In his book, Nudge, expert on behavioral economics, Richard Thaler, wrote, “Loss aversion helps produce inertia, meaning a strong desire to stick with your current holdings.” Having experienced this “inertia” first hand, I couldn’t agree more.
As a transplant to New England from Texas, I’ve had to make a few adjustments. The people talk faster, the weather is colder and the closets are… smaller. When planning my cross-country move, I decided to get rid of most of my non-essential clothing and sign-up for a closet sharing subscription, Le Tote. Founded in 2012, Le Tote charges a small subscription fee to rent out three articles of clothing and two accessories you choose, per tote. You wear them as much as you’d like and ship them back when you’re done. They handle the laundry and the storage, making my new, small closet a non-issue. Love something you’ve borrowed? Simply keep it when you return the rest of your tote and they automatically bill you for it. Here’s the catch: You almost always want to keep the things you pick. The “borrowed” clothes begin to feel a little less borrowed and a little more yours and before you know it, you can’t bring yourself to part with them. The result? A trip to Ikea for some closet storage solutions.
In less than four years, the San-Fran based start-up has grown almost 500% year over year and has raised over $27.5 million to continue expanding and recently launched their maternity division (why buy maternity clothes?). By the end of this year, they will have shipped $100 million worth of clothes and will have maintained a 94% customer retention rate. Why is this business model so successful? Simple: Loss Aversion.
I first learned about loss aversion when reading Dan Ariely’s book, Predictably Irrational. In it, Ariely shares an experiment he conducted at Duke University, where basketball tickets have to be won, not purchased. Students camp out for days and take part in several odd rituals in hopes of becoming recipients of these valuable tickets. After the tickets were awarded, Ariely wanted to know: “would the students who had won tickets—who had ownership of the tickets—value those tickets more than the students who had not won them, even though they had all ‘worked’ equally hard to obtain them?” Here’s what he found: Students who hadn’t won tickets were willing to pay a maximum of $175 for a ticket. Students who won tickets however, wouldn’t sell them for less than $2,400. Surprised? Don’t be. We ascribe more value to the things we own simply because we own them. That’s the endowment effect.
In his article, Behavioral Finance 101: Loss Aversion and Endowment, Gerald Townsend says, “Modern economic and investment theory rests on a foundation that assumes people are rational and markets are efficient, but people often think and act irrationally, and real financial markets rarely resemble textbook models of efficiency.” He adds that “The pain of losing $1 is greater than the pleasure of gaining $1.” The odds that a mutual fund will do well during the good times and the bad are low, so what’s the best way to retain investors if they begin to lose money?
As a third-party marketing firm, capital raising and asset retention for our clients during the good times and the bad is our mission. Our efforts need to be effective for a strategy when it is performing well and effective for a strategy when it is lagging. For all of our clients, we try to stay ahead of the game when it comes to investors facing potential losses. How do we make that happen?
- Quarterly Conference Calls: Hosting quarterly conference calls allows investors and prospects to hear about the mutual fund’s performance from the previous quarter, first hand, from the portfolio managers themselves. RIAs can ask direct questions and get a better understanding of how the mutual fund is positioned and why.
- Staying in Contact: At Havener, we make it a point to develop close, personal relationships with our investors and prospects. From the thought that goes into the voicemails we leave to the emails we write, we always strive to put ourselves in the shoes of the other person. If you’re an RIA, explaining less than ideal performance for a fund in your line-up can be difficult. We strive to arm advisors with useful information to support their on-going due diligence process and assist them in conversations with their clients.
- Investor Letters: We know that RIAs know when performance begins to waver. We know that the end investor knows it as well. Instead of waiting for the panicked calls and emails to roll in, together with our portfolio managers, we send out investor letters to let each RIA know that our mutual fund clients are on top of it, share what portfolio managers are thinking and how they are responding.
- Blogs & Market Insights: With weekly writings, portfolio managers share their views and market insights. RIAs don’t have to sit tight until an asset manager’s commentary is released or wait to tune-in to their quarterly conference calls to know what’s on the minds of our mutual fund clients. Hearing the portfolio manager’s voice through writing helps investors stay connected and dig deeper into current positioning and outlook.
If you are a mutual fund wholesaler and the unpredictability in the markets is triggering your investors’ loss aversion bias, consider implementing some tactics to help your investors sleep easier in the face of volatility and unsteady performance.
How do you keep your investors and prospects calm in times of potential losses? Share your ideas with us below in our comment section!
About the Author
Laura Lewis is the Operations Manager at Havener Capital Partners. She is responsible for translating data and statistics to actionable improvements in sales and marketing processes. Analyzing structured and unstructured data sourced from both external and internal sources including sales opportunities, marketing campaigns and market research, Laura helps the firm increase efficiencies on behalf of our clients.