Advisors have to learn some tricks to manage their clients’ return-eroding tendencies
In the investment industry, know-your-client has become standard among all firms. But while advisors in general are very familiar with determining risk profiles, they might be underestimating the value of managing risky behaviours.
A recent report from Russell Investments has found that advisors who work to temper behavioural foibles, apply a disciplined portfolio-management strategy, and deem asset allocation as part of a comprehensive financial plan can raise client returns by up to 4% per year, according to Financial Advisor IQ.
The study examined investment-flow data from 1987 up to 2016, comparing returns achieved to a buy-and-hold strategy using a total-stock-market benchmark. The analysis revealed a profile of behavioural costs, where investors tended to get out of their equity positions at the wrong time.
“The biggest threat to a strategic investment plan is likely to be less about a portfolio's potential long-term gains and more about someone’s emotional responses to short-term market fluctuations,” said Brad Jung, a managing director in US private-client services with Russell Investments and author of the report.
Jung asserted that advisors can greatly increase their client’s returns by keeping abreast of the latest in behavioural-management research and continually sharpening their coaching skills. By his estimation, just eliminating “poor” investment behaviour can improve long-term returns by around 2%. Annual results can be increased by another 0.75% by incorporating coaching strategies into a “holistic” financial-planning approach.
Advisors should know how to deftly steer conversations toward uncovering people’s emotional biases, said Jonathan Blau, CEO of Fusion Family Wealth in New York. “You can’t just come out and tell people that what they’re thinking about doing is crazy; you’ve got to work to get them to understand how their behaviour is counterproductive,” he told the publication.
One example, which is commonly discussed in academic circles, is the tendency for investors to feel pain from financial losses more acutely than pleasure from investment gains. Blau has found that new clients who’ve recently suffered portfolio losses tend to resist his initial recommendations. “If you try to force their hands too quickly, they’ll really drag their feet about doing anything,” he said.
According to Michael Liersch, who is in charge of behavioural finance and goals-based consulting at Merrill Lynch, advisors should resist the temptation to reform clients based on their “negative” biases. Instead, he suggested helping them focus on goals with deliberate and descriptive questions, such as, “What’s your intent for using your money?” and “How much capacity do you have to take a certain amount of risk?”
Not everyone is a fan, however. To Daniel Solin, an independent financial consultant based in Florida, behavioural coaching isn’t “complicated” or special enough to get the attention it’s receiving. “A lot of behavioural specialists are overstating the need for behavioural coaching,” he told the publication. “Advisors should be preparing clients not to panic at the first sign of market risk as a regular part of their responsibilities. This just isn’t rocket science.”
But while he dismisses the idea that behavioural coaching adds 2% or more to client returns as “ridiculous,” he still acknowledges that clients need guidance. “There still is real value in advisors focusing on education as a normal part of the onboarding process with new clients,” he said.
For more of Wealth Professional's latest industry news, click here.
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Are most risk-tolerance questionnaires actually useless?
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A recent report from Russell Investments has found that advisors who work to temper behavioural foibles, apply a disciplined portfolio-management strategy, and deem asset allocation as part of a comprehensive financial plan can raise client returns by up to 4% per year, according to Financial Advisor IQ.
The study examined investment-flow data from 1987 up to 2016, comparing returns achieved to a buy-and-hold strategy using a total-stock-market benchmark. The analysis revealed a profile of behavioural costs, where investors tended to get out of their equity positions at the wrong time.
“The biggest threat to a strategic investment plan is likely to be less about a portfolio's potential long-term gains and more about someone’s emotional responses to short-term market fluctuations,” said Brad Jung, a managing director in US private-client services with Russell Investments and author of the report.
Jung asserted that advisors can greatly increase their client’s returns by keeping abreast of the latest in behavioural-management research and continually sharpening their coaching skills. By his estimation, just eliminating “poor” investment behaviour can improve long-term returns by around 2%. Annual results can be increased by another 0.75% by incorporating coaching strategies into a “holistic” financial-planning approach.
Advisors should know how to deftly steer conversations toward uncovering people’s emotional biases, said Jonathan Blau, CEO of Fusion Family Wealth in New York. “You can’t just come out and tell people that what they’re thinking about doing is crazy; you’ve got to work to get them to understand how their behaviour is counterproductive,” he told the publication.
One example, which is commonly discussed in academic circles, is the tendency for investors to feel pain from financial losses more acutely than pleasure from investment gains. Blau has found that new clients who’ve recently suffered portfolio losses tend to resist his initial recommendations. “If you try to force their hands too quickly, they’ll really drag their feet about doing anything,” he said.
According to Michael Liersch, who is in charge of behavioural finance and goals-based consulting at Merrill Lynch, advisors should resist the temptation to reform clients based on their “negative” biases. Instead, he suggested helping them focus on goals with deliberate and descriptive questions, such as, “What’s your intent for using your money?” and “How much capacity do you have to take a certain amount of risk?”
Not everyone is a fan, however. To Daniel Solin, an independent financial consultant based in Florida, behavioural coaching isn’t “complicated” or special enough to get the attention it’s receiving. “A lot of behavioural specialists are overstating the need for behavioural coaching,” he told the publication. “Advisors should be preparing clients not to panic at the first sign of market risk as a regular part of their responsibilities. This just isn’t rocket science.”
But while he dismisses the idea that behavioural coaching adds 2% or more to client returns as “ridiculous,” he still acknowledges that clients need guidance. “There still is real value in advisors focusing on education as a normal part of the onboarding process with new clients,” he said.
For more of Wealth Professional's latest industry news, click here.
Related stories:
Are most risk-tolerance questionnaires actually useless?
The lifelong habits your retired clients need to kick
