Morningstar Advisor - October/November 2012 - (Page 8)

Behavior Gap Ill Communication By Carl Richards In the financial industry, we’ve gained a reputation for talking in a way that no one outside the industry understands. We’ve developed our own little language—a sort of gibberish. In fact, I would venture that we often don’t fully understand much of what we’re saying. This idea came up in a recent conversation with a nonfinance colleague. She has a Ph.D. from Harvard in computer science, and Fast Company named her one of the most creative people on the planet. Translation: She’s really smart. I was showing her the S&P Persistence Scorecard, and we came across this phrase: “Random expectations would expect a rate of 6.25%.” She asked me to explain. I responded, “Of course, I know what it means. I just have no idea how to explain it.” She asked another colleague, a statistics guy. He managed to explain what it meant, but then pointed out that in the real world the notion of “random expectations” doesn’t really make much sense. Now, please don’t get caught up in this one example. You may know exactly how to explain the idea of random expectations of 6.25%. However, this experience got me thinking of all the other words and phrases we use, such as “risk management,” “standard deviation,” and even “volatility.” Would you like to be talked to like that? It’s no wonder that our clients look slightly dazed when they leave a meeting with us. Here are the problems: First, if we really don’t understand the terms, our explanations to clients may be less than accurate and lead to some serious problems. Second, even if we do understand them, other people’s understanding of those words may not line up with what they really mean. When we say “risk,” we’re probably referring to randomness within a set of defined boundaries. When my mom thinks of risk, she’s just as likely to equate it to what we might call “uncertainty.” To solve both these problems, we need to start by making sure we know what we’re talking about before discussing it with a client. Then, we need to make sure that the client thinks the same thing. I heard a story that illustrates this perfectly. Two moms were outside chatting while their kids played in the yard. One mom looked up and noticed her 3-year-old getting close to the corner of the street. She yelled at him to get back from the corner, but when she looked back a second later, he was almost in the street. After racing to grab him back to safety, the mom asked, “Why didn’t you do what I asked and stay away from the corner?” His response: “Mommy, what’s a corner?” Take the time to explain the financial version of corners to your clients. You won’t regret it, and your clients just might believe you when you say you know what you’re talking about. K Carl Richards, CFP, is author of The Behavior Gap: Simple Ways to Stop Doing Dumb Things With Money. 8 Morningstar Advisor October/November 2012

Table of Contents for the Digital Edition of Morningstar Advisor - October/November 2012

Morningstar Advisor - October/November 2012
Contents
Contributors
Letter From the Editor
Ill Communication
Do You Use Factor-Investing Strategies?
Practicing What She Preaches
How to Determine the True Price of ETFs
The Quant Factor
Managers Dispute the Death of Equities
Investments á la Carte
Investment Briefs
Five Inconvenient Truths of Manager Research
Health Care’s Outlook Clarifies
Exploring the World of Factors
Uncloaking the Alpha Machine
Factor Strategies Gain Footholds in Practices
Big Mo
Fitting Factors Into the Formula
Clients Have a Friend in Luther King
Less-Liquid Holdings Mean More-Solid Results
Retirement-Withdrawal Strategies Quantified
Amid Turmoil, Don’t Discount Foreign Equities
Our Favorite Mutual Funds
50 Most-Popular Equity ETFs
Undervalued Stocks With Wide Moats
Should I Stay or Should I Go?

Morningstar Advisor - October/November 2012