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Financial Planning

Behavioral Finance and Your Clients’ Portfolios

Catherine Tsai

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Why It Matters:

  • Basic human behavior can get in the way of clients saving for the future, without clients even realizing it.
  • Behavioral finance — which explores the influence of psychology on investor behavior — offers a framework for helping clients make more rational, less emotional decisions. 
  • Awareness of behavioral finance can help you give clients better guidance on the path to reaching their financial goals.

The thing you love about your clients may also be the greatest obstacle to them reaching their retirement goals.

Your clients are human.

The choices they make about their money may not always be rational. Some decisions may be driven by emotion. Clients may need help with self-control, and they may be influenced by long-held biases toward spending and saving.

Slipping into familiar habits can happen when life gets busy or when an economic downturn strikes. While juggling families, friends, personal health, careers, short-term needs, and long-term goals, clients may easily slip into behaviors that are detrimental to their financial strategy.

Being aware of behavioral finance, or how psychology influences how we behave with money, can help you coach clients to bat away their emotions and biases, so they can stick to a diet of smart money choices within their risk appetite but also their financial risk capacity.

Hidden Factors That May Be Driving Clients’ Decisions

Biases and cognitive errors can lead clients to make money mistakes.

1. Emotion: When everyone’s rushing for the exits, it can be hard not to follow the herd. Panic selling during downturns can cause investors to exit the market at just the wrong time instead of considering stock market performance in sickness and in health. Meanwhile, hot trends can fuel fears that they’re missing out by not getting in on a buzzy stock, cryptocurrency, or latest luxury vehicle. Impulse buying and selling show there can be limits to clients’ self-control.

What you can do: Step in as a voice of reason so clients have facts to make informed decisions that fall within their risk appetite as well as risk capacity. Helping clients build financial literacy can pay off. The financially literate tend to have more savings, be less debt-constrained, and spend less time stressing about financial issues, according to a 2020 survey.1

2. Framing: Humans can be influenced by how information is presented, as Nobel Prize-winning economist Richard Thaler has described. Driving 30 miles to the next town for a free $100 gift card somehow seems more enticing than driving 30 miles across town to save $100 on a $75,000 Tesla, even though we’d save $100 either way. Mental accounting, where we tend to think of a dollar differently depending on how it’s earned or lost, could lead your clients to spend every last bit of their bonus or tax refund instead of diligently saving a little like they might with a hard-earned paycheck.

What you can do: Work with your client to create a financial strategy and encourage him or her to stick to it. People with written financial plans are more likely to have good investing behaviors, such as automating part of their income to go into savings and having an emergency fund,  according to a 2019 survey.2 Maybe having a written financial strategy makes it that much easier to follow a rational plan of action.

3. Overconfidence: You’re well aware as a financial professional that past performance isn’t a guarantee of future results, but a string of good luck during bull markets could give clients the false impression that everything they touch is gold.

What you can do: If clients are set on betting a sliver of their assets on a big idea, you can encourage them to diversify the rest of their portfolios with different types of assets, tax-advantaged accounts, and fund styles to hedge against the risk of any one big bet going wrong.

Financial Risk Tolerance vs. Financial Risk Capacity

The guidance you offer as a financial professional will vary from client to client. Knowing their risk tolerance, capacity to take on financial risk, and the reasons behind their risk tolerance will help you give them better advice.

Aggressive: These investors take on higher levels of risk for the potential of higher rewards. They may have a few decades to recover from any major losses before retirement, but watch for signs of overconfidence that could lead them to take on too much risk.

Moderate: These investors are willing to accept some risk, balanced with safer investments. Perhaps they are in their 40s and 50s, with less time to recover from big losses before they retire. Perhaps they want to build enough wealth to leave a legacy to family members or a charitable cause one day.

Conservative: These investors would rather keep what they have than risk losing anything. The financial and emotional scars left from recent downturns may have left them reluctant to move cash into investments, or maybe they are in retirement and trying to preserve assets. Determine if staying on the sidelines will be enough to give them a chance to carry out their retirement goals.

Just as personal trainers help us stick to a workout routine when the couch looks super inviting, you can help clients stick to a financial strategy, so they have a better chance of meeting their financial goals.

Things to Consider:

  • Good investing habits can lead to positive results.
  • With coaching, you can help clients counteract the negative biases, impulses, and misperceptions that influence how they spend and save.
  • Taking time to understand the “why” behind a client’s risk appetite can help you tailor your advice.

1 “The 2020 TIAA Institute-GFLEC Personal Finance Index,” TIAA Institute and GFLEC, April 2020

2 “2019 Modern Wealth Survey,” Charles Schwab, 2019 

Neither Transamerica nor its agents or representatives may provide tax or legal advice.  Anyone to whom this material is promoted, marketed, or recommended should consult with and rely on their own independent tax and legal professionals regarding their particular situation and the concepts presented herein.
Transamerica Resources, Inc. is an Aegon company and is affiliated with various companies which include, but are not limited to, insurance companies and broker-dealers. Transamerica Resources, Inc. does not offer insurance products or securities. The information provided is for educational purposes only and should not be construed as insurance, securities, ERISA, tax, investment, legal, medical or financial advice or guidance. Please consult your personal independent professionals for answers to your specific questions.