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.