All of the studies and resulting data that have looked at the issue appear to agree that client behavioral management is one of—if not the most—important functions of financial advisors. In one of the seminal research studies—although not technically an inquiry into the role of financial advisors in relation to client behavioral management—the researchers concluded that of all the activities undertaken by large corporate pension fund managers, strategic portfolio allocation accounted for on average 93.6% of total variation in actual portfolio returns (Brinson, Hood, and Beebower, “Determinants of Portfolio Performance,” Financial Analysts Journal, 1995; the “Brinson Study”). There has been much debate regarding the interpretation of the data underlying the Brinson Study, but there has been little disagreement regarding the ultimate conclusion to be drawn from the data. In his paper titled “The 93.6% Question of Financial Advisors,” Meir Statman disputed the relevance and meaning of the 93.6% figure and supporting data, but nevertheless asserted the critical role that client behavioral management plays in the financial advisory relationship. He states:
“Financial advisors are investor managers. They examine the financial resources and goals of investors, diagnose deficiencies, and provide financial education and care. Their work is different from the beat-the-market work of investment managers, and it calls for different skills. The 93.6% figure does not show that the investor management role of financial advisors is important, but the role is important indeed.”
– Statman, “The 93.6% Question of Financial Advisors,” The Journal of Investing (2000); 19 (emphasis in original).
In a study first published in 2001 and updated periodically since then, including most recently in September 2016, Vanguard has undertaken to quantify the value that financial advisors provide through their client behavioral management function. The so-called “Advisor’s Alpha” study calculates that on average a qualified financial advisor adds a net return of approximately 3% annually to their clients’ portfolio returns. (Francis M. Kinniry Jr., et. al., “Putting a Value on Your Value: Quantifying Vanguard Advisor’s Alpha,” 2016). Of this net 3% incremental value, 150 basis points—or fully 50% of the “alpha” provided by a financial advisor—is attributable to what the study labels “behavioral coaching.” Vanguard defines this client behavioral management primarily in terms of managing risk tolerance and preventing emotional reactions to market movements. The remaining 1.5% of advisor alpha is comprised of a basket of functions including: asset allocation; investment cost reduction; portfolio rebalancing; asset location (taxable versus non-taxable accounts); drawdown strategies; and total-return versus income investing. No other function of the financial advisor contributes as much to the net value proposition as client behavioral management—and the 1.5% net value calculated by the Vanguard study relates only to the management of amounts already saved and available for investment by the client. The calculation does not, therefore, include any value from client behavioral management that leads to additional savings and amounts that could be invested (or that were invested as a result of productive client behavioral management).
Future Value of Client Behavioral Management
As we move toward a world-view where it is accepted as conventional wisdom that few investment managers can consistently beat the market, it will be inevitable that more emphasis will be placed on the value that a financial advisor can provide as an investor manager as opposed to an investment manager. It is also, therefore, inevitable that client behavioral management will expand beyond the narrow scope of risk tolerance and investment-transaction decisions. The market will create pressure to provide (and prove) real value in the form of holistic client behavioral management as the most fertile ground for improved financial outcomes, and this will require enhanced and expanded counseling and coaching in all areas of finance-related and finance-impacting behaviors.
Don’t be caught behind the curve. Forward-thinking financial advisors need to start implementing these client behavioral management practices with their clients now. This effort will require the cultivation of a different set of advisor skills, and new tools to facilitate this expanded area of advisor focus. Advisors and firms that implement and master these concepts early will have a distinct competitive advantage in the marketplace.
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