Advisors can teach clients that what seems counterintuitive — buying when the market is down, or selling when it is up to return the portfolio to the desired asset allocation — is actually in their best interests.
Advisors who seize this opportunity can add an average of 1.50% of additional return for their clients annually. This is part of a total 3% in potential additional net returns advisors can add by following best practices that we detail in a 2014 research paper.
If you doubt the opportunity, compare investor returns (internal rates of return, IRRs) with fund returns (time-weighted returns, TWRs) over time. Although all mandates should expect a return drag versus the benchmark over longer periods due to more money continually coming into a growing mutual fund market, and due to a rising market, larger differences can be a sign of performance-chasing. History suggests that investors commonly receive lower returns from mutual funds than they would tracking the market, since higher returns tend to attract, rather than precede, cash flows.
Investor returns versus fund returns: Ten years ended December 31, 2014
Notes: Figure displays the difference between the investor and fund returns, as defined by the asset-weighted average in each category. Investor returns are calculated as the internal rate of return that sets the beginning and ending fund assets equal, given the interim cash flows. Market returns are the asset-weighted average fund return. Both are derived from aggregate flows data for funds domiciled in Canada, with asset classes defined by Morningstar Category. Returns are in Canadian dollars, net of fees, with income reinvested.
Sources: The Vanguard Group, Inc., calculations, based on data from Morningstar, Inc.
Additional return attributed to behavioural coaching is likely to be intermittent, as some of the most significant opportunities to add value occur during periods of market duress or euphoria, when clients are tempted to abandon their well-thought-out investment plans.
But how can an advisor be an effective behavioural coach?
Educate and set expectations
Establishing a solid base of education in your initial meetings with clients should help them stay the course. Strong relationships need to be established before the bull- and bear-market periods that challenge investors’ confidence in the plan detailed for them. Your clients need to fully understand each step in the investment process, from setting goals and time frames to choosing and rebalancing assets to addressing tax implications and drawing income. This knowledge may provide a counterbalance to clients’ emotions during times of stress.
Make the financial plan an anchor
The financial plan that you design and agree upon with clients should be central to every conversation and meeting. It should reflect not only the clients’ long-term goals, but also the results of an in-depth exploration of risk scenarios. It should contain a wealth of information, including the client’s short- and long-term objectives, risk aversion and anticipated savings rate.
A collaborative financial plan can serve as an important emotional anchor when clients feel panicked or are hungry for gains. Reminding clients that their asset allocation was the result of careful consideration and discussion may help them regain perspective.
Practice emotional sensitivity
Your job doesn’t end when you make sound investment recommendations. The success of your efforts may depend on getting clients to stick to these recommendations.
Don’t discount your clients’ emotional reactions, but rather, use them as another avenue for communication. Try addressing risk and return opportunities on an emotional level, posing such questions as “Is the opportunity for a small increase in annual return worth the much larger increase in stress that a higher-risk strategy may entail?” “Will you be Ok with the anxiety that can accompany such volatile investments?”
Widen the frame
With this behavioural technique, your goal is to refocus clients’ attention on the performance of their entire portfolios, beyond the performance of an individual investment or asset class. Through give-and-take discussions, you should coach your clients to evaluate the progress toward their long-term goals, rather than concentrate on recent investment returns.
When a particular asset is underperforming, it’s important to show clients how other parts of the portfolio are contributing. By showing clients the big picture, you can help them work through moments of emotional crisis and stay committed to their broader financial strategy.
Reaping dividends for your practice
Integrating behavioural coaching in your relationships with clients may require an adjustment to your status quo—as well as a bit of practice before you achieve a successful approach. Yet the benefits run deep: Through well-executed behavioural coaching, you have the ability to help clients practice willpower, see the big picture, and attain the outcomes they ultimately desire. Their resulting satisfaction can produce significant dividends for your business in the form of loyalty and referrals.
Advisors who adopt behavioural coaching techniques reap rewards not only through these deeper client relationships, but also through the introduction of stronger, differentiated practices into today’s challenging marketplace.