In spite of good intentions, people keep smoking even when they know it is bad for them and they say they want to quit. In the same way, many people continue to use UV tanning beds, even when there is compelling evidence that UV exposure significantly increases the likelihood of skin cancer. In each case, a rational person decides to do something that is clearly bad for him and that he knows, rationally, he should avoid. Why?
The answer is more than that it is “just human nature.” It has to do with the sequencing of pleasure and pain. Many (if not most) human beings struggle with doing the right thing even when they know what the right thing is.
Managing behavior has to do with how vividly and realistically a person projects the mental images of future negative outcomes. Without such vivid mental images, most of us will wait until there is a compelling reason to act before doing so. Remember when you were in school and got an assignment to write a long paper; when did you start? Why are there long lines at the post office at 11 p.m. on April 15?
There is a parallel in the financial-services world. As a practice management strategist who works with advisors every day, I help advisors understand why investors aren’t repositioning themselves for a rising interest-rate environment. Unfortunately, the advisors who are actively grappling with the importance of this issue seem to be in the minority, at least among the people I’m talking to. Here at AllianceBernstein, we are very concerned that many advisors aren’t dealing with the negative outcomes that are possible in the near future. Few advisors are encouraging their clients to take action now and prepare for the challenges their investments will face in a rising interest-rate environment.
Of course, I’m not “calling the market” when I suggest that rates will be rising. Investors know that interest rates are at or near historic lows. Rationally we know that, eventually, rates are going to rise. After 30 years of falling interest rates, it isn’t surprising that we are avoiding the negative thoughts about tomorrow.
It’s comforting to hope that things will stay as they are. Unfortunately, comfort is not a strategy. As advisors we know that when rates rise, taxable and tax-free bond portfolios are going to be deeply affected. We can even shock-test portfolios and determine how much they will be affected at varying interest rates. But this kind of rational thinking doesn’t motivate most people. As understood and predictable as these future negative outcomes are, they haven’t happened yet. They are still safely “out there” in the future. We are still enjoying the benefits of the low interest rates and high premiums in our bond portfolios.
The most common response I hear from advisors when I raise a concern about preparing for the inevitable is, “When you think the Fed is about to raise rates, give me a call and we’ll talk about our options.” They seem to be waiting for a bell to ring before rates shift so that they can make an orderly adjustment to meaningful investment alternatives.
Mental Exercise for Advisors
Just like smokers and dieters and owners of beachfront real estate, these advisors are waiting for some compelling signal to tell them it is time to take action. They look to financial analysts, media experts and industry spokespeople to fire the starting pistol. This is just like waiting for April 14 to arrive before starting tax preparation. Unfortunately, in this case there isn’t a calendar to warn us that the deadline is approaching. When it comes to rates, once they start going up, it’s a bit late to “prepare.”
Consider this mental image: many people are trying to buy generators and the clerk suddenly shouts, “We only have two generators left; first come, first served!” Or imagine being in line at the post office on April 15 and the postmaster says, “We’re closing in five minutes.” Or even worse, imagine a doctor saying, “Your weight problem has caused Type II diabetes.”