Premise

A popular notion floating around the financial planning industry is that individuals don't think rationally when it comes to investing. Investing is a largely emotional process, we're told, and the client is essentially helpless at the helm. This is why a financial adviser is necessary.

The adviser helps the client by taking over control of the investment portfolio, making suggestions on what constitutes a good investment, and then continues to follow up with the client every year to make sure the client stays "on track." Because client emotions can cause the client to make poor decisions, the best option is to hand over major investment decisions to the financial adviser.

Reality

Many individuals do get very emotional when investing their savings. They want to make money-fast. They want to trade actively for that quick "win" in the market. But, they also don't want to lose money. When they lose money, they want to sell to avoid suffering any further losses. Sometimes, they just want someone else to do it all for them. But the solution isn't to hand over trading authority to an adviser.

The solution is to realize and recognize one's emotional state and that it does not represent a fact of reality that one should act on as though it's an irreducible primary. When a client loses 10 percent of their savings, they might want to sell off an investment position. When they lose 40 percent, that feeling can be overwhelming to the point of an anxiety attack. This is especially true with older folks who are nearing retirement. I once met with a would-be client who became so angry and upset talking about his former adviser and all of the money he lost that he literally could not speak and his wife had to do all of the talking for him.

An adviser with discretionary trading authority or even an adviser who must sign the sell order for a client can step in to calm the client in situations where the client feels overwhelmed by the decisions he must make. In this way, the client still yields authority to the adviser, but the adviser is able to help the client keep their money invested or make what appears to be rational decisions for the client.

Is the adviser helping the client to think more rationally? No. You see, the next time the client has a panic attack over a market correction, he'll be on the phone with his adviser once more. The reality is that clients need more education about investments and financial markets. They need to understand how investments work so that they can side-step ignorance and invest in what they know.

When this happens, panic attacks over losing money can and often will subside. It's not surprising if you think about it. When is the last time you were overly worried about something you knew how to do well? Intelligent investors do occasionally lose money, but they don't lose their minds.

In other words, clients don't need authoritarian advice. They need objective guidance.

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