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Financial Planning > Behavioral Finance

How Behavioral Finance Can Boost Goals-Based Investing

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For many financial advisors, the practice of behavioral finance still remains somewhat abstract.

They recognize the importance of understanding investor behavior and working through it to improve investment outcomes, said Chuck Widger, founder and executive chairman of investment management firm Brinker Capital, but, largely because of a lack of practical tools, finding the best way to implement and incorporate behavioral finance into their practice is still a challenge for many advisors.

Widger and Daniel Crosby, behavioral finance expert and founder of consulting firm IncBlot, co-authors of the new book “Personal Benchmark: Integrating Behavioral Finance and Investment Management,” believe behavioral finance works best when it’s meshed into a workable investment management solution that’s grounded firmly in the idea of goals-based investing. The financial advisory business is increasingly embracing the idea that individuals need to have personal benchmarks that are meaningful to them in order to achieve their investment goals, Crosby said, and is consequently moving away from the conventional approach of index-based investing. Yet sticking with a goals-based program can be quite challenging for most people, since they’re distracted by common behavioral pitfalls.

Ensuring the success of a goals-based investing program requires that advisors help their clients avoid certain repeatable and bad behaviors that are counterproductive. An embedded approach to the principles of behavioral finance as part of an investment management offering can greatly improve an investor’s experience, Crosby said.

“We did a survey and found out that 77% of financial advisors are talking to their clients about behavioral finance, which is a great thing,” Crosby said. But most advisors and their clients “lose the good knowledge when they need it most,” he said, which is why behavioral finance should be embedded into a practical, workable investment strategy.

Brinker Capital’s Personal Benchmark investment solution is designed along these lines. The product uses the principles of behavioral finance to structure investor portfolio strategies with the goal to create purchasing power for investors while managing volatility. It is focused on the idea of risk management, and it “automates the delivery of behavioral finance” by embedding the science into a multi-asset-class investment product that divides assets — international equity, domestic equity and fixed income, as well as selected non-traditional asset classes — into a set of different buckets that, depending on their content, “dial the level of risk up and down,” Widger said. This helps both manage and reduce the volatility that inevitably leads to negative investor behavior and detracts from investment goals. Ultimately, it leads to an increase in investor purchasing power.

“We believe the best way for an advisor to increase investor returns is to concentrate more on managing risk and less on trying to increase returns via stock picking or market timing,” Widger said.

More importantly, this type of investment management solution helps investors stick to their own personal investment goals, since the larger market forces are countered by the focus on risk management. As such, the conversation is less about “the economy” and more about “my economy,” which is what goals based investing is all about, Widger said.

Overall, investors just want three things, Crosby said: “Safety, consistency and surety.”

The psychological underpinnings of human beings, though, cause people to deviate from their goals, and most of the time they are not even aware of it. That’s why transforming behavioral finance theory into practice through its integration with a mainstream financial product can help financial advisors change the conversation with their clients, Crosby said, and truly make it more goals- and outcome-focused.

“Personal Benchmark: Integrating Behavioral Finance and Investment Management,” which was published in October, offers an in-depth account of how the integration of behavioral finance can help in a purpose-driven investment strategy.

“We know the industry is heading in this direction, but we feel that advisors need automated solutions to change the conversations with their clients,” Crosby says. “Our research has shown that goals-based investing can really enliven the process of saving as it increases the likelihood of staying invested in volatile markets. It is particularly appealing for groups that have been underserved by the financial advisory profession over the years, including women and younger people. The industry has embraced the idea, too, but we still need more workable solutions.”  

— Check out 10 Commandments of Investor Behavior on ThinkAdvisor.


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