Ravi Samalad: Hi, I'm Ravi from Morningstar and joining us today is Erik Johnson. He's part of the Behavioral Insights team at Morningstar. And today we're going to discuss about the importance of behavioral coaching for advisors while they deal with their clients.
Thanks, Erik for joining us.
Erik Johnson: Thank you for having me.
Samalad: So Erik, client's goals keep changing, and our needs are constant. So how do financial advisors incorporate all these changes in the financial planning.
Johnson: So yeah, I think there should be some level of flexibility there because like you mentioned – the question like our needs are sort of constant and there is always kind of fundamental things that we need to – goals that we need – goals or even like personal needs we need to be with money. And as a financial advisor you can only help clients meet those needs. But when you think about that flexibility in terms of the strategies to meet those needs. So some are kind of more fixed, more long term than others like we know that every clients' going to need money to retire for example. So you have to have a pretty long term plan that is a little more inflexible because we know we have to save x amount of dollars over the certain amount of time.
There are those other ones that are more flexible over time where its there might be a period where you are saving for a home for example and then when you get your home then that goals been met. Or you are saving for education for your children or something like that. So I think as financial advisor it's always important to understand what are those kind of evolving needs and what are the different ways we can go about meeting those needs while maintaining the progress towards those goals. And adapting that over time based on those different needs. Also understanding what kind of a life style is that the person wants to lead. So how do you help them meet those goals while also achieving kind of the day-to-day needs that they have.
Samalad: Markets can be very volatile. So how do advisors coach investors when markets are volatile, come and redeem their investments.
Johnson: Yeah, so with volatility lot of things happen before the volatility actually occurs. It's just sort, of a natural part of human psychology that when things are kind of volatile and unpredictable we tend to react very emotionally to it and the markets are no different than that. So when you are working with clients it's not necessarily about being ready to do something when the volatility hits. It's more about preparing the client ahead of time. No matter how good our intentions are or how well versed we are in investing we're still always going to have kind of a natural emotional reaction to those kind of volatile times. So we want to prepare our clients for that moment to understand that when you are sitting down and making long term financial plans with them that's got to be part of the plan and explaining to them and making really clear that this is not always going to be easy. There is going to be times where it's very stressful, it's very difficult. So let's plan ahead for that.
Kind of key insight from behavioral science in general is just that will power is very limited and will power is often not a good strategy for trying to achieve goals. Because eventually our will power is going to break down. And it’s a same sort of thing working with our clients that when market volatility hits, they are probably not going to be at the strongest will power. They are going to want to make rash decisions to kind of fix the problem in the short term, but hurt them in the long term. So we have a variety of strategies that we've come up with to deal with that, where the number one is setting that expectation and that there are going to be challenging times no matter how easy it looks on paper it's going to be times where it's much more challenging.
And also preparing them for that moment. One strategy that we've employed and tested with some clients is we call letter to your future self. So when you are sitting down with a client making a long term plan. They kind of write this letter to that future person, that future state of themselves which might be panicking when the market is volatile. So number one you are making it really clear that this is something that is probably going to happen in the future. And that’s also something making a reference at that time sort of like remind them of their long term goals and remind them of their long term goals. Remind them this is something that’s natural and it’s a part of the investing process and that they made these long term plans, made to navigate those times. So you can kind of remind them and bring them down from that emotional state and get them back into kind of that long term plan of theirs.
Samalad: So it's says that investors should remove their emotions while investing, but I think it's easier said then done. So how can advisors deal with that.
Johnson: So like you said it's easier said than done and I don’t think you can ever fully remove emotions from investing. What you can do is just be conscious of the role emotions play and build kind of systems around your decision making so they don’t have outsized impact that you don’t want them to have. So kind of similar to last example thinking about clients and market volatility. For any of us as investors we should also prepare ourselves for times when emotions are going to override our rational decision making. So one again is just consciousness and knowing as an investor what are my weak spots. Like what are the kind of times when I know that emotions are going to play a bigger part than I want them to.
So for example maybe you are the type of person that gets really excited about something kind of like trendy investment that’s going on, that’s really kind of popular in the investing world. You tend to get really hyped on those trends and want to buy into that. So you want to have kind of a framework in place for when that time comes to sort of push back against your worst tendencies. So maybe you take more contrarian point of view, if I am getting really excited and ready to buy into some popular investment have some sort of tool ready for yourself to say well let me think about it kind of factually. Why is it that – what's the other explanation, what's the sign that says I shouldn’t do this or if I am trying to buy an investment, what's going on at the other side, like why is somebody selling this if it’s such a great thing to hold out to.
So that kind of gets you out of that emotional state and helping you think a little rationally and looking at other opinions beyond kind of the decision you may have emotionally already made. So to kind of reiterate the point. Emotions are a part of – we're human, we're very emotionally driven and we can't hope to ever really get rid of that. But we can build kind of frameworks and systems for decision making that take into account the emotions that come into play and help us kind of avoid making decisions that we'll regret later because of that.
Samalad: So speaking of investing according to trends. So how can you avoid herd mentality.
Johnson: So I think that’s another example of kind of being conscious and building in those frameworks. That’s sort of a theme in behavioral science that we understand like there are certain ways that we think and the best thing we can do is build systems around that. So herd mentality is obviously a really common one in investing and it's one of the things I think trips people up the most. And it's sort of very natural human reaction and that we are very, humans are very social and we tend to kind of naturally want to follow the crowd. Because in a lot of ways it feels like there is safety in numbers. And in many cases in life that’s true that there is safety in numbers. But investing is kind of the opposite of a lot of things in life.
So I always remember like Warren Buffet has a famous quote of be fearful when others are greedy and greedy when others are fearful. So for one we can just kind of plant that heuristic and that whenever we see something getting really popular and a lot of people going towards something. Even though you might have some sort of emotional temptation use that as kind of red flag and its like if a lot of people are kind of flocking to something that seems too good to be true well it probably is. So then kind of making your point. There is going to be a ton of information out there confirming why you should follow the crowd. So you've got to take it upon yourself thinking why should I not follow the crowd and kind of build that contrarian case. And then you can sort of make decision based on one of those like nothing is ever universal like sometimes the crowds are right and sometimes they are wrong.
But if you can contrarian yourself and just flag that and think of that as something that you should pay more attention to rather than diving into. Then you can sort of use some of that emotion to make a more of a rational data driven decision.
Samalad: So investors today are inundated with information from various sources. So how can they deal with this information overload, how can they cut out the noise and stick to their goals.
Johnson: Yes, so we have probably way more information out than we would ever need as investors. Every phone that we get comes pre-loaded with like a stock app for example. That could be a challenge for advisors, working with clients and that all the clients are sort of training to be constantly paying attention to the market always be up-to-date on the news. But we know through research that that’s usually not a winning strategy because we tend to overreact to information in the short term while kind of missing a lot of long term information. Investing is really about long term decisions, right.
So as an advisor you can't necessarily (indiscernible) people from looking at too much information and as behavioral scientists we generally think you don’t want to like block somebody from doing something. You should always give your clients the freedom to seek whatever information they want. What we can do is sort of set a good expectation or maybe a healthy habit on what that information is. So if you are meeting and making plans with a client you can sort of give them the freedom and say that this is kind of you are welcome to check whatever information you want and you are welcome to ask questions any time. But I am going to send you all the information you need on a regular basis maybe that’s weekly email, maybe that’s a monthly newsletter you send to your clients, maybe that’s a quarterly update. But you can sort of set that expectation and set that habit saying that I'll take care of the information for you in these intervals that I think is best to help you succeeding as investor. Maybe they might look at some other stuff and possible that they will get information outside of that. You are at least kind of setting the expectation and a habit of what kind of healthy amount is and also as an advisor they absolutely trust you with these kinds of things. So they'll trust you to make those recommendations and find the information that they'll need.
Samalad: You know some people acquire sudden money through lottery or inheritance. So we have seen many examples of people splurging that money and end up getting broke. So how do advisors deal with such kind of situation.
Johnson: So I think when you face kind of a windfall if you will like a larger sum of money. If you have a good long term relationship with the client, it shouldn’t be really any different than any other type of income. So like we talked about before if you have really clear long term goal set and you are really clear on kind of the lifestyle a client wants to lead and that they want money to support than that money should just support those. So if you kind of have set goals you can look at their progress on those goals and say how can this additional windfall of money help complete those goals or help those further along and similarly if you have kind of an idea what that kind of lifestyle is how does this support that, how can we fit that into what we want to do. So in some ways the psychology may work with us actually in this particular scenario in some ways there is some research people tend to be a little more responsible with windfalls at times because we look at those larger chunks of money and feel like you want to handle them more responsibly whether or when smaller amounts of money are coming in and it just feels easier to kind of like spend that a little more purposefully.
So there maybe an advantage and there is already a little bit of long term thinking with that and if you already have kind of those long term goals everything set aside then it should be kind of easier to follow those to that. One concept that makes that (hopeful) is something in behavioral economics they call mental accounting. And that’s where we tend to kind of put money in sort of these psychological buckets that are little vague in different ways rather than making sort of rational calculation of how much money goes where and that’s why having real clear goal set and really clear direction for where money is going with clients is really helpful with these scenarios. Because then if you get this big windfall of money then you can very easily separate it into those buckets of goals wherever those are. Those long term, short term goals or it's general lifestyle stuff. So if all that’s stuff sort of taken care of a windfall shouldn’t be any different than any other income and it should really just support the life that the client is trying to build.
Samalad: And if advisors want to learn more about behavioral coaching to guide their clients where can they go and are there any books or resources on Morningstar.com where they can download some stuff.
Johnson: So we actually have kind of a Behavioral Science guide for advisor. So I think if you search advisor toolkit it's called 'Simple, but Not Easy' and that should be on one of Morningstar's websites as a free download. That’s just like a short book that kind of summarizes lot of key concepts Behavioral Science as it applies to financial advising and also has a number of ready-to-go toolkits, worksheets things like that, that you can use directly with clients. So look that up on Morningstar site. And that's resource I'd like to recommend get started.
Samalad: Thank you so much for sharing your valuable insights and I hope advisors have benefited from Erik's perspective. From Morningstar I'm Ravi thanks for watching.