The ClientWise Blog

Alan Greenspan Missed the Last Bubble, Will Your Clients Miss the Next One?

Posted by Chris Holman on Apr 14, 2010, 11:35:00 AM


Last month, in an apparent attempt to burnish a bruised reputation, Alan Greenspan presented a 66-page kinda-sorta apology to the Brookings Institution entitled, "The Crisis."

Although not a full-on mea culpa, Greenspan acknowledges that the Central Bank failed to grasp the magnitude of the housing bubble. Surprisingly, he continues to maintain, on the macro level, little could have been done to prevent this global breakdown.

The operative question for all financial advisors is...can we do better?

In an excellent recent article in Horsesmouth, "How to Ride Out the Next Market Bubble" (subscription required), author Steve Utkus argues that financial advisors can prepare themselves and their clients to "counteract the human tendencies that go into making a bubble and get into a position to ride out the next inevitable collapse as comfortably as possible." [Steve Utkus is the director for Vanguard's Center for Retirement Research.]

In this insightful piece, Utkus goes on to explain the four common "bubble biases" and the innate tendencies that contribute to investors' bubble behavior:

  1. Representative Bias is the tendency of investors to add an overlay of emotion to the interpretation of statistical information...and overweight events that have happened more recently.
  2. Investor Overconfidence and Aversion to Losses are the flip sides of the same coin. The former is the predilection to overestimate one's own investment acumen. The latter is to extrapolate that, when markets are declining, that everything could go to ZERO.
  3. Group Polarization is the idea that people take more risks in a group than when standing alone, i.e. the herd mentality.
  4. Past is Prologue is the recognition that the social and group aspects of risk, as well as wild, over-excessive views of the future (both positive and negative) are nothing new. "There is nothing new except what has been forgotten"...Marie Antoinette

Deferring to the viewpoint of Mr. Greenspan, bubbles may be inevitable. How we respond to them...isn't.

For financial advisors, the following coaching questions seem opportune: How did you and your clients respond to the last bubble? What did you learn? How are you and your clients positioned to handle the next bubble? Rather than wait for the next upheaval to materialize, start asking your clients, and prospective clients these questions now..."I'm curious, how is your portfolio positioned for the next bubble?" or "Have you analyzed your investment portfolio for the four 'bubble biases' that investors are susceptible to?"

Do you think this might lead to some interesting discussions?

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Topics: Investing