Behavioral finance can become an important tool to help clients better understand their investment choices—and for advisors to help guide clients. Even Vanguard CEO William McNabb noted its importance to his company in his presentation at the Morningstar Investment Conference on Wednesday. But figuring out how to put the lessons of behavioral finance into action can be a sticking point for some advisors. Sarah Newcomb, a behavioral economist with Morningstar, discussed goals-based investing during a presentation Tuesday at the conference in Chicago, and provided some practical tools for advisors to get the most out of those lessons.
Newcomb began by exploring how advisors can help clients shape their goals to become better investors. These include overcoming psychological barriers, identifying issues and accessing tools to use with clients.
She explained the process using the Theory of Planned Behavior, which shows that while our behavior is critical, it is led by intentions. But our intentions are colored by our behavioral attitude (how a person feels toward a given action); subjective norms (what people around us think about our intentions) and perceived control (the perceived ability to follow through with our intentions).
So in focusing on goals-based investing, Newcomb noted that motivated people want three things: self-growth, security and safety. “So our primary motivator is that we are emotionally committed to an outcome.”
Ah, but there’s the rub: we have emotional barriers to achieving those goals. One example: a client might not even have a clear view of what they are saving for, so it’s up to the advisor to clarify that vision. Newcomb cited a study in which subjects were asked to list their top reasons for saving for the future. Yet when compared to a master list–which included typical reasons such as covering unseen medical expenses, living comfortably with loved ones, etc.—many times those typical reasons weren’t on the lists clients provided. Part two was to have clients prioritize their goals, but many found it difficult to do so, another issue advisors must help them achieve, Newcomb said.
So how to overcome this obstacle? Newcomb borrowed some steps from Shlomo Benartzi’s 7 Steps to Setting Retirement Goals. First she believes it best if an advisor works with the client face to face, and then make sure the client separates his priorities into high, medium and low buckets.