February 19, 2018 7:14 AM

If you’ve been in the profession long enough, you’ve likely encountered some variation of the saying, “Diversification means always having to say you’re sorry.”

The crux of this position is that by diversifying investments, you are mitigating risk, but at the expense of putting all your eggs into that year’s winning basket. When the markets fall, even diversified clients lose money (although not as much). But if markets rise, a diversified portfolio won’t perform as well as some high-flying stock sector.  

However, clients who understand the purpose of their investment portfolios won’t be seeking an apology for diversification.

Advisors who think of themselves as “behavioral investment counselors” are prepared to have tough, but necessary, conversations with clients about risk, reward, and the meaning of investments.

What is Behavioral Investment Counseling?

Behavioral investment counseling is part of the evolution of the financial services profession and the advisor’s role in it, says Kris Venne, CFP®, director of financial planning at Ritholtz Wealth Management in New York City. Venne sat down with The American College of Financial Services for a series of interviews on modern wealth management, which can be viewed via the Granum Center for Financial Security

A behavioral investment counselor is not just a title, Venne says, but a description of the client/advisor relationship. As the act of selecting investments becomes more commoditized, creating an efficient portfolio becomes a less valuable activity for the advisor. The advisor’s value shifts to working with clients to create a goal-oriented financial plan, and using the investment portfolio to make the plan happen, all while staying the course amid the highs and lows of the markets.

Essentially, behavioral investment counseling adopts the idea that investor behavior – not the markets – determines an individual's wealth prospects.

Client buy-in is a big part of this. Clients who do not understand that, philosophically, they are not trying to “beat the market” with their investment portfolio will become upset when they see the Dow Jones industrial average or Standard & Poor’s 500 index performing great, only to find that the returns on their investment statement don’t match domestic market gains.

The advisor’s role, says Venne, is not to outperform the market, but to produce market-based returns.

“Benchmarking yourself to the domestic stock market of your choice tends to be problematic,” he says. “The client might not need to match the S&P 500 returns to meet his or her goals. Communicating this early on sets a tone for a much more successful relationship, since the client is going to own a diversified portfolio with assets across the spectrum. An educated client who understands the goals and the plan will know not to panic or overreact when they see a statement with returns that are below a domestic market benchmark.”

Kris Venne talks about behaviroral investment counseling and evidence based investing.

Making the Best Use of All Available Evidence

Clients generally want to ensure that their life savings and investments are enough to sustain them to – and through – a long, healthy retirement.

When it comes to investing, in most cases the best thing clients can do is stay out of their own way. There is plenty of evidence to back this up.

Consider that over the course of a century, the Dow moved from 68 on January 2, 1900, to 10,787 at the end of December, 2000. This performance happened through multiple recessions, a depression, two world wars and other international conflicts, an energy crisis, nuclear threats, disruptive inventions, and so much more.  

“Over time, consistent investment in a diversified portfolio of stocks works wonders,” says Robert Johnson, former president and CEO of The American College of Financial Services. “Generally the best thing to do when the market goes crazy is absolutely nothing.”

Once clients understand that the objective of their investment portfolio is not to beat the market, and they’re not paying an advisor to pick the “right” stock or produce the maximum returns over time, then it becomes clear that the value the advisor brings is to help clients make thoughtful, goal-oriented financial decisions and have the confidence to stick to them even during turbulent markets when the client’s instinct is to make drastic changes.

With evidence-based investing and a strong, goal-oriented financial plan that clients understand, you’ll hopefully get to take “I’m sorry” out of your vocabulary and replace it with “You’re welcome.”

Understanding Modern Wealth Management

An education in evidence-based investing and behavioral finance will prepare you to help clients reach their financial goals, even in the face of situations – both client- and market-driven – that may otherwise become roadblocks.

Here is a quick video lesson on the bucketing approach, a useful way to incorporate behavioral finance into investment management and get clients to think about their investments in a different way.

If you like what you see, you might want to learn more about the new Wealth Management Certified Professional® designation, or WMCP®, which focuses on evidence-based research and what advisors need to know to develop efficient, goal-based investment portfolios.

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