Practice Management

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Solving The Dangerous Voids in Risk Profiling

No doubt, intense discussions surrounding risk tolerance and behavioral finance are on the rise. Michael Kitces, who writes the Nerds Eye View Blog, has written a very good summary on the state of play regarding risk tolerance questionnaires in his article: The Sorry State of Risk Profiling Questionnaires for Advisors.

Michael articulates various risk factors in distinguishing between tolerance, capacity and perception. Likewise, for advisors using Financial DNA, addressing the differences between tolerance, capacity and perception is very clear. And these users are provided with the structured framework in which to do it.

Then there is how the risk profile is used. In goals-based planning, where the client has a portfolio designed to achieve buckets of goals, there may be multiple risk profiles. Given that there are different goals, the risk tolerance of the client must be known and the framework outlined and applied.

Many advisors believe that risk tolerance can be determined by observation or casual interaction. However, these methods are neither objective nor validated. Relying on the advisor’s perception of the client under preset circumstances (in a comfortable office or out for a meal) opens the door to a myriad of pitfalls. The advisor is influenced by their own risk profile and biases, which removes objectivity. The client, while self-reporting, may not be faced with the pressures of considering a volatile market or other life-changing event, which would alter decision making or goal-setting, again removing objectivity from the equation. Also, not using a validated psychometric risk profiling process means that the advisor does not have a consistent process for handling the risk conversation with the client. This further leads to discolored results, and not just for a given client, but across the entire firm.

While current regulations do not specify that a validated psychometric process must be used, it is the direction in which we’re headed. If the firm wants to have a robust process of mitigating client complaints and maintaining compliance, these tools provide the solution. Plus, as Kitces points out, it is not just the tool itself, but also the planner’s behavior and skill in deploying the tool that is important.

Conversely, some advisors state that they do not wish to bother a client with more paperwork, so they do not have them complete a risk questionnaire. But experience shows that the addition helps keep the focus client centered during the planning process, plus the client feels more engaged because they’ve participated at a higher level. So it becomes a service quality enhancement, which deepens the advisor / client relationship and ultimately leads to greater revenue.

Next, the discussion turns to the design of the actual risk tolerance questionnaire – “right data in, right data out”. Kitces is right (as is Plan Plus), most tools are inherently flawed for many reasons, and many purport to be something they are not. The questionnaire structure is important to the outcome, and must follow an accepted psychometric model.

Our view is that all of the risk profiles (even the validated ones) use situational based questions – that is, the client could respond to the questions differently depending on any one (or combination of) market or personal events, attitudes, feelings, perceptions, education etc. While this template provides a basic baseline profile, it does not provide the most accurate or effective insights as to the emotional state of a client. Daniel Kahneman, psychologist known for his extensive work in behavioral finance and decision making, details our “Level 1″ automatic decision-making style as when we are under pressure or how our baseline, “hard-wired” instincts will drive decision-making. So unless a clients (or your own) Level 1 style is known, it is impossible to build a long-term portfolio, as it will be emotionally incompatible. So the questionnaire has to be designed to uncover this Level 1 behavior – free from personal or situational bias. The Financial DNA design does just this and the validated results are accurate and constant over time.

Whats missed in all of this is risk tolerance being only 1 dimension of a clients financial personality. There are several more factors to consider within the broader field of behavioral finance in order to fully understand the decision-making biases of both the client and advisor. Not communicating these biases only creates more risk to the client / advisor relationship, decision-making, goal-setting and overall compliance. So, the risk discussion is not complete without knowing the clients full set of behavioral biases and knowing how to communicate on the client’s terms. And this is why it is so important that the questionnaire design must be objective, robust and validated.

One thing for sure is, the regulatory process will not go backwards. And in today’s competitive and complex world, costly client complaints will not go away. But, on the positive side, those advisors who are investing in building client centered and compliant processes have the upper hand. So, invest in a stronger “Know Your Client” process, as what is good for the client will be much better for the advisor and firm too.

 

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Avoid Irrelevance- Reinvent Your Financial Practice

Avoid Irrelevance: Reinvent Your Financial Practice

Business school’s books and the internet are filled with examples of industries or companies that failed to heed the winds of change and now, they no longer exist. When my husband and I visited the Guinness beer factory in Dublin Ireland, I was intrigued by the story of the barrel makers (coopers) and how that was a thriving craft until cheaper?methods, and easier to use materials became available.

The most recent memorable example is the mortgage industry. It was booming before the Great Recession due to favorable lending terms and rates. When the financial crash came, many companies were on the brink of collapsing (Lehman did.) Individuals in the mortgage lending business also had to find ways to reinvent themselves.

Technology has already revolutionized other industries and careers (Uber, Amazon, Call Centers, etc.) How people adapted to those changes determined whether they remained relevant. The Financial Services industry is currently involved in a sea change due to technology (Robo platforms), potential legislation (DOL) and changing market demand (tech-savvy and Gen Y clients.)

Many people advocate focusing on a “Niche” and creating a “differentiating” value. Many of those ideas don’t really involve doing anything different, other than marketing and segmentation. Don’t get me wrong, those are good ideas, but they are just versions of what Advisors are already doing.

Fidelity’s Tech Guru Predicts FAs Will Become Life Counselors

Other people and companies are looking at Financial Advice with a different lens. What if you focused more on helping the client achieve their overall life goals and developing the finances needed to support those? What if you were able to assist in managing their emotional and behavioral biases that so often result in costly decisions? What if you became a Wealth Mentor?

Avoid Irrelevance Reinvent Your Financial Practice

Behavioral Biases are our natural, hard-wired reactions to events and situations (market volatility, family, etc.) We all have them, whether we want to admit it or not. As a Wealth Mentor, you can identify the client’s natural behavioral biases and help manage them before the client is triggered to make an emotional decision that will disrupt their Financial Plan needed to accomplish their goals. The best investment recommendations and financial plans are useless if the investor ignores that advice abandons the plan with the next “trigger.”

Cost of Ignoring Behavioral Biases
By Jay Mooreland, The Emotional Investor

Helping them stay on the plan to achieve their goals is the best value you can provide that will differentiate you from the rest of the pack.

Most Financial Advisors were attracted to managing investments and narrowly defined their service and revenue model along those lines. Not only is investment management becoming a commodity, but the whole Financial Advisor business model is being questioned. Many companies and people are eager to fill in the gaps. Merrill Move Upgrades Behavioral Finance.

How will you adapt?

Robo 2.0

Robo 2.0, Your Torrid Behavioral Finance Fantasy Comes True

Yesterday, my friend shared a link to a new artificially intelligent personal assistant that can communicate independently with clients. Her name is Amy and she is superwoman compared to Siri. Unlike Siri, Amy can work independently, multi-task, make her own decisions and can even teach herself to emotionally connect with others based on their digital footprint. The scary thing is robots are having more engaging conversations over email than we are (talking about interests like the Atlanta Falcons, paddle boarding or the BCS Championship). This evolution will cause ripples in the financial services industry, hold advisors to higher engagement standards and dramatically shift the traditional advisor’s role. Are your ready for Robo 2.0?

The Financial Advisor will be held to higher client engagement standards with Robo 2.0 in order to remain valuable in the client’s eyes. Superficial conversations are “out” and deeper wealth mentoring relationships are “in.” Are you Robo 2.0 ready?

Robo 2.0

With “robots” entering Fintech with robo-advice platforms (Robo 1.0) our industry is going through a major shift. Are you prepared for the next round of enhancements? I am predicting that Robo 2.0 will bring an army of “Amys” to advisor’s offices handling all previously manual tasks like answering client email, booking appointments, superficial “checking in emails”, documenting client meetings, building portfolios and lead gen. Amys will assist in nearly every facet of financial planning except for the actual meeting with clients and managing their behavioral biases.

Many have speculated that an advisor’s role in the future will be akin to a pharmacist equipped with an automatic pill dispenser, a check and balance in the financial planning process. I disagree. This is inefficient and not the best use of advisor’s talents. In Robo 2.0, firms will review and prepare all portfolios centrally and deploy their advisors to be the firm’s face and voice. The advisors will be the shoulders to cry on during a death or divorce, a counselor for health and wealth, and a gladiator for the client’s goals. Robo 2.0 advisors will be pushed to non-traditional work hours to keep up with the demands of their clients and the reality of the 24/7 capabilities of their Amys and the diverse services being offered. Not all Robo 1.0 advisors are suited for 2.0.

Higher client engagement standards.

The main advantage that a robot has over the human is that they fully prepare before a meeting. In a research study, we recently completed, advisors will not emotionally engage 40% of prospective clients. The way that they approach them in their first interactions will be a complete turn off (whether it be too pushy, too salesy, or just a personality mismatch). Robo 2.0 platforms will be able to reduce this mismatch by drawing on data from data.com, behavioral science, and demographic databases to know exactly to whom they are talking, their interests, their personality, their likely needs and key demographics and the ability to change their pitch accordingly.

In order to be competitive, advisors must emotionally connect to their clients, quicker and more reliably, by better understanding their financial personality and how to provide the type of personalized support each person needs.

Financial Advice is Becoming a Commodity

Financial Advice is Becoming a Commodity: Get on Board or Get Left Behind

It’s inevitable. Social media is taking over marketing. Further, the “robots” are also storm trooping the industry in how financial advice is provided and how investments are managed.

The reality is that many parts of the financial advice process and investment management are becoming a commodity. As a consequence, many in the financial advisory business could suffer as a consequence of this move away from the traditional view of financial advice.

However, you can take advantage of this shift to increase your practice. The key to success is to differentiate your service model from other financial advisors and the increasing array of online resources and systems. The number one strategy for financial advisors is right under your nose at the initial step of the financial advice process. That is to have a much deeper understanding of your client’s needs and related behavioral finance biases, and to directly involve the client in the discovery process to increase engagement. Inadequate 5 to 20 question assessments that address only risk’ won’t cut it anymore. Neither will guess who the client is. Clients should be given the opportunity to participate in the completion of a comprehensive process which then enables the advisor to comprehensively know their client and their life journey.

As the new landscape for advisors evolves, you don’t have to bemoan it. If you adapt, you can seize this as an opportunity to actually grow your business. Look at the areas of the advisory process that can and should be commoditized. Leverage these technical platforms so that you and your team spend less time on investment management. Educate them, not only on the technology and investments, but more importantly, on how their approach to finances, investments and money can move clients towards achieving their life goals. The key starting point is to holistically identify the client’s financial personality. Then use those insights to help clients manage their behavioral biases to prevent setbacks or missed opportunities and further grow their nest egg to achieve their goals.

It’s time for financial advisors to recognize that clients don’t have to be lost to the new world order of do-it-yourself’ financial planning. Those financial advisors who have long ago invested in building relationships based on knowing their clients, knowing the plans they have for their lives, knowing and being a part of strategizing their financial roadmap to achieve their goals will not lose clients and actually grow their business.

Here are 7 practical tips:

  1. Use an independently developed and robust questionnaire based discovery process with clients at the point of entry and at annual reviews with existing clients. This will give you a clear insight into what they want to do with their finances.
  2. Focus on goals-based life planning and the financial plan to achieve those goals.
  3. Take the mystery out of investing. Proactively build areas in your advisory process where clients can manage their investments for themselves. This will keep them connected with you as their ‘go-to guy.’ Be a source of knowledge for the client.
  4. Build trust. Get to know how much clients understand markets and then educate them around the gaps (this builds trust.) Knowing their communication style and how they want to work with you will build trust quicker.
  5. Focus on the relationship being a two-way partnership.
  6. Match advisor to a client based upon their financial personality and communication style. This is a key differentiator for success.
  7. Help clients to understand their behavior during market movements. Understanding behavioral finance should be bedside reading for every financial advisor.

Time to develop your value position as a financial advisor. Don’t get left behind in the commoditization of the traditional financial advice process. Embrace the exciting Behavioral Finance future.

Try Communication DNA or Financial DNA to see how you can become the Financial Advisor of the future.

Investment Committee integrated graphic blank

Investment Committees through the Behavioral Intelligence Lens

Most investment committees have a very clear mission: Serve as stewards for assets of the organization they represent.

Recruiting the right people to do that is critical to the success of the Investment Committee. But how do we define “right”? Is it a professional background? Education? Investment knowledge? And where does the diversity lens come in, if at all? What about their inherent risk-tolerance and behavioral biases toward investments?

In a study by Vanguard’s Vanguard Investment Counseling & Research on Group Decision Making for Investment Committees, there are definitely biases (both investment behavioral biases and workplace behavioral style differences) that should be considered when forming a committee with such important responsibilities in an organization.

Group Decision Making for Investment Committees Source: Vanguard Research

Most investment committees focus on five critical decision-making areas:

  1. Establishing goals or objectives for the investment portfolio they are managing.
  2. Setting an investment policy-on everything from strategic asset allocation to rebalancing policy to performance metrics.
  3. Selecting managers to implement the portfolio’s investment policy.
  4. Evaluating short- and long-term investment performance-both for the portfolio and for individual managers.
  5. Selecting experts (e.g., a consultant) to guide the committee as necessary.

As you think about how your committee recruits and selects new members, are you making the most of the opportunity to broaden the search to include those who would bring a diverse and beneficial perspective to the group?

As the research shows, this can lead to a more effective team and, in turn, a better outcome for the committee’s main mission.

Using a Behavioral Finance approach can shed light on the risk-tolerance and behavioral bias of the Investment Committee Members who may possibly be more wired for a Newness Bias or the More Anchored Bias. There are several behavioral biases that can either create conflict for the Investment Committee or potentially a group-think bias that could create risk for the firm.

In selecting an expert to guide the committee as indicated in bullet point 5 – Selecting an Expert, using a behavioral discovery process can add a dimension of behavioral diversity to the important function of the Investment Committee by ensuring the group can function collaboratively and effectively while also preventing “Group think.” Find out more on using Behavioral Intelligence and how to recruit the right behavioral fit for this important role in the organization.

Should I waste my time on team development with behavioral assessments?

Should I Waste My Time on Team Development with Behavioral Assessments?

Most people who have worked in the corporate environment have taken a behavioral assessment, or 2 or 4, or participated in some form of team or leadership development. Sometimes, I hear from leaders that they aren’t sure how to guarantee the exercise provides long-term, bottom-line value. Or I hear from participants, this is great, but I am not clear on what to do with this information. As a former Corporate Leader and a consultant who facilitates these types of exercises and discussions, we have found most people go through the following phases of development:

KNOW

Most people and consultants are aware of the common phrase “the first step is awareness.” But a good number of people think that means just learning the “lingo” of the particular assessment or methodology and what their “type” is. We encourage the leader, team and participants to honestly evaluate the current effectiveness, strengths and challenges of the team, including, their strategy, goals, and organizational structure (roles, process, and technology) that supports the execution of tasks to accomplish those goals. A more comprehensive review of how the team is working within the context of organizational factors, combined with, an analysis of the different behavioral styles, their natural strengths and struggles, the fit for the role and the fit within the organizational structure, values and behaviors (some people call this ‘culture’) will lead to a greater depth of understanding.

ENGAGE

But never stop at Knowing. Many people do and that is why they don’t see a lasting value with these exercises. The entire team, with the leader leading by example, needs to actively participate in the dialogue of what to do with this knowledge. And it can’t be just one team session talking “about” it. The team discussion needs to focus on how to apply this knowledge to their people, process, and technology. Each team member has to internalize ownership by explaining specific actions they are going to take to change how the team is working together. Often people want to focus on what other people need to do and not take ownership.

  • Is the reason the budget process is ineffective due to the instructions not being specific enough for Cooperative people who work better with specific instructions?
  • Is the process so detailed and constraining that Creative people have even more difficulty following it and the goal is not accomplished?
  • Does the CRM / HR / Process technology incorporate this behavioral knowledge in a way that is easy to access and apply at the moment?

GROW

Even great leaders and team members, tend to stop at the team session. Research shows that people, on average, require 7 interactions to be able to absorb information and change behavior. Most of us are lucky to communicate something 3 times before we lose patience. In order to truly grow the organization, there needs to be an intentional, specific, coaching or action plan (practice) over time with clear expectations to ensure that all this great learning translates into sustainable productivity enhancements.