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Protect Clients From Their Worst Financial Enemies: Themselves

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More than 20 years ago, the advanced and, indeed, essential way to succeed as a financial advisor was to build relationships with clients. Now FAs must take that principle a step further and become clients’ behavioral coach — or else struggle against a mounting tidal wave of commoditized digital advice. So says behavioral finance expert Brian Portnoy, director of investment education at Virtus Investment Partners, in an interview with ThinkAdvisor.

Helping clients overcome inborn behavioral biases — like the availability bias and the belief bias — can prevent them from making bad investment decisions. That’s critical because clients can be their own worst financial enemies simply being human, Portnoy argues.

A holistic approach pivoting on goals-based investing is the way FAs can help clients achieve wealth, which is, according to Portnoy, “the ability to underwrite a meaningful life.”

He details this philosophy as well as provides practical guidelines in his new book, “The Geometry of Wealth: How to Shape a Life of Money and Meaning” (Harriman House -June 11, 2018).

With Hartford, Connecticut-based Virtus since 2014, Portnoy has counseled thousands of financial advisors about coaching clients using behavioral finance. His book, directed at FAs, employs the three basic shapes of circle, triangle and square to represent the holistic financial planning process.

The author’s sharp angle of vision is that what constitutes a meaningful life is “funded contentment” — which has nothing to do with beating the market, he contends.

In the hedge fund and mutual fund industries for nearly 20 years, the chartered financial analyst previously held posts at Chicago Equity Partners, Mesirow Financial and Morningstar, where he was a mutual fund analyst. He has a doctorate in political economy from the University of Chicago and has lectured at the Securities and Exchange Commission. His first book was “The Investor’s Paradox: The Power of Simplicity in a World of Overwhelming Choice” (2014).

ThinkAdvisor recently interviewed Portnoy by phone. The conversation included a discussion of the provocative concept of the “less-wrong mindset,” which, he says, is maintained by “the best investors.”

Here are highlights of the interview:

THINKADVISOR: “The investor’s primary problem isn’t figuring out the market — it’s figuring out himself,” you write. Please elaborate.

BRIAN PORTNOY: Finance is an intimidating — and limiting — concept. Most people don’t need to worry about finance; they need to worry about money, not just investing because that [comes] at the end of the road, after you’ve figured out how you’re going to make a living and what your savings and spending behaviors are.

How can financial advisors help?

The highest and best use of the financial advisor in 2018 is not as investment expert. It’s as behavioral coach. This is critically important. The investment piece that advisors have typically [handled] is increasingly commoditized; and even when it’s not, it’s becoming a lower and lower margin business. The answer is to take a more holistic approach, which puts behavioral coach at the center of whatever [clients] are trying to do.

How do the advisors you meet with react when you tell them that? Do they resist or embrace it?

Some financial advisors are exactly that: advisors, not brokers. So they absolutely embrace it and are successful. There are brokers who don’t embrace it. They are and will remain very challenged in their [business] prospects.

Why is behavioral finance so important in helping clients invest?

The human brain didn’t evolve in order to make quick and savvy decisions in fast-moving capital markets. People aren’t irrational; they’re just human and normal. A lot of the behavioral biases we’re born with serve a function. In other circumstances, they might cause problems. For example [in investing], we’re selective as to the information we pay attention to; we tend to be overconfident in our beliefs.

How, specifically, should advisors be helping?

The hard part isn’t figuring out the yield curve or the price of oil, the Dow’s level or what the dollar will do relative to the euro — because at the end of the day, no one knows anyway. The really hard part is recognizing that, because we become scared and worried, we’re going to feel the urge to make what could end up as bad decisions.

But isn’t investing expertise just as important?

Choosing specific investments [should take] a much lower priority than thinking about how we’re going to modify our behavior over time through volatile markets — and after that.

To what extent does coaching actually benefit clients?

People who work with financial advisors tend to have better outcomes not because advisors know the markets better but because they’re someone on the outside who can serve as a coach and educator.

Your new book, aimed at advisors, uses three basic geometric shapes to represent the holistic financial planning process. What does the circle stand for?

The circle refers to defining one’s purpose and need to adapt over time because life is unpredictable. It represents the willingness and ability to course-correct through life’s ups and downs.

And the triangle?

[The three points] represent the three main priorities that we have in our money lives: protect, match and reach. Protect is risk management. The first step in setting broad money priorities is to think about the risks you’re taking and to be sure they’re calibrated with the goals you want to achieve.

The second point represents match.

It’s what you own vs. what you owe. This isn’t sexy and is often boring. But the gateway to financial success is to make sure you’re not spending more than you have and not getting into debt.

What about the third priority: reach?

That’s defining your aspirations — to reach for more as related to [good] things that really matter to you but that aren’t specifically about you. So it could be your religion, your nation, a particular idea that you pursue [etc.].

What does the square help visualize?

Whereas the circle and the triangle are about money broadly defined, the square is about investing, per se. The square represents things you want to be thinking about whether you’re an  investor on your own or having a conversation with a financial advisor.

What four things should clients and FAs know concerning any investment under consideration?

Growth potential, the emotional pain that’s potentially involved in holding the investment through thick and thin, where the investment fits into the broader portfolio and how much flexibility is provided to change their mind. People tend to have significantly better outcomes in [situations] where it’s not particularly easy to change investments at a moment’s notice. When they want to make a quick change, they’re able to resist the impulse.

What’s critical to know about taking risk?

Most people don’t think very clearly about risk. The first question should be: How much risk are you going to take to get a [certain] return?

Vis-a-vis risk, you write about the concept of being “less wrong.” Please explain.

All the best investors have a less-wrong mindset. They’re not gunslingers — they’re not just trying to make more. They’re looking to pick stocks and take risks when the probabilities are very, very much on their side, as opposed to just flipping coins. I strongly encourage people to adopt the less-wrong mindset to strike a good balance between potential risk and potential reward.

You say that “taking more risk increases the variability of future outcomes,” not that it increases the chances of getting greater returns. Many would disagree with that.

The conventional wisdom that taking more risk equals more returns is one of the more dangerous ideas in all of finance because it’s not true.

Should beating the market be the goal?

The game is not about beating the market. It’s not about earning more. It’s about being able to afford the things in life that really matter to you. Beating the market might have absolutely nothing to do with being able to afford those things. Beating the market is not something that’s tied to people’s true underlying goals.

“Volatility is the emotional cost of achieving the growth we seek,” you write. Clients need to be made aware of that, I would think.

Yes. It’s very hard to see your way to retirement, to compound your capital well in excess of inflation, by putting all your money in the bank and watching your purchasing power erode over [decades]. You do have to invest and put your capital at risk.

This is the chance investors take, especially when investing in equities, correct?

Stocks are volatile and very difficult to hold when they go down a lot. That’s where the advisor as coach comes in. It’s such an important element of the value they bring.

What do advisors consider their biggest challenge right now?

How to define their value proposition. There’s a lot of technology out there that very effectively and cheaply provides investment advice, asset allocation and portfolio construction. So advisors need something bigger in order to have a sustainable franchise. Otherwise, it’s hard to see where they have much of an advantage.

What’s the solution?

There are many headwinds; so how the advisor actually creates a good experience with clients is something that’s up for grabs.

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