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Using Behavioral Finance to Help Clients Discover Goals and Set Priorities

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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. 

One key obstacle in reaching a goal is how we naturally discount the future, something called psychological distance. People know what they want today and next week, but knowing what they’ll want 10 years from now is much fuzzier. To overcome this challenge, advisors should use visualization exercises with clients. Though we’ve been taught to only picture success, in this particular area that’s a problem. For example, let’s say you decide to buy a boat, and you tell people. Their happy response might be all you need, and then you never buy the boat. 

Newcomb recommends picturing a goal and thinking of a key hurdle that you believe you can realistically overcome.  For example, if your goal is to buy a house but you are worried about a down payment, come up with the practical steps on how to put together funds for the down payment. By coming up with a plan to overcome the hurdle, a person can achieve her goal. An advisor can help “put clarity into the mental picture,” she said. 

One point Newcomb highlighted was advisors’ role in helping clients understand how they change. An easy way to illustrate this is asking them how they’ve changed over the past 10 years. Once they’ve discussed those aspects (e.g., marriage, family, elderly parents), they may better understand they can change in the future as well.

This type of review should be done on a yearly basis, Newcomb recommended.

See Sarah Newcomb’s guest blog for ThinkAdvisor, 3 Rules for Clients to Build a Healthier Relationship With Money.