An Advisor's Role as Behavioral Coach

The financial advisory field is rife with talented professionals who do a great job of managing their clients’ portfolios and developing strong, tax-smart strategies for retirement and other life events. Advisors' real value lies in managing client behavior. Their mission is to keep their clients focused on their goals, even as their short-term objectives may change.

It’s how well you perform this crucial aspect of your role as their advisor that will determine how well you serve your clients. This holds especially true during periods of stock market volatility.

Behavioral Finance

The field of behavioral finance argues that people are not nearly as rational as traditional finance theory makes out. For investors who are curious about how emotions and cognitive biases drive individual decisions as well as broader market prices, behavioral finance offers some interesting descriptions and explanations.

The idea that psychology drives economic behavior flies in the face of established theories that advocate the notion that markets are efficient. Proponents of the efficient market hypothesis say that any new information relevant to a company's value is quickly priced by the market through the process of arbitrage. As long as all market participants know the same information, there is a logical method of determining the value of the market.

For anyone who has been through the internet bubble and the subsequent crash, the efficient market theory is pretty hard to swallow. Behaviorists explain that, rather than being anomalies, irrational behavior is commonplace. In fact, researchers have regularly reproduced market behavior using very simple experiments. Everyone may know what to do and have a plan in place, but following that plan and abandoning emotions is often a difficult task.

Market Volatility and Returns

How does this play out in reality? Let's consider market volatility, which can cause investors a great deal of concern and cause them to act irrationally such as selling their investments at the slightest dip in the market. Of course, relatively limited declines are still declines, and it’s highly probable that a number of your clients can feel scared with negative market news or small drops in the market.

Your clients won't experience a realized loss until they decide to sell. However, unrealized losses feel real. Your clients might have spent years to get their investments where they are at, and seeing the value of their portfolio drop may be too much to handle.

This type of uneasiness can cause clients to panic and make emotionally based investment decisions in an attempt to “lock in” gains. It’s up to you as their advisor and behavioral coach to step in and keep them invested in accordance with your agreed-upon plan.

Where Advisors Add Value

A recent Vanguard study estimates that an advisor adds about 3% of “advisor alpha” annually within its own advisor network. That is, working with a financial advisor adds an average of 3% to their client’s portfolio over time.The majority of this value is usually added during periods of heightened greed and fear in the markets when advisors can step in and help their clients stick with their investment plan, even when their emotions are driving them to do something else. About one-half of this extra return comes from the behavioral coaching that top advisors routinely provide to their clients.

Financial advisors who bring a process-oriented approach to their clients’ financial plans are helping to shape their clients’ behavior. Systematic reviews, periodic rebalancing, proper asset allocation, and spending plans are all examples of behavioral coaching. These and other strategies help clients make financial decisions in an ordered, rational fashion, rather than putting them in a position to react to news about the stock market or the economy.

If you've been in the industry a long-time, you also provide the benefit of historical expertise. Not every investor has weathered a recession, and not even investor has experienced certain macroeconomic conditions that impact their portfolio. The longer you and your firm have been in business, the more historical knowledge you have of previous downturns and what strategies might be employed today.

The Power of Listening

The best financial advisors play a number of roles such as investment manager, relationship manager, or entrepreneur. The key trait that the best financial advisors share is that they’re outstanding listeners. They take the time to sit down with their clients and prospects and discern their concerns, hopes, and goals: How do they feel about money? What financial issues keep them up at night? What do they want to achieve?

In order to be a strong behavioral coach, it’s important to have a baseline for each client. Understanding their concerns, goals, and fears is a starting point from which you will be able to help steer their financial behavior. When prospecting, active listening will help you to catch red flags that would lead you to suggest that you may not be the best advisor for their particular situation.

The power of listening is an ongoing effort. Your client's goals may change over time, or their investing preferences may shift as they get older. It's your responsibility to not only understand what your clients want but to understand changes as they occur and manage your client's portfolio accordingly.

Differentiating Yourself

In the face of downward fee pressure and the commodification of traditional advisory practices, advisors are increasingly trying to add new services to their toolkit. Enterprising advisors use services like behavioral coaching to then help clients navigate life decisions from both a values-oriented and a financial standpoint.

For example, while it might make financial sense to relocate to a lower-cost area of the country, will your client really be happy living far from their friends and family?

Advisors who integrate their clients’ values and nonfinancial concerns with their financial plans will increasingly have a leg up on other advisors who are more one-dimensional. This approach can help you achieve client buy-in and deepen their commitment to the financial plan that you construct with them.

The Bottom Line

Money is about more than dollar signs. A financial plan needs to be tied to a client’s emotions and values in order to resonate. Advisors who understand this dynamic are better able to manage their clients’ money behavior to their long-term financial benefit.