Behavioral finance took a huge leap forward in 2017. Richard Thaler winning the Nobel for his work in the field focused a lot of attention on what many asset managers already know – investor emotions play a big role in how they perceive opportunities and shrink from risk, usually at the wrong time. There are some asset managers who operate from a core principle – behave the opposite of the prevailing market emotion, and you’ll reap big rewards. Any simplistic view of behavioral finance was severely tested this year.
2017 was a year where investor emotion ran rampant, and fear collided with optimism every time the markets hit a new high. Even Thaler was stumped. "We seem to be living in the riskiest moment of our lives, and yet the stock market seems to be napping," he said, soon after winning the Nobel in October. "I admit to not understanding it." He was worried, and understandably so.1
Who can make sense of a nine-year-old bull market that has tripled in value since the 2007-2008 crash? Investors seem to be shrugging off political turmoil and global volatility and betting that past performance is a guarantee of future success.
How do we apply Behavioral Finance?
In the 1989 San Francisco earthquake, segments of the Oakland Bay Bridge collapsed. One driver pulled to the side, fired up his camcorder (this was pre-iPhone), and filmed cars driving off the end of a destroyed section. When I saw the clip, playing on every news channel at the time, I wanted to scream: “Stop filming, and run out with hands waving and try to stop them!”
Unfortunately for advisors, much of what behavioral finance literature offers is definitional. In other words, it’s great at identifying problems without presenting solutions.
Investor biases are a huge problem that affect millions of people. Poor timing when making investment choices causes investors to lose billions of dollars. Not only that, turbulent markets also erode investor peace of mind and their ability to achieve their life ambitions. The advisory community has historically addressed this by advocating greater discipline and education for investors. But it hasn’t worked.
What can we do about it to try to improve investor outcomes and peace of mind?
In 2012, after watching investors and advisors chase performance (to their detriment) for over 15 years, we began creating tools and workshops to help advisors get real traction in helping advisors curb investor biases. After five years of consulting with over 400 advisors across the country, we have formalized our processes that guide advisors to transform their practices.
Instead of reacting to investor biases once it’s too late to effect change, we recommend a pro-active approach in the way that advisors interact with and guide their clients. The goal is not just to curb investor biases, but also to help investors do the opposite of the crowd and take advantage of the herd’s poor decision-making abilities.
We recommend building an investor behavioral component into your practice.
That means acknowledging that behavioral challenges are an inevitable and potentially corrosive element in investors’ lives and that new measures in how you advise clients are necessary. It also means that you position yourself as a behavioral coach who intends to comprehensively address market risks.
In 2017, we developed a guide for investors that discusses behavioral challenges and offers a suite of solutions that include 1) portfolio modifications made to address these challenges, and 2) proposed courses of action for investors to take when behavioral challenges emerge.
We refer to these actions as “Investor Pre-commitments.” For example, after extreme declines, assets that have experienced the biggest declines are most likely to realize significant gains. The goal of the pre-commitment in this example is for advisors to help investors systematically rebalance their portfolio into assets with steep declines and take advantage of “Black Friday” prices.
Behavioral Finance takes training
Over the past 5 years of offering behavioral training, we’ve concluded that just reading about investor behavioral ideas does little. For the last quarter of 2017 and during 2018, we’re offering our Investor Behavioral Workshops for Advisors and have launched an entirely new Behavioral Coaching program. These programs are designed to allow advisors to “plug-in” to advisor training and become a trained investor behavioral coach.
Why do this? Behavioral coaching can add 1.50 bps of value to an advisors’ relationship with a client, says one of the large asset managers. The payoff in a relationship that spans decades can be significant, not only in performance, but in client engagement and retention. We recommend going beyond the simple hand holding and sympathetic ear advocated by most behavioral coaches. Building portfolios that attempt to anticipate market dislocations, and having pre-commitments in place, bond advisor and client in a course of action when markets don’t behave in ways we anticipate.
1 Accessed 11/30/2017 at https://www.bloomberg.com/news/articles/2017-10-10/nobel-economist-thaler-says-he-s-nervous-about-stock-market.
2 CE Credit Designations: CFP®, CPA, AIF®, CLU®, ChFC®, RICP®, CLF®, CASL®, CAP®, ChSNC® and FSCP®
Toews is an SEC-registered investment adviser and developer of Behavioral Portfolio Design™. Founded on years of research in Behavioral Economics, Rules Based Investing, and Goals Based Investing, Toews is evolving the practice of applied behavioral finance for the investing community. Through CE accredited workshops and one-on-one coaching, Toews provides advisors with the tools needed to understand and implement Behavioral Portfolio Design™ in their practices. These skills help advisors design plans of action for investors ahead of market disruptions, comprehensively address various market risks, and add value as behavioral coaches for clients. Established in 1996, with offices in New York City and across the U.S., Toews manages approximately $1.8 billion in risk management strategies in its mutual funds and separately managed accounts. For more information visit: http://toewscorp.com/advisor-training/.
The information provided is intended to be general in nature and should not be construed as an offer of specifically-tailored individualized advice. All statements other than statements of historical fact are forward-looking statements (including words such as “may” and “expect”). Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to be correct. Various factors could cause actual results or performance to differ materially from those discussed in such forward-looking statements.
Pre-commitments serve only as suggested investor response plans and are non-binding.
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