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How Behavioral Finance Can Boost Goals-Based Investing

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For many financial advisors, behavioral finance is still somewhat abstract. They recognize the importance of understanding investor behavior to improve investment outcomes, said Chuck Widger, founder and executive chairman of investment management firm Brinker Capital. However, due to a lack of practical tools, finding the best way to incorporate behavioral finance into their practice is a challenge.

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 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 index-based investing. Yet sticking with a goals-based program can be challenging for 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 behaviors. Embedding the principles of behavioral finance in an investment management offering can greatly improve an investor’s experience, Crosby said.

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 of creating purchasing power for investors while managing volatility. It is focused on risk management, and embeds behavioral finance principles 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 different buckets that “dial the level of risk up and down,” Widger said. This helps manage 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 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.

“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 said. “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.”

—Savita Iyer-Ahrestani