Client behavior is a better benchmark for measuring success

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The most critical part of a financial plan is usually whether or not the client has done their part.

December is a natural time for reflection and taking stock before a new calendar year begins. Focusing on the right benchmarks can make all the difference in nudging clients’ behavior in 2020.

[More: A better set of performance metrics for RIAs]

News outlets are constantly updating the public on overall market behavior, making those measures seem like critical information when they likely have little or nothing to do with the long-range health of a client’s financial plan. As a result, clients can put far too much emphasis on the behavior of markets, and far too little on their own behavior.

As an adviser, you can help direct their attention to what matters.

In general, metrics of success should be determined based on the goal and strategy, not the market. Yes, if you have chosen funds that were meant to track certain indices then knowing how well they are performing that function is important, but the most critical part of a financial plan is usually whether or not the client has done their part, and market performance is secondary.

Behavioral benchmarks are specific, measurable behaviors that the client agrees to execute, and you can use them to keep your clients’ focus on the things that they can control.

Are they in the accumulation stage? If so, then savings-rate targets, debt-to-income goals and limiting unplanned withdrawals might be the guidelines you want to measure against.

Are they in retirement? If so, then setting withdrawal rates and benchmarking portfolio growth to inflation may be in order.

Setting these behavioral benchmarks at the beginning of the year can set the stage for end-of-year reviews that are more meaningful to the client than general market performance metrics.

Researchers at Northwestern University’s Kellogg School of Management have shown with data what most of us already knew intuitively; making changes to behavior is easier when we pin those changes to some meaningful psychological timing.

[More: It’s time to make ‘behavioral finance’ more than a buzzword]

This Fresh Start Effect is a trick of psychology that allows us to make a break from past behavior and start anew. The New Year is a perfect example. We have conditioned ourselves to think of Jan. 1 as a time when we get to wipe the slate clean and start fresh. You can use this to help your clients set meaningful financial goals for 2020, and in doing so you can set up behavioral benchmarks to review next December.

Imagine an annual review conversation that goes something like this:

“We started 2020 with a goal of reaching a net worth of $2.5M through a combination of savings contributions, asset appreciation and portfolio growth. Savings contributions were met at 60% of the planned rate, appreciation was 3%, as expected, and your portfolio grew at 1% above the target rate of 4% real return. This puts us at an actual net worth of $2.4M today, lowering the probability of goal attainment from 95% last year to 93%. The largest driver of this shortfall is in the savings rate. For 2021, let’s look at ways to improve the savings rate to reach our target.”

The market is a player in this assessment, but not the MVP. When returns are mentioned, it is in the context of a plan-specific goal, not the broader economy.

The client’s ultimate question, “Am I going to be okay?” is clearly addressed, but the onus of reaching their goals is on them, not the Dow. If a client insists on using an external economic benchmark, the one that makes the most sense is likely inflation, not the S&P.

Teaching clients to focus on what matters — not on what makes news — can be a huge value-add to your services.

Our minds will always anchor on the metrics we are shown, and our thoughts will always be biased toward that which we see and hear repeatedly. With this in mind, advisers can help their clients learn to focus on what will make a real difference, rather than on the short-term numbers that ignite fear and desire, but rarely warrant the weight they are given by the news.

By turning a client’s attention onto what they actually control (their own behavior), and how it affects their chances of reaching their long-term goals, you can use the natural forces of attention bias and anchoring to their benefit.

Sarah Newcomb is director of behavioral finance at Morningstar.