How to Use Behavioral Finance in Asset Management, Part II

Yesterday, I laid out the ways we think about and use Behavioral Finance at RWM in the practice of running a wealth management firm. That discussion was about what we do to manage our own cognitive and behavioral issues.

Today, I want to focus more broadly — on how we have built a firm to use what we know from behavioral economics in the work we do with clients.  What follows is an eclectic, incomplete list of examples from our practice. Nothing here is a secret — all of us have discussed these publicly. Collectively, they add up to better behavior from clients, with the highest likelihood of meeting financial goals.

RWM’s clients experience a broad variety of these, ranging from modest nudges, gently shifting people towards better behavior, to others more robust and explicit behavioral controls. The goal of these are to prevent all of our natural instincts from interfering with our portfolios. Its not that people are stupid — our clients happen to be a very smart collection of accomplished and successful people. But the key word is people, and all of us are subject to the same hard-wired traits that while great at making humans the dominant species on the planet, interfere with our success in the capital markets.

What follows are just a few of the ways we work to outsmart our own wetware:

1. Asset Allocation/Diversification: Let’s start with the big one. We use an evidence based approach based on academic research and data. That means we are not alpha-chasing stock-pickers, as we know this is a poor probabilistic risk. Instead, our portfolios are broadly diversified, global, low cost, mostly indexed holdings. We have modest tilts within the portfolios and our international exposure mitigates home country bias.

2. Portfolios Names: A modest nudge with an outsized impact. The traditional naming of accounts (Conservative, Moderate, Aggressive) rubs some people the wrong way (Aggressive? or “I am not a Conservative”). So instead, we named them based on how far various NASA missions travel: Mariner (inner solar system: Mars, Venus and Mercury), Pioneer (Jupiter), Voyager (Saturn, Uranus and Neptune, and beyond our solar system).

3. Milestone Rewards: The average holding period of a mutual fund is 3.3 years. Rather than let this “3-year itch” cause undue turnover, taxes, etc., at the 3 year mark we lower clients’ fees by 15 percent. To qualify, they must have shown good behavior (e.g., no day-trading their accounts, or selling their EM because they heard something bad about Turkey).

4. Financial Literacy Limitations: Research shows financial literacy has a short shelf life. After about 6 months, it fades. So we constantly keep our clients informed about the things we know that matter — and those things we know do not — for the markets, the economy and their portfolios. We put together a quarterly conference call for all clients  where I delve into those topics in (painful) detail. They get regular emailed updates with just our best commentary (including our podcasts and favorite other voices). All of our client facing advisors follow the 12/4/2 rule of regularly speaking updating clients, reviewing life changes, and performing a full revisit of their financial plans. Speaking of which:

5. Financial Planning: We build into our practice the idea that every client’s financial plan is central to their long term success. Even before a prospect becomes a client, we are focusing on a few planning concepts: that money is a tool that can be used to accomplish specific goals; that the purpose of investing is part of a broader plan to achieve those specific goals; and lastly, that good investing is supposed to be boring, and this is not a competition or for entertainment purposes.

6. Communication/Debunking: We spend a lot of time responding to client requests for information about things they read/heard/saw elsewhere. Many of our columns and blog posts, and much of our quarterly conference call comes directly from these client requests. We have examined the Hindenburg OmenNYSE margineconomic conspiracy theoriesbuybackssentimentsingle-factor indicators and so many others as the result of their questions. Helping people properly understand reality (to paraphrase Ray Dalio) is one of the most important aspects of our jobs.

7. Goaltender: There are plenty of tactical portfolios out there, trying to capture alpha. Not ours. Instead, we have created a portfolio designed to be an emotional release valve. Based on published quantitative research, was designed to: a) let investors leave their main pool of investment capital alone during periods of volatility and larger drawdowns; and b) allow cash withdrawals to occur from bonds that are (usually) rallying versus stocks that are (usually) selling at distressed prices.


I do not think I am giving away any secrets when I share these things – even if we opened our kimonos completely and revealed all of our “secret” stack of technology, philosophy and portfolios.

Our real secret sauce? The combination of our culture + hardcore commitment to the philosophy we espouse — thats an unbeatable pairing for any firm to enjoy.



Coming tomorrow: How Behavioral Finance helps when we interact with the public


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