Applying Behavioral Finance Practices Leads to More Clientele

Posted by Communications Staff on Oct 9, 2020 9:45:00 AM

“The most important quality for an investor is temperament, not intellect.”

-Warren Buffett


Warren Buffett, the billionaire octogenarian investor, once said “The most important quality for an investor is temperament, not intellect.” While I would not argue with Warren Buffet, I would add a caveat, that even more important than temperament, is an understanding of the impact behavioral biases can have on an investor.

The BeFi Barometer 2020 findings, recently released by the Investments & Wealth Institute and in collaboration with Charles Schwab Investment Management, Inc. and Cerulli Associates, explores the implications of behavioral bias and the impact they can have on both clients and advisors alike.

Behavioral finance, the study of the intersection of human behavior and economics, has been an important topic as of late. As advisors face an onslaught of client inquiries and questions as the world faces a time of great uncertainty and market volatility, they need to be aware of how their biases can impact their clients and their success. The BeFi Barometer 2020 findings explore the biases of both clients and advisors, and how advisors can use behavioral techniques to better serve their clients.

Here were some key findings. . .

The 2020 report found that more advisors are using BeFi techniques than in 2019.

More advisors are recognizing the value of behavioral finance and implementing these techniques in their practices, however, the study also found that the primary reasons advisors do not use BeFi continues to be the difficulty of translating theory into practice and implementation. The lack of software and tools to implement within practice also remain a hinderance.

What You Can Do: Come to the table with actionable advice around investment and portfolio activity. Keep clients focused on long-term plans but, if changes are required, focus on advising them to make smaller, less permanent changes. For instance, make some changes to their household budgets or for those clients in retirement, suggest that they don’t take an inflation adjustment on distributions for the year, or hold off on rebalancing their portfolio for 12-months. It is important to steer them away from making permanent changes, like selling their home and be willing to make scalable model portfolios and decrease custom portfolios for clients.

According to advisors that were surveyed in 2020, the most important benefit of incorporating behavioral finance is to keep clients invested during market volatility.

Strengthening client trust and relationships was also an important factor for advisors. This finding is particularly important given the current state of the world and market volatility. The study shows clearly that behavioral finance is beneficial in helping to keep clients invested, particularly during times of market stress and volatility.

What You Can Do: Approach clients from an emotional perspective and respond to clients in a more accommodating manner.

In addition, the study found that advisors who use BeFi were almost twice as likely to gain clients as non-BeFi users. Interestingly, among the advisors that gained clients, the most frequent source was from clients who were dissatisfied with their other [former] advisor.

Advisors should not underestimate the impact of proactive client communication can make during times of market stress and volatility like we are experiencing currently. The COVID-19 crisis has likely fueled greater emphasis on enhancing client communications and a firm’s digital capabilities.

What You Can Do: Increase your client communication and use a variety of communication tools with investors. Use a greater combination of 1:1 meetings, texts, emails, and check-ins.

Like 2019, advisors cited recency bias as the most common client bias, followed by loss aversion and familiarity bias. It is important for advisors to not only be aware of client biases, but to also be aware of their own biases to deliver better client outcomes.

The most prevalent advisor biases remained consistent with 2019, although loss aversion and overconfidence were more pronounced in 2020. While BeFi users were less subject to loss aversion, they were more subject to overconfidence and confirmation biases as compared to non-users.

What You Can Do: Check out the study findings and familiarize yourself with the different biases, which differ based on segment by investors, clients, genders and generations. Understand those driving behaviors and adapt your conversations and plans around them.

Consistent with 2019, the most common reason for a portfolio change was a change in client investment goals or risk tolerance. In 2020, more advisors pursued tactical investment opportunities or replaced under-performing funds versus. 2019. Interestingly, since Q1 2020, non-BeFi users were more likely to reduce risk assets and increase downside protection in client portfolios, while BeFi users focused more on tax-loss harvesting and other proactive activity.

What You Can Do: Review the generational data before making client contact and use those insights to construct a plan of advice and create simple, clinical frameworks. Clients are craving certainty and while you can’t provide that, you can provide a thoughtful, scenario-based analysis. Place a greater focus on long-term financial planning and provide more investment and market commentary than you did before, maintaining the strategic asset allocation (re-balancing as needed) and tax-loss harvesting.

While changes to client portfolios may be warranted as clients mature and investment goals shift, portfolio construction changes should be more proactive rather than reactive according to the study findings. Befi Barometer 2020 builds upon the 2019 findings, however the impact of the timing of the survey cannot be overlooked.

The 2020 findings give greater detail to the impact that behavioral biases can have on clients and advisors alike, however, the study also sheds light on how proactive communications and BeFi techniques can impact an advisors’ practice in a positive way and allow advisors to provide greater value to their clients.

The facts are even clearer this year, advisors who can try to mitigate their own behavioral biases and help clients do the same will provide greater value to their clients, especially in this time of great market volatility.

Read the full report: BeFi Barometer 2020.


Charles Schwab Investment Management: 0820-06Y9

Topics: economics

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