Behavioral finance is a hot topic. It’s hard to find a professional magazine without at least one story on the subject. Unfortunately, all too often the story is interesting but not very useful as it leaves you wondering what to do with the information. Well, here are a few ideas we’ve developed from the lessons of behavioral finance that have proved useful over the years.
Consider the concept of framing; i.e., how something is presented can significantly alter how a person responds. Consider the following scenarios:
1.) Does your quarterly report provide last quarter and year-to-date performance data? Is your practice and value based on long-term planning? In behavioral finance terms that’s bad framing. Why focus your client’s attention on short-term market noise when we should be keeping their focus on the long term? Consider eliminating any performance less than one year. If asked why the change, it’s a great opportunity to remind them about the concept of long-term investing.
2.) Do you use the S&P 500 as a return benchmark on your quarterly? Ask yourself why. Are all of you clients’ portfolios 100 percent invested in large cap domestic stock? Again, this is bad framing. While it’s certainly appropriate to use the S&P as a benchmark for your core large cap domestic manager, just as you would use the S&P 600 value as a benchmark for your small cap domestic value manager, using it as a portfolio benchmark is focusing your clients’ attention on an index that is unrelated to their portfolio. What’s an alternative? If you have in fact done some serious planning for you client with MoneyGuidePro, you’ve based their needed target return on a real return. If so, the appropriate benchmark is inflation as that will enable both you and your client to measure the portfolio success relative to their planning needs.
3.) Ever have a client come in anxious to draw a large chunk of their nest egg to invest in a wonderful hot investment they just heard about from their friend/next door neighbor/handyman? If so and you’ve tried to logically change their mind you probably have not been to successful. Instead of trying to persuade them, let a financial plan do it. Rerun their plan with all of their optimistic assumptions. You then may be able to tell them: “Why that’s great, instead of that one week Caribbean cruise y’all were planning on, you can take an around the world cruise first class.” Then run their plan assuming things are not so rosy and they lose half of their investment (which could happen). Then the conversation might be: “Well, if it works that would indeed be great but if it tanks you do see you’ll have to work two more years.” That is powerful framing. When someone is excited about an opportunity they rarely think about potential negative consequences and are unlikely to listen to your warnings; however, when they provide their own framing (i.e., their own MoneyGuidePro plan) they often listen.
I hope you find these tidbits useful. They have all been tested over many years with real clients and they do work.
Harold Evensky, CFP®, AIF®, is a research professor of personal financial planning at Texas Tech University and the president of Evensky & Katz Wealth Management in Coral Gables, Florida and Lubbock, Texas. Email HERE.