Financial advisers are smart people, well-versed in the various aspects of financial planning including areas like investing, estate planning, insurance and retirement planning. As such, they can offer clients invaluable advice and strategies designed to help them achieve their financial goals.
One of the most important roles, however, is that of client behavior coach. How well an adviser can do this plays a critical role in determining how successful their clients are in terms of achieving their financial goals.
What is Behavioral Finance?
Behavioral finance looks at how psychological behaviors and biases might influence the behaviors and actions of investors. This segment of financial research looks at how investors actually behave during various market and economic conditions, compared with how financial theories indicate that they should behave. Behavioral finance shows that investors don’t always make rational decisions, and sometimes their emotions come into play.
Behavioral finance can provide insights into what may seem out of character, or seem like irrational behavior by a client on occasion. For example, a client who was never rattled by a sudden drop in the market may suddenly call their adviser and want to sell out of some or all of their holdings. Maybe something has changed in their situation, or perhaps this is pent-up fear speaking.
Adding Value as an Adviser
A study by Vanguard called Advisor’s Alpha attempted to quantify the amount of alpha, or additional value, that working with a financial adviser adds to a client relationship. They came up with an average alpha of about 3%. This goes beyond just increases in returns, it includes the value you can add as your client’s behavioral coach.
A key part of this is balancing the intellectual approach with one that recognizes the client’s emotions as you advise them. Many of your clients may have lived through the market decline that started with the dot-com bubble bursting in 2001, that was exacerbated by the tragedy of 9/11, and the financial crisis of 2008. To many of them, the market declines in the wake of the COVID-19 pandemic might have felt similar.
Your guidance and counsel during times like these is critical to helping them craft a strategy that is consistent with their risk tolerance, while providing opportunities to achieve the potential returns that they need to achieve their financial goals. The key here is not so much your skills in designing the optimal investment strategy for them, it's more along the lines of the hand-holding that may be needed to calm their fears about losing money during periods of steep market declines. This can mean the difference between their investing in a way that fits their situation versus taking too little risk and endangering their ability to achieve their financial goals.
As successful financial advisers know, the most important part of communicating with a client is listening to what they have to say. This means not only listening, but being sure you understand the concerns they may or may not be articulating. You can come up with the “perfect” strategy for a client’s portfolio or their retirement planning. However, if they don’t buy into the strategy emotionally, they may not feel comfortable following your advice.
By listening to and understanding their concerns and what’s important to them, you can marry the best strategies with their concerns and priorities. Sometimes this might entail an adjustment to your recommendations, but even with these adjustments you can still design appropriate strategies for their situation.
From Robert Powell's Retirement Daily on TheStreet, read 10 Odd Social Security Rules and Practices That You Don't Want to Forget.
For example, it might make financial sense for your client to downsize their residence in retirement. If they live in a larger home than they need, they can likely save money on property taxes, upkeep and maintenance, utilities and other costs. But if the client has family in the area and their home is a hub for family activities, they may feel an emotional attachment to the family home and opt to keep it. As long as they can afford it, why not? If cost-cutting is a priority for the client, perhaps there are other areas in which they can cut back.
Advisers who can combine their investment and money management expertise with an understanding of behavioral finance can offer their clients an unbeatable combination of skills to help them achieve their financial goals.