

Best Behavior

Financial advisers find behavioral finance a handy tool for soothing client anxiety, anticipating future needs
 – Contributing writer


As pensions dwindle and investors work to create robust portfolios, financial advisers are finding that they aren't just crunching numbers and giving advice. Sometimes, they're also serving as counselors and soothing fears.

Behavioral finance, and its closely related cousin behavioral economics, tap into research about emotional biases to better understand how people make economic decisions. In the past, economists believed that investors acted rationally on their own behalf, but behavioral finance theories note this isn't always the case. As anxieties surface, investors may not think of the long-term effect of their actions, and could actually be hurting their own portfolios.

In a recent Harvard Magazine article on behavioral economics, it stated that when it comes to actual human beings rather than classic models, "We find, instead of robot-like logic, all manner of irrational, self-sabotaging and even altruistic behavior."

Applying this thinking to finance isn't new. The philosophy was first discussed in the 1970s, and then gained prominence in 2002 when the Nobel Prize in Economics was given to a psychologist employing behavioral work. Despite being around for decades, though, behavioral finance was mainly discussed, rather than practiced formally.

Times have changed.

Across the country, and in local financial advisory firms, the field's tactics are slowly gaining momentum and being implemented to help clients balance their feelings and fears about drawing on their retirement funds, embarking on high-risk investments and planning for the future.

Minneapolis-based LPL Financial has an adviser, Randy Asmus, who gives regular seminars on behavioral finance. AXA Advisors, also in Minneapolis, recently hired an adviser with a psychology degree who focuses on behavioral finance.

At St. Paul-based Securian Financial Group, a program based on the strategy will be formally rolled out early next year. The company has already started training its advisers, sending some to seminars held on the topic at Harvard University.

"Behavioral finance is becoming important in a couple of different ways," said Tom Ibsen, executive vice president at AXA. "First, the industry has traditionally been focused on helping people accumulate wealth, but a larger percentage of the population is looking at distribution, and needing guidance in that area."

Clients fret about how much to put in each fund, whether they're saving enough or if they're moving their money around correctly, said Ibsen. Recognizing that making these decisions can be stressful helps both client and adviser plan better.

"Often there's an emotional adjustment," said Ibsen. "We have to play counselor while talking about asset allocation and taxes."

Another way the strategy is helping is with retirement decisions. With the dwindling number of pensions, and baby boomers nearing retirement, Ibsen is finding that some counseling also is needed to assure clients that their money will outlast them.

"Without the safety net of a pension, people have recognized that what they save is basically all they'll have for retirement," he said. "There's a pretty big fear factor with that switch. With behavioral finance, we provide comfort, but also education, to help people feel comfortable with their decisions."

Understanding why clients act as they do helps financial advisers create more effective long-term plans while addressing short-term emotions. For example, if a client seems unwilling to dip into a retirement fund after retiring, it could be because he or she is anxious about the transition from growing his/her money to actually spending it.

Training advisers in the practice gives a firm more tools in its kit, said George Connolly, president and CEO at Securian Financial Services, the broker-dealer arm of Securian Financial Group. The implementation of behavioral finance takes the best of classic advisory strategies, such as asset allocation and diversification, and adds a layer of client empowerment.

"We believe it's useful to help a client make their own decisions, not to dictate to them about what they should do," he said. "With behavioral research, you can see general tendencies about loss aversion, and build some decision making into an individual's program."

Advisers, too, benefit by creating more robust communication with clients, Connolly added. They can frame questions during client discussions that can give them valuable perspective on a client's expectations and anxieties.

"It's not a magic wand," he said. "But it does allow an adviser to have a more mature, more realistic conversation about the journey the client is on financially. Behavioral finance gives you a whole new avenue for communication about certainty, risk and specific types of investment."

Behavioral finance is about more than therapeutic hand-holding, however. Going beyond individual investor behavior and emotions, the field looks at financial models used in money management and asset valuation to discover patterns in investor behavior. A major focus is on overreaction to market news and the potential effect on individual portfolios.

Carol Clark, investment principal and partner at Minneapolis-based Lowry Hill and author of "Investing Psychology 101," has worked to address this kind of over-reaction, trying to aid clients in seeing the market in terms of long-term strategies rather than a series of hot stock tips and radical market fluctuations that require different, immediate investment tactics.

"Being a good investor means you go somewhat against the crowd," she said. "Whether you're managing your own portfolio or you're an institutional investor, it can be disconcerting to try to resist that pressure for short-term performance."

Behavioral finance helps to create awareness both inside and outside the firm, and see markets in a broader perspective because it creates a common language and illustrates general trends, she added.

"It's one of those things that's moving from theory to practice, and now there's just an explosion of interest in it," she said. "It can be a squishy field, because you're dealing with psychology and human tendencies, and people have to admit that maybe we're not as rational as classic economists would paint us. But, ultimately, I think it will help us do wealth management more effectively."

Behavioral finance principles put into practice:

Looking at whether an investor is consistently overconfident, and what the effect is on that client's portfolio;
Assessing correct reading of financial news and whether investor sees messages in a positive, neutral or negative way;
Determining whether investor has a tendency to "go with the crowd" in buying and selling decisions;
Assessing an investor's fear of regret, anxiety over outliving their money, fear of leaving no legacy or worry about general market fluctuations.

 – Contributing writer