Behavioral Finance

5 Tips for Behaviorally Driven Goals-Based Planning

5 Tips for Behaviorally Driven Goals-Based Planning

Times continue to change for financial advisors. Investor fears, lack of confidence and market uncertainty are provoking clients to demand better, more personalized advice from their advisors.

Financial advisors who have moved to a behaviorally driven goals-based planning process will be the winners.

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Since the global financial crisis and recession, clients are driving the industry.

The Client:

1. Unique; each has different wants and needs.
2. Each having cognitive biases, emotions, fears, anxieties, greed and excitement.
3. Thinks they are better informed in taking control of their finances.

And advisors are struggling to navigate client’s emotions, inconsistent thoughts, and biases while maintaining control of the advisory process.

The Financial Advisor:

1. Trying to understand client’s behavior and emotional decision making.
2. Engaging to uncover and understand a client’s life goals.
3. Applying an understanding of client behavior to their investment style.

So how can firms develop a scalable framework and service model for financial advisors to address the unique wants and needs of individual investors?

Goals based Planning, based on the following 5 step process.

1. Use a trusted financial behavioral process to uncover:

a. Client’s inherent approach to finances and wealth creation
b. Biases, that get in the way of solid decision-making
c. Quality Life Goals, like retirement and family wealth transfer

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2. Outcomes from the behavioral process to build a goal based plan that is clear and precise:

a. Enable both client and advisor to have a clearer understanding of the goals
b. Identify, for the advisor, the client’s likelihood of achieving the goals and then enable measurable steps to be added.
c. Goals set relative to feasibility and other life and family priorities.

3. Create measurable checks and balances to:

a. Articulate a vision for wealth creation
b. Understand how bias and emotion might impact their decision-making
c. Be accountable even when markets are unpredictable

4. To add further value to the advisory process, Financial advisors should also complete the behavioral process.

a. The advisors own naturally ingrained biases will be revealed and can be managed.
b. Produce long-term relationships with clients when matching character traits and communication styles.
c. Advice given based on life plans and dreams, rather than by pure performance of investments.

5. Deliver a greater level of communication and a deeper trust will be built.

a. Meetings are more effective with the focus on achieving goals as a way to increasing wealth and achieving quality of life.
b. Turbulent markets are easily navigated with awareness of how the client will respond and then, how to communicate accordingly.
c. Linking financial personality with communication style will deliver a significant step forward in the way of financial planning.

Developing goal-based plans is not a new concept. However, linking it with the key foundational process of uncovering inherent behaviors is. The two approaches together will deliver not only a more effective outcome for the client but will be an industry differentiator for the advisor.

Investors get into trouble for one reason! They make bad decisions

Investors Get Into Trouble for One Reason! They Make Bad Decisions

But here’s the rub – how many investors actually learn from their past mistakes? How many don’t realize that their bad decisions come from ingrained behavioral biases? If you don’t know you have behavioral biases, then keep on keeping on making poor decisions. Because what you don’t know, is what’s hurting you.

Behaviorally Smart investors know their propensity for rushing through their natural behavior when under pressure. They’re keenly aware of their knee-jerk reaction to unsteady markets or the latest, greatest bandwagon opportunity. They know the danger in not taking a breath – to check themselves before they wreck themselves - or seek outside counsel before deciding on a major investment opportunity. Conversely, investors who do not have this insight will continue to get into trouble and make bad decisions.

When investors allow emotions to invade investment decisions, they’re set to fail. However, developing an understanding of how we inherently react to market volatility or investment opportunities will lead to becoming a Behaviorally Smart decision maker.

In his book, Behaviorally Smart Financial Planning, Hugh Massie makes the following observation:

Very often, without a heightened level of personal awareness, investor’s blind-spots can lead to investing behavior that results in sub-par outcomes
He continues by explaining the two levels of distinctive thinking which drive:

How the mind works inherently in its natural state to instinctively make financial decisions based on natural DNA “hard-wiring”. This behavior reflects the automatic biases which consistently reveal themselves throughout life (“System 1″)

How the conscious thinking evolved through circumstances, experiences, education and values situationally influence financial preferences at different times in the course of life. This is learned behavior which generally reveals itself as a result of behavioral management (“System 2″).

Emotion and psychology affect every decision we make and investing is no different.
It’s true to say that most investors revel in the process of creating wealth, but pay little or no attention to managing it or themselves. Without understanding behavioral biases, investing becomes a lottery and any gains are held for ransom by the investor’s own ignorance.

Don’t allow blind spots in your own behavior to highjack important decisions you will make in life. Change course by learning about your inherent behavioral biases and how to mitigate their affects on your decision-making capabilities.
It’s not rocket science – just four easy steps:
Step 1. Make the decision to educate yourself
Step 2. Use a validated, accurate and trustworthy process such as Financial DNA to uncover your behavioral biases
Step 3. Select an advisor who not only has your best interests at heart but also has educated themselves about investor DNA and Behavioral Biases. Great advisors examine the reasons behind decisions their clients make.
Step 4. Always remember your natural, go to’ behavior when markets get rocky (as markets will).

In conclusion:
“Invest in as much of yourself as you can, you are your own biggest asset by far.” Warren Buffet
“The whole problem with the world is that fools and fanatics are always so certain of themselves, and wiser people so full of doubts.” Bertrand Russell

Duke University Professor and founder of The Center for Advanced Hindsight behavioral economist Dan Ariely.Predictably_Irrational refutes the common assumption that we behave in fundamentally rational ways. Blending everyday experience with groundbreaking research, Ariely explains how expectations, emotions, social norms, and other invisible, seemingly illogical forces skew our reasoning abilities.

“Not only do we make astonishingly simple mistakes every day, but we make the same “types” of mistakes, Ariely discovers. We consistently overpay, underestimate, and procrastinate. We fail to understand the profound effects of our emotions on what we want, and we overvalue what we already own. Yet these misguided behaviors are neither random nor senseless. They’re systematic and predictable–making us “predictably” irrational.”

As investors the financial decisions we make can be both complex and stressful; they can change our financial long term security forever. Their impact can be life changing. This is why self-education and understanding decision-making approaches in terms of why and how we make decisions need to be top priorities.

Shocking News for Investors  You and Your Financial Advisor Are Biased

Shocking News for Investors – You and Your Financial Advisor Are Biased

I can hear investors saying, “I’m not biased” – well sorry but you are! And guess what? So is your financial advisor! But, if you take time to invest in knowing your financial behavioral biases you can work very effectively with them, instead of blindly against them

Understanding behavioral finance and the effects of human behavior on financial markets provides insight into the human side of financial decision making. This insight can help investors take a more rational and less emotional view and remain committed to long-term strategies and goals during periods of market volatility.

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Both investors and advisors often make incorrect judgments based on personal beliefs, past experiences, personal preferences, and emotions. These biases direct them away from rational, long-term thinking. Further, biases focus the investor or financial advisor on only one aspect of what could be a complex financial decision-making process.

Ariel Cecchi – Consultant on Behavioural Economics and Service Design University of Geneva observes the following:

A common interpretation in behavioral finance is that rationality is the result of a pure cognitive process which can be behaviorally biased. In general, the bias has a negative connotation because it produces a distortion in the calculation of an outcome. When a decision-making process is cognitively biased the outcome leads to sub-optimal results or judgment errors. Roughly speaking, the subject might make irrational choices due to faulty reasoning, statistical errors, lack of information, memory errors, and the like. Differently, when the decision is emotionally biased, it means that the cognitive process has been influenced by feelings, affects, moods, and so on (let’s label these states “emotions”). This leads us to irrational decisions or actions.

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Biases are influential underpinnings in terms of the decisions we make. Such behavioral biases cannot be completely eliminated, but recognizing them is the first step in managing them, reducing their effects and avoiding self-destructive behavior.

In increasing numbers financial advisors are adopting the behavioral components of investing. They may have worked with their investors for long periods of time, focusing predominantly on risk tolerance and objectives. Not so now. Advisors are making the effort to understand why investors often react in the moment and revert to short-sighted beliefs that may hurt their returns.

Many advisors are implementing behavioral insight processes that deliver greater self-awareness for recognizing potential advisor AND investor behavioral tendencies. Tools such as ones provided by Financial DNA measure each of these behavioral biases independently and display them on a Behavioral Management Guide. This enables financial advisors to discuss the strongest biases with the client and develop a strategy for managing them.

Managing money is too important to be driven by our emotions. Running to our inherent go to’ behavior when markets fluctuate has to be managed. The responsible first step in any investor/advisory relationship, therefore, is to objectively uncover the financial personalities of both advisor AND investor, using a measurably reliable, independently validated discovery process. Anything less degrades the advisor’s fiduciary responsibility and investor experience while opening the door for compliancy issues and loss of clients.

The Top 4 Ways Your Brain Wrecks Investment Performance

The Top 4 Ways Your Brain Wrecks Investment Performance

As behavioral finance goes mainstream, investor behavior has become more accepted as the major influence on investment performance. So how does one become Behaviorally Smart? Dalbar research shows investment losses to individual investors due to their behavior to be an average of 8% per year over the last 30 years.

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And not just limited to the investor, based on research performed by Cabot Research, professional investment managers are leaving 1% to 3% a year on the table, which is significant when you realize the size of these large portfolios. So even the professionals who use sophisticated technology and extensive research make mental errors in their decision making. After all, they are also human and have to manage their cognitive biases and emotions when under pressure.

This begs the question how can investors improve? There is no simple tonic to improved performance, as this requires wholesale behavioral change – a paradigm shift in how one engages the world around them.

Steps to Investor Improvement
1) greater level of self-awareness as to why they repeat the same mistakes
2) develop an investment process that provides a “check yourself before you wreck yourself” step to mitigate these blind spots.

Greater Self-Awareness
With more than 15 years of research, DNA Behavior has learned that easily identifiable behavioral traits lead to patterns of decision-making that are then very closely aligned the structure of an investor’s portfolio. So the combination of traits and patterns makes up their financial personality style. The portfolio mirrors who they are! In fact, investors should look at their portfolio as the composition of all their decisions and not just a series of market positions.

Next, the reality is that some behavioral biases cost more than others. Based on Cabot Research (read Michael Ervolini’s book “Managing Equity Portfolios“, the top 4 ways the brain can wreck investment performance are summarized as follows:

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1. Holding on to winners for too long. Known as the Endowment Effect, the investor falls in love with a winner and loses sight of the fact that its best days are gone. There is the fear of selling the position too early and missing out on future growth.

2. Selling young winners too early. This is attributed to Risk Aversion, resulting in the investor having fears about the future and not wanting to take the bumps in the road as the stock goes up in value.

3. Holding on to losers for too long is caused by Loss Aversion. The investor is fearful of the pain that will be caused by taking a loss and therefore, ends up with a portfolio full of losers.

4. Not adding to winners when they take off is attributed to Regret Aversion. This is an investor who, through fear, is hesitant in their decision-making and backs out of building the stock position as it gains momentum.

Based on your history of decision-making which of these 4 patterns has cost you the most? And remember, there are also many other behavioral biases, which coupled with these, will further contribute to reduced performance. To help you on the journey of closing the investment performance gap, start with self-awareness of your behavioral traits. Take the first step by completing your Financial DNA Discovery – click here.

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4 Hacks For Managing Your Nightmare Clients

Advisors and their staff love to stereotype their clients. Without even realizing it, most firms segment their clients based on communication style using a crude method of stereotyping. While this segmentation is informal, it 100% aligns to the four fundamental client communication styles. Below is a guide to the four most common client communication styles and how to serve them based on their common stereotypes. Any seasoned advisor will agree that these tips can save your client relationship.

1. The Engineer: By far, the most common stereotype I hear is “the engineers”. Many firms will avoid engineers at all costs. But for firms that have mastered communication to engineers, this is their bread and butter business. The key many firms use when training new staff is: “don’t you dare show up to a meeting for an engineer without doing your homework.”

Tips for working with “The Engineer” (The information focused)

  • Make the meeting have structure, provide an agenda ahead of time.
  • Provide research to back up recommendations. Give them space to review the research and contemplate options. Ask leading questions to draw them out beyond simple yes/no options.
  • Follow-up the meeting with additional resources to educate themselves and a to-do list as “homework”.
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2. The Talker: The “talker” can be a potentially great referral source, but they sure can do a number on your calendar!

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Tips for working with “The Talker” (the Lifestyle focused)

  • Make the meeting fun and inspiring.
  • Swap stories of influential people that share a similar situation.
  • Follow-up the meeting with a phone call, even invite them to a social event. Everyone likes the life of the party, or at least wants to hear what they’ll say next.

3. Mr. or Ms. Guarantee: Averse to risk, Mr. or Ms. Guarantee cant stand the thought of losses and immediately jump to the worst case scenario. They wont like the idea of complete uncertainty and will often ask for written guarantees and whole-heartedly compare their performance to benchmarks. They need continuous reminders to stick to their plan and that slight ups and downs are normal.

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Tips for working with “Mr. or Ms. Guarantee” (the Stability-focused)

  • Make the meeting relaxed. Use a coffee table or living room type setting.
  • Reference past experiences and make recommendations accordingly.
  • Follow-up the meeting with a phone call AND email about next steps.

4. The Hardheaded: “Do as I do, not as I say”. The hardheaded have a view of the world that every rule is intended to be broken. These clients are the best selective listeners in the world and will interject on a dime to keep the discussion focused on their self-centered plans goals.

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Tips for working with “The Hardheaded” (The goal-setting focused)

  • Make the meeting formal and focus on how you will meet THEIR goals for returns.
  • Be prepared with a sample big picture plan.
  • Afterward, follow-up with an email or text summarizing the discussion.

 

 

 

Following these guidelines will keep most client experiences on the right path to success. But if you ever find you can’t quite find the right fit, either try a mix of the options above, or there are tools and training available to support your needs.

Managing The Rise In Clients Non-Financial Issues

Pull Up The Couch For Your Next Financial Client

According to David Dubofsky, Ph.D., CFA, and Lyle Sussman, Ph.D. in their study, “The Changing Role of the Financial Planner Part 1: From Financial Analytics to Coaching and Life Planning”, approximately 25% percent of the financial advisor’s contact with clients is devoted to non-financial issues. About 74% percent of planners estimate that the amount of time they are spending on these issues has increased over the last five years. Source

There is mounting evidence to show that financial advisors indeed have to radically change their approach to the way they relate to investors.

Money has always been a ‘touchy’ ‘emotional’ subject. Whether discussions resolve around – making it, losing it, sharing it, incorrectly quoting about it i.e. “money is the root of all evil” when the correct quote is, “For the love of money is a root of all kinds of evil.” Timothy 6:10 – the topic can become toxic.

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Why then are we surprised (as I was) to find financial therapists popping up in our world? Or why do we think that financial advisors need to know all about our life and emotional state like a doctor? Is it unlike the mechanic that inquires about our driving habits as part of diagnosing a problem, or advising if those squeaky brakes need to be changed sooner than later? In that case, we’ve surrounded ourselves with all sorts of professionals and experts, acting as doctors and therapists to help us along in meeting our daily needs and lifelong goals.

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Source Photographer: Josh Dickinson

Well, it’s actually quite simple really: the majority of us have no idea what triggers we inherently have that govern the way we manage our finances. We would be alarmed to know we have inherent behavioral biases. We would cringe at the thought of having allowed the bankruptcy our grandparents suffered to dictate the ugliness with which we now accumulate and “store” our wealth.

But take heart these triggers can be revealed, they can be managed and we can work with our financial advisors to develop plans to create wealth that line up with our life goals and values.

In his book Behaviorally Smart Financial Planning: Behavioral Finance Made Practical for Advisors’ Hugh Massie makes the following comment, “Observations and traditional risk profiles don’t get below the surface where much about investor behavior is hidden. Financial advisors should know how to uncover what is happening as investors think through’ decisions.”

The truth is financial advisors need to know how to uncover what lies below the surface of our decision making. They need to know what historical events impact our view of creating/managing wealth. So yes, they do have to approach the advisor/investor relationship a bit differently today. But here’s the good news, they don’t have to spend 8 years or so studying to become a doctor.

The right tools and training for uncovering our core natural behavior is the key. For example, DNA Behavior International has a significant discovery platform called Financial DNA that reliably discovers all dimensions of an investor’s financial personality and inherent bias for making life and financial decisions. The discovery process is fast and accurate and places vital information in the hands of financial advisors before the first meeting with their investor clients.

Investors need an advisor who can guide them towards making informed decisions, one who speaks to them in a style that’s easily relatable while mitigating emotional, kneejerk responses. Emotion plays a significant role in so many parts of our lives that having an investor to coach us through the feelings and reactions, and keep decision making on the right track is necessary.

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Financial advisors must understand their clients at a deeper level. It is essential to have a practical understanding of the psychology, emotions and biases that significantly influence investor’s imperfect decision-making patterns. Furthermore, advisors should understand how to recognize and manage their own biases when working with investors.

Ultimately, it is fair to say that the role of the financial advisor has changed, and will continue to do so. But there is no doubt that with a reputable and appropriate process, advisors can be well informed in advance of a first investor meeting.

Conversations around money will always be complex. While we talk more freely about other intimate subjects, when money enters the conversation, emotion, distorted stories, ego, and even fear enter right along with it.

In conclusion, if we understand our financial behavior then we can balance our emotions and beliefs. We will act more wisely with our money. Conversely, if we lack understanding and are confused about why we make certain decisions, then the decisions will be poor, creating financial chaos and discontent. Advisors need to be fully equipped and prepared to unravel investor’s complex issues around money. Investors need to be able to trust advisors in order to reveal information.