Executive Summary
In today's competitive environment, it is increasingly popular for financial advisors to talk about “behavior management” as a key value proposition for clients, as more and more studies have come out (e.g., Morningstar's Gamma, Vanguard's Advisor Alpha, and Envestnet's Sigma) showing that financial advisors can often more-than-recover the entire cost of their advisor fee just by helping clients to stay the course, not succumb to their investment biases, and close the behavior gap. However, while financial advisors may create value for clients through such hand-holding efforts, it's not clear whether marketing "behavior management" is actually an effective way to show our prospective forward-looking value to get clients to work with us in the first place. And, in fact, the message it sends could be driving prospective clients away!
In this week’s #OfficeHours with @MichaelKitces, my Tuesday 1PM EST broadcast via Periscope, we discuss why hand-holding is not an effective value proposition to communicate in order to get new clients, particularly in light of the way it forces prospective clients to awkwardly admit to themselves they've made mistakes in the past (in a manner they may not want to do!).
To understand why “You need an advisor to help you manage your behavior” is not an effective value proposition to win clients, put yourself in the client's shoes for a moment. Imagine a typical affluent individual who is approaching retirement with a $1 million portfolio, knows they need some guidance on making the transition (Social Security timing, retirement projections, etc.), and is perhaps even aware they've made some mistakes along the way (e.g., getting caught up in tech stocks during the late 90's, or a bad rental real estate purchase during the housing bubble). Such a financially successful individual may see the message "research shows bad investment behaviors can result in 1.5%/year or more of performance drag"... but being already financially successful, is more likely than not to assume they are one of the above-average individuals not being fully impacted!
Of course, the advisor can try to "convince" the client of the depths and extent of their problematic investment behaviors... but this can actually sour the relationship even more! For instance, imagine a client that did get caught up in tech stocks and the housing boom, and the prospective advisor says "Well, one of our primary value propositions is to help you manage your behavior so you don’t make those kinds of big mistakes again, that in the future could derail your retirement." From the client's perspective... mistakes may have been made, but this can feel like rubbing it in their face! And if a couple is involved, where usually one spouse is primarily responsible for managing their assets, now the advisor is asking that person to acknowledge, in front of their spouse, that they’re so bad at investing, and so hopeless and incapable of learning, that the only solution left is to just walk away and hand it to you, the advisor, to manage instead! Which to say the least, is an awkward conversation for any couple to have!
On the other hand, the reality may be that there's a niche of clients out there who already have internalized this message, and are looking for an advisor for these reasons (we may even see a lot of these clients since they tend to seek us out knowing they need help). But in the end, this may still only a small subset of investors. For the rest (who may be below-average investors, but they don’t know or realize it, or they still think they can improve and get better), trying to convince them that they need behavior management is doomed to fail because it requires them to make a very negative change about their own self-image… and most people just don’t want to do that! And it completely eliminates your chance to work with clients who simply want to pay you for your advice and expertise about all the other financial planning value-adds that we can bring beyond the investment portfolio and remedying investment behaviors!
Ultimately, the key point is to that framing hand-holding as a financial advisor value proposition may not always work, and, in some cases, may even alienate many of the prospects you are trying to win over. This may be true even when managing behavior actually is valuable for a client who is inclined to make those common investment mistakes (and, as a result, helping clients actually manage their behavior could be a good way to retain clients), but that doesn't necessarily mean that behavior management is a good way to convince clients to work with you in the first place! Or stated more simply, be wary not to underestimate the power of denial, for those investors who don't want to admit to themselves - and their spouses - of the mistakes they've already made along the way!
(Michael’s Note: The video below was recorded using Periscope, and announced via Twitter. If you want to participate in the next #OfficeHours live, please download the Periscope app on your mobile device, and follow @MichaelKitces on Twitter, so you get the announcement when the broadcast is starting, at/around 1PM EST every Tuesday! You can also submit your question in advance through our Contact page!)
#OfficeHours with @MichaelKitces Video Transcript
Welcome, everyone. Welcome to Office Hours with Michael Kitces.
For this week's Office Hours, I want to talk about the rising popularity of financial advisors discussing behavior management as a key value proposition for clients. You know, usually framed us, "We'll help you manage your behavior and avoid selling out at market bottoms." Which frankly is something I think a lot of us as advisors have advocated as part of our value proposition for a long time, but it seems to be getting a lot more popular in recent years. And I think, in part, that's just because we're starting to use it as a way to differentiate from robo-advisors and technology. You know, saying, "They just allocate your portfolio, but they won't be there to hold your hand when the bear market comes. I the financial advisor will be here to help you, keep you from making a mistake and selling at the wrong time."
And I suspect part of the rising popularity of talking about behavior management is just because most of the studies coming out these days about the value of a financial advisor attributes a significant portion of the advisor value-add to that behavioral management component. You know, we've had studies, Morningstar's Gamma from David Blanchett, Vanguard's Advisor Alpha, Envestnet's Sigma, each attach as much as half of the total advisor value-add to the behavior management component, closing the so-called behavior gap.
After all, with a behavior gap as much as maybe 1.5% a year of inferior performance with ill-timed investment decisions, depending on whose research you're using, if the advisor can help a client stay the course and close that gap, then, in theory, if all-in advisory services cost 1.5%, your entire fee is "free" because it's covered by the behavior management piece alone. And all that other financial planning advice (retirement and tax and other stuff) is just gravy. It's pure value-add on top.
But the problem is that, while it may end up being true after the fact, the client would have sold at the bottom but didn't, ends up making our entire advisory fee back in the long run just from an intervention of one crucial moment that matters, or even more generally just because the advisor helps clients overcome all those behavioral finance biases that distort investment behavior over time. I don't think it's an effective way to show our prospective forward-looking value to get clients to work with us in the first place. Because, ironically, the biases that impair the decisions of some investors also impair their ability to realize they need help and should pay for it in the first place.
The Mother Of All Biases: Self-Confidence And A Positive Self Image [Time - 2:37]
To understand this "You need an advisor to help you manage your behavior" framing better, let's imagine that you've decided you want to hire a financial advisor. You're getting close to retirement, you know you need some guidance about proper timing on claiming Social Security, wouldn't mind a second opinion just confirming you've got enough to retire and your spending is reasonable, and you realize that you probably need some help with your retirement portfolio because, looking back, you made a few mistakes over the years. You were a little too exuberant about tech stocks in 1999 and got hurt a little. It was only last year you finally sold that ill-timed rental property you bought in 2006 that got slammed in the financial crisis and took a decade to recover its value. Now, fortunately, you are ready to retire on your retirement savings and you've accumulated a very healthy $1 million account balance. So clearly it hasn't all been bad. You saved and invested your way to 1 million dollars.
And so you start going to shop and you check out the website of some of the financial advisors and you see this value proposition, "Our value is helping our clients manage their bad investment behaviors which research shows can be 1.5% or more per year of investment drag." So the first thing that investor, that prospective client probably thinks is, "Huh, I wonder how much I've underperformed. I've never really compared it to anything else. I don't know. I guess I did lose some money on those tech stocks back in 1999, and that rental property obviously didn't work out very well, but I have accumulated $1 million for retirement. And the media says that most people aren't going to have enough to retire. So I must be better than average. Maybe I've been losing 0.5% a year on average."
So, the first problem you'll notice is that while we may talk about a behavior gap of 1.5%, the prospective client assumes that must be other people, not me. Because the typical affluent client already knows that they have above average wealth and retirement savings, and so they're going to naturally presume they must be above average investors. In truth, it's more likely that they had above average income or above average savers, not necessarily because they were above average investors, but most consumers don't know the difference. They don't do the math on savings versus investment performance and calculated time-weighted, dollar-weighted returns to figure this out. There aren't that many consumer tools that can show you your investment results relative to a benchmark.
For instance, retail and online brokerage platforms certainly don't show you. If they did, more people would realize how bad they are and stop trading, which is not good for their business. So most platforms don't give good tools for self-directed investors. Most consumers don't know how good or bad they really are at investing relative to a benchmark, or they can't distinguish long-term investment results from long-term savings behavior and the relative contribution of each.
Of course, this isn't the end of the process for the potential client evaluating the advisor. Perhaps this whole behavior management thing sounds kind of appealing because the investor does recognize bad tech stock buy in 1999, bad real estate purchase in 2006, assumes he's probably losing 0.5% a year, which still matters, so he and his wife come into your office for a potential meeting.
And as an advisor, you start asking them about their needs and their goals and you start asking them about their investment experience, and they mention the 1999 tech stock losses and that 2006 rental property fiasco. And as the advisor you start pushing, "Well, one of our primary value propositions is to help you manage your behavior so that you don't make these kinds of big mistakes again that in the future could derail your retirement, right? Because I want to understand what's at stake here. You could derail your retirement if you make one of these mistakes once you're retired and you're exposed to sequence of return risk."
But now I want you to think about this from the client's perspective. The client says, "Whoa, whoa, whoa, whoa, whoa, okay, we've made one or two mistakes along the way. Who hasn't? But I'm not going derail my retirement. I'm proud of what I've accomplished. I've done a pretty good job to get our family to where we are today." To which the advisor responds, "Well, I know you've done some great work saving and investing already to get to where you are, but as you pointed out, you did make some mistakes with those tech stocks back in 1999 and that real estate property. And I suspect if you measured your results, you'd find you've already been giving up 1% or 2% a year in returns."
And the client says, "Okay, I admit that I made some mistakes in the past but you don't have to rub them in my face. These were stressful times for our household. I had to get a side job for 2 years in 2004 to make up the money we lost from the tech crash so we could put our youngest through college. And frankly, we bought that rental property in 2006 because we were still trying to make up for lost time. But we've gotten through that now. We have enough to retire. I've learned from those prior mistakes. I'm not going to do that anymore."
And the advisor says, "Well, you know, we've worked with a lot of clients who said that but I've been an advisor for 20 years, I've seen how our clients react in times like the tech crash in 2000, the financial crisis of 2008. I've had a lot of clients who said they weren't going to make a dumb mistake and sell at the bottom but when the moment comes, you're not thinking straight. Emotionally, these bear markets can get really scary and a lot of people make irrational decisions. That's why it's so important that we will be here to hold your hand through it."
And the client responds, "Wait, did you just call me dumb and irrational in front my wife? You know, I put myself through college, I built my first business with my own 2 hands, we put two kids through college, paid in full, and we managed to save $1 million. So maybe I don't have your fancy investment strategy, but I think we've done pretty damn well without you already and I don't need to sit here and be insulted."
It's funny how that conversation can go sideways really fast, isn't it? Because the fundamental problem that starts cropping up, the tension that gets created with this approach of hanging our hats on the behavioral finance component is that it requires the prospective client to admit, to acknowledge, and to embrace that they've made mistakes. That they made bad mistakes and that they're so hopeless that they won't be able to stop themselves from making those mistakes in the future and the only way to be saved is to let you the advisor do it instead. And if it's a couple where usually one spouse is primarily responsible for managing assets, you're asking that person to acknowledge in front of their spouse that they're so bad, so hopeless, so incapable of learning, that the only solution left is just to walk away and hand it to you the advisor to manage instead.
And the end result, in most situations, I think you're going to find that most clients at best get defensive and then decide to walk away from you, and at worst are actually insulted when you try to make your case about the value of behavior management. Not because the point that you're making about their investment stakes and behavioral issues isn't true, it may very well be, but making it a core value proposition requires the prospect to admit to themselves and their spouse and their loved ones that they failed and that they failed beyond the point of recovery. And that's a hard thing for anyone to admit, even to themselves, much less to anyone else. We try to convince us of our failures, than to admit it's a problem and hire the advisor. Which means as the advisor, you don't get the client by leading with, "We'll help you manage your investment behavior," because it's a situation where you can only win and prove your value proposition by dragging down your client's self-confidence and self-image in the process.
Investment Behavior Management Is A Niche, Not A Mainstream Value-Add [Time - 9:32]
To be fair, the reality is that there is a subset of clients who really are this bad at investing and they know it, if only because they made the mistake over and over and over again and they really are ready to just walk away and let go. And you don't have to prove to them that they're bad at investing and suffer from behavioral biases given their own result. And so it's not to say there's a behavior gap, these are clients most likely to say, "Yeah, you know, every transaction there's a buyer and a seller and a winner or a loser, and I'm usually the one on the losing side that gets it wrong."
For this type of client, the one who's already surrendered their problematic investment behaviors because they sold at the bottom in 2002, they sold at the bottom in March of 2009, they sold when the news came out about Greece and then missed the rest of the run-up, all the stuff that's happened in the past couple of years. With this type of client who's already surrendered to the problem, absolutely, it's a value-add to help them, and there's nothing wrong with showing them your value proposition. Because for this type of client, when you say, "I'll be there to hold your hand so you don't panic in the next bear market," they'll reply, "Yeah, I know I need the help. I blew it in the tech crash. I didn't get back until '07. I blew it again in March in 2009 and sold it and I've been out for 9 years. I just can't do this on my own."
And the reality is that we as advisors do see a lot of these clients because frankly, they're the ones who seek us out. Because, as we said, they know they're bad at making investment decisions, they know they're bad at managing their own portfolio, they know the results have been bad. They've accepted this about themselves they need to make a change, given this, you know, string of bad results, that's why they contact us as an advisor and say, "I need to work with someone to get some help."
But in the end, I fear this is only a small subset of investors. Yeah, the behavior gap data in the aggregate tells us that a lot of investors aren't very good at investing but most of them don't know. They don't even have good tools to measure, and they certainly haven't acknowledged it about themselves, accepted it, changed their self-image to the point of saying, "Geez, I just have to stop touching this stuff all together because all I do is turn gold into lead instead of the other way around."
For the rest, they might be below average investors, but they don't know how to realize it, particularly in a bull market where their account balance goes up every year. Or maybe they think they can improve and get better even if they've made past mistakes. And trying to convince them that they need behavior management is doomed to fail because it requires them to make a very negative change about their self-image, and most people just don't want to do that. Living in denial may be an unfortunate problem, but telling someone in denial about a problem to stop being in denial about a problem rarely actually makes them stop being in denial about the problem.
Which means to me the whole idea of leading with, "We'll help you manage your investor behavior," is, I think, really more of a niche solution than a mainstream one. For that small subset of investors who really are bad at investing and they know it and they've accepted this about themselves and they want help and they want to delegate, great, serve them, help them, give them the value they need. But for the rest, again, I'm not saying we don't add value by helping our clients make better investment decisions, but saying your value proposition have to only work with those who have to first admit they're terrible at this themselves may be more limiting than you realize about who you can work with.
And, even worse, it risks obfuscating, it risks distracting, it risks completely eliminating all the other value that we can provide and all the other clients who just want to pay us for advice and expertise about all the other parts of the financial planning value-add: the retirement expertise, the tax expertise, guides about insurance and estate decisions, help with cash flow and budgeting, prudent savings and spending habits, you know, all those things we bring to the table. I love Mitch Anthony's framework for this, in particular, that the value of financial advisor is: organization, accountability, objectivity, proactivity, education, and partnership. Six powerful value-adds for clients that are all predicated on having a good financial planning relationship and may indirectly impact behavior but aren't built around the idea of saying, "You need to hire me because you're too incompetent to do it yourself."
Again, by all means, let's keep adding real value to ongoing clients by helping them avoid problematic investment behaviors and biases that damage their portfolio and long-term returns. We may retain a lot more clients and we could sit down with them and say, "Remember that time in 2009 in the spring when you wanted to sell everything and I convinced you to stay in? Look at what we've accomplished in the nine years since." It's a tremendous value to retain clients.
But just because it's valuable to retain clients and you can prove after the fact that you added value with behavior management, doesn't mean it's necessarily going to be very effective to market hand-holding and behavior management as an upfront value proposition for an advisor. Because, in the end, it's only compelling to that small subset of clients who are really willing to acknowledge and accept that they're so bad at it themselves and so hopeless and incapable of learning that they have to hand off their portfolio to you. Which I fear just isn't that many people, if only because denial is still one of the most powerful behavioral biases of all.
I hope that helps a little as some food for thought about communicating the value of advice to clients and what may or may not attract clients to your advisory firm. This is Office Hours with Michael Kitces. We're normally 1 p.m. East Coast time on Tuesdays. We're a little bit late this week, but thanks for joining us at the unusual time, and have a great day.
So what do you think? Is there a problem with selling behavior management as a financial advisor value proposition? How do you discuss avoiding behavioral mistakes with clients? What is the best way for an advisor to describe their value add? Please share your thoughts in the comments below!
