How to Quantify the Value of Behavioral Coaching?

By Helen Yang, CFA, Founder and CEO of Andes Risk

Behavioral coaching during market cycles can minimize emotionally driven decisions and improve outcomes

The industry has come to a consensus that generative AI, such as ChatGPT, will not replace human financial advisors. Investors value the emotional connection with a real person who understands them and provides essential behavioral coaching. Often, investors are their own worst enemies, driven by fear and greed, leading to irrational investment decisions that jeopardize their financial goals. 

One of the biggest value-adds of financial advisors is to provide guidance and enforce discipline during these challenging times. But how do you quantify the value of behavioral coaching? Do investors benefit equally from it?

According to a Vanguard study, advisors add “up to, or even exceed, 3% in net returns,” out of which behavioral coaching “may add 100 to 200 bps in net return,” making it the biggest component in the value of advice.

Behavioral finance is essential to behavioral coaching, but it is a vast field. Where do we start? 

Nobody wants to sit through a lengthy questionnaire or add another task to the to-do list. How can you make behavioral finance fun, easy, and enlightening for your prospects and clients?

Just like our DNA is made of many genetic markers, investor behavior is influenced by multiple behavioral factors. You can address these factors piece-meal and embed them into existing workflows.

For example, while doing the risk tolerance assessment, you can also find out if your prospect is a passive investor (buy-and-hold), a trend follower (buys when the market rises and sells when it falls), or a contrarian (does the opposite). What if one spouse is a trend follower and the other a contrarian? This insight can lead to more engaging conversations and help you navigate potential points of conflict.

Now you have assessed each behavioral factor, how do you get an overall view of the investor’s behavior risk?

Doctors assign Apgar scores to newborns to indicate their overall health. An newborn is evaluated on Activity, Pulse, Grimace, Appearance, and Respiration, each assigned a value from 0 to 2, adding up to an Apgar score of 0-10.

Similarly, for an investor’s behavioral risk, we can roll up relevant behavioral factors into a Behavioral Risk Index (BRI), a single number from 0 to 10 to indicate how likely an investor makes irrational decisions during market volatility.

An investor with a low BRI, say 1 or 2, tends to stay calm during market turmoil, taking a long-term view or even a contrarian approach, while an investor with a high BRI, say, 9 or 10, are likely to panic and make emotionally driven decisions.

The BRI is color-coded, from low to high, green, light yellow, yellow, orange and red, as shown in the table in the section below.

Since investors with different BRIs behave very differently, the value of behavioral coaching varies significantly across the spectrum. Intuitively, the higher the behavioral risk, the higher the value of behavioral coaching. But how can you quantify it?

One approach is to infer investor behavior from transaction data, but long-range transaction data is hard to get, and not all transactions are driven by emotional responses. 

An alternative is to simulate typical investor behavior during market cycles based on the investor profile and its impact on investment outcomes. The table below shows the impact of typical investor behavior for each BRI level, i.e., the value of behavioral coaching. The result is consistent with the Vanguard study. Furthermore, our results offer much greater granularity and personalized insights that advisors can use with prospects and clients.

* The value of behavioral coaching is calculated as the annual return of the baseline portfolio (for example, S&P 500), minus the “behavior-adjusted return” for a given level of behavioral risk.

It takes human intelligence to navigate these conversations, ensuring people feel comfortable and understood rather than judged. Demonstrating your unique value proposition in this way can effectively convert prospects. Once they become clients, you can use behavioral finance to deepen the relationship.

For instance, at the six-month review meeting, identify if they have loss aversion, a common behavioral bias. These insights not only keep the meetings interesting but also help clients learn and grow as investors, enabling you to provide better-tailored advice.

When a prospect decides to work with you, use an Investment Policy Statement (IPS) to document their risk tolerance, time horizon, and risk-return trade-offs, ensuring alignment. This is another excellent place to incorporate behavioral finance, helping clients understand the inevitable emotions during market cycles and securing their pre-commitment to stay on course.

If your existing clients don’t have an IPS yet, create one now to preempt potential future issues. When the market declines, refer to the IPS to remind them of their commitment to maintain perspective.

While ChatGPT may be highly knowledgeable, your unique human intelligence makes you irreplaceable for the human side of advice. It is time to leverage behavioral finance to guide your clients on a journey of self-discovery, helping them learn and grow as investors to avoid common behavioral pitfalls.

This approach will enhance your emotional connection with clients, deliver originality and unique value propositions, and distinguish you from both machines and other advisors.