In times like these, should you consult a psychologist or a financial adviser?
Recent economic news on increasing unemployment, speculation on impending recession and the consequences of possible trade wars are enough to tempt all of us to curl up in a foetal position and stay in bed.
Who do you have to help you add perspective, calm down and stop you from making irrational mistakes with your investment plan? Lots of articles have been written about how to choose a financial advisor, the services offered by financial advisors and the role they can play.
Most of these articles describe the process whereby an advisor helps the client establish financial goals, and devise a plan to reach these goals. Typical services include the crafting of the initial investment plan against the backdrop of relevant tax laws, an annual rebalancing of investment portfolios, implementation of investment strategies and annual reviews. All of these services have the capacity to steadily boost client’s returns.
A 2017 study from Russell Investments, a large US-based asset management firm, estimated that good financial advisors delivering services over and above investment-only advice had an average ‘contributory value’ of 4.08% per annum. This figure was derived from the total benefit of typical advisory services. The biggest contribution to this value was the estimated benefit of preventing behaviour-related investing mistakes which was valued at 2% of the 4.08% or just less than half of the total contributory value.
The study showed that advisors that persuaded their clients to stick to pre-agreed investment plans helped make a significant long term contribution to the total value of the client investments. Good financial advisors were those that managed to prevent their clients from changing plans or making emotional investment decisions by providing steady, fact-based advice and reassurance when bad investment news dominated the media.
The study results explained that left to their own devices, many investors became irrational in the face of volatile markets which cost them valuable potential investment gains. The value of 2% was derived from the fact that in the 33 year period between 1984 and 2016, the Russell 3000® Index climbed 10.7%. However, the average stock fund investor’s inclination to chase past performance cost an annual 2% during this period. Between 2009 and 2013 this pattern was more apparent; investors who sat on the side lines in cash during this period missed a cumulative return of 300% based on the Russell 3000® Index. The Russell study concluded that behaviour coaching was one of the most vital parts of the trusted advisor job description.
Vanguard, a large US-based investment company, has also attempted to quantify how much a financial advisor can add to investment returns. Vanguard has dubbed the ‘added value’ contribution of a financial advisor the ‘Advisor’s Alpha’. Vanguard’s conclusion, like Russell’s, was that much of the value provided to clients derived from supporting clients though volatile markets and persuading them not to change their agreed investment strategy.
The most recent Vanguard study, conducted over a period of 15 years, estimated that when best practices were followed, the result could be an Advisor Alpha of 3% per annum. The single biggest component of this, up to 1.5% per annum of increased annual returns, was attributed to behavioral coaching.
So what is behavioral coaching? And what skills should financial advisors learn to ensure that clients buy into and stick to agreed investment strategies?
Behavioural economics incorporates the study of psychology into the analysis of the decision-making behind an economic outcome. Unlike classical economics, in which decision-making is assumed to be rational and logical, behavioural economics acknowledges that people make errors of judgement and do not always behave in their own best interests. Behavioural economists try to understand the reasons for these lapses in judgement. The study of investing behaviour has established that many people have biased interpretations of financial facts, and make recurring errors or biased interpretations of data in particular circumstances.
Carl Richards, an author, artist, and financial advisor, coined the term ‘behavior gap’ to describe the difference between the higher returns that investors might potentially earn and the lower returns they actually do earn because of their own behavior. He has written extensively on the importance of emotional control when investing.
Lessons from behavioral economics can be used by financial advisors to coach their clients to make more considered decisions. Behavioral coaching attempts to persuade investors to move from an intuitive freeze or flight mode to a more considered perspective, from a position of only considering part of the information at hand to consciously including all relevant information and from a spontaneous decision making stance to rule-based, deliberate process.
Obviously these strategies have a greater chance of success if clients have comprehensively bought into the initial investment plan in the first place.
Within the current volatile markets it is important to have a team of financial advisors /experts who have the necessary experience to assist clients make important decisions. During periods of volatile markets and rand weakness clients need a high degree of comfort with their respective investment plans.
At Rosebank Wealth Group we aim to assist our clients make the correct financial decisions to ensure the longevity and success of their investments.