressure

Investors who have a concentrated position in a stock recommended or gifted by a family member may be placing undue pressure on themselves to hold onto it, no matter how out of favor it may be in the current financial climate.

Listen for: References to advice from family members long ago.

Ask: "How do you think your family member would advise you if they were here?"

Status Quo Bias

Psychologists have found that investors have a pronounced status quo bias. That is, they feel more regret if they took action and get a negative result than if they'd done nothing and gotten a similar outcome. The current state of affairs tends to be the frame to which other decisions are compared. Put simply, the status quo is familiar and, therefore, comforting. This bias is particularly common among investors that have amassed a concentration through organic growth.

Listen for: Indications that significant thought hasn't recently been given to the holding or signs of complacency.

Ask: "Can you share your thought process for holding on to this position?"

Loss Aversion

Investors are loss-averse and dislike losing money twice as much as they like gaining it. Clients with loss-aversion may be slow to sell a stock that has fallen from its previous high with the intention of holding until it bounces back to its high, even if they are in the black overall on the investment.

Listen for: Statements relating to returns to a prior valuation such as "I bought it at $50 so once it bounces back above that, I'll happily get rid of it."

Ask: "If the position continues to decrease in value, what, if any, adjustments would you consider to your portfolio?"

When it comes to diversifying a concentrated position, you don't need to be all right or all wrong. Clients who are reluctant to sell an entire position may be willing to consider starting small and moving away from the concentration over time.

Bottom line: Ask clients open-ended questions that will help you understand the underlying biases at the heart of their concentrated positions and move the diversification conversation forward.