Getting Behavioral Coaching Right

Interesting analysis by Vanguard estimating that a good financial advisor has the potential to add 3% annually (net) to their client’s portfolios.  See below for the breakdown of their estimate:

Vanguard Study

By their estimation, the area where a financial advisor has the most potential to add value for their clients is in Behavioral Coaching.  I would agree that “providing support to stay the course in times of market stress” is among the areas of greatest opportunities for advisors to add value.  I am sure we all know clients that made drastic asset allocation changes towards equities in the late 1990’s, arriving just in time for a bear market, or away from equities following the 2008-2009 financial crisis, and have been very slow to return.  Such changes can cripple the financial health of an individual and family.

There are all kinds of ways that an advisor could attempt to help their clients stay the course in times of market stress.  They could show their clients the data on historical returns of the stock market.  They could show their client data with the percentage of rolling 3, 5, and 10 year periods where the stock and bond markets have produced positive returns.  They could give reasons why they personally believe that it makes sense to be bullish over the coming year.  They could cite the views of a well-known “expert” who believes that the market is going to rise from here.  They could share behavioral finance research with the client to try to persuade them that they are being irrational.

Some of the above approaches may have their time and place, but ultimately, I believe they are insufficient to keep clients from making the big mistakes—the types of mistakes that alter their standard of living in retirement.

In my view, an absolutely critical component to helping clients stay the course in times of market stress is to have an asset allocation that can adapt to different, even scary, market environments.  Most strategic asset allocations won’t cut it.  They are too static and too dependent upon bull markets in the stock and bond markets.  I will be the first to admit that being a perma-bear has been a losing proposition over time.  However, there must be some portion of a client’s allocation invested in a tactical strategy that can play defense.   Take the following as a sample allocation:

  • 25% in fully-invested global equities
  • 25% in fixed income
  • 50% in a Global Tactical Allocation strategy driven by relative strength

What if that 50% in Global Tactical Allocation had the ability to be heavily focused on equities in favorable equity markets.  Then, the majority of the time the client is going to have a moderately aggressive allocation in order to participate in good markets.  However, the client has the peace of mind that a meaningful portion of their overall allocation can deal with major bear markets.  This peace of mind will minimize the chance that they will demand wholesale changes to their overall asset allocation at exactly the wrong time (because a portion of their asset allocation is already shifting as dictated by relative strength) .  The last two bear markets are always going to be top of mind for this generation of investors.  Permanently defensive strategies (like a constant allocation to gold) are not the answer.  Strategic asset allocation falls short.  However, a relative strength-driven global asset allocation strategy does a much better job at providing a robust long-term solution for clients.

The relative strength strategy is NOT a guarantee.  There may be times where all investments and strategies are unfavorable and depreciate in value. 

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