You know that friend who always arrives 15 minutes late, so you tell him the movie starts at 7:15 when it really starts at 7:30?

Advisors who use a strategy they call policy-based financial planning do something like that. A good advisor knows that, while you cannot change human nature, you can use a client’s habits and behavioral biases to craft a financial plan that works for him.

For example, some people have a bias dubbed mental accounting, treating money differently based on its source or purpose, which makes it difficult to save intelligently when their cash is all in one account. So a policy that splits their funds into buckets — a vacation fund, an emergency fund, a fund for the children’s education — can capitalize on their behavioral bias and help them save.

“They can embrace the idea because it comforts them to look at these individual accounts and see they’re making progress,” says advisor David Yeske, managing director of Yeske Buie, with offices in Vienna, Va., and San Francisco. But when the money is all lumped together, they have trouble making prudent financial decisions.

The trick, he explains, is in creating financial policies, or rules, that account for the clients’ own biases or behaviors.

“We all have habitual ways of thinking and acting,” Yeske says. “If we want to make changes, we have to overcome those habitual patterns, and that is hard to do. So you have to understand what a client’s personal bureaucracy of habits looks like in order to structure financial planning policies that act on her needs.”

Yeske says people exist on a spectrum. And while a smart policy isn’t going to magically turn a spendthrift into a disciplined saver, it will nudge the client down the right path. “Human nature is what it is, but if we can just get a shift in a positive direction, the person’s going to be better off,” he says.


A good policy should return an unambiguous answer for clients even if circumstances change, so it should be structured around percentages and other adaptable targets. For example, a young client (or a client’s adult child) who needs a strategy for saving might have a four-part policy that sounds something like this:

  • I will save the first 10% of every paycheck.
  • All of that will go into my emergency fund until I amass three months’ wages.
  • After that, the savings will go into a retirement vehicle up to the maximum contribution.
  • Any remaining savings will go to a supplemental retirement account.

Yeske’s observations on policy-based financial planning are among the insights he has developed with his wife and business partner, Elissa Buie. They appear in a recent book, Investor Behavior: The Psychology of Financial Planning and Investing, by H. Kent Baker and Victor Ricciardi.
At more than 600 pages, the book has 30 chapters written by investment professionals and academics. “The majority of the content focuses on the decision-making process of the individual investor,” says Ricciardi, a finance professor at Goucher College in Baltimore.

The book tackles a wide array of subjects, including the effects of religion on investment decisions; the neuroscience of financial decision-making; post-crisis investor behavior; and the real world of trader psychology.


The famous Warren Buffett quote — “Be fearful when others are greedy, and greedy when others are fearful” — is basically a more poetic version of “buy low, sell high.” Still, many individual investors (and even professional financial advisors) fail to follow this strategy.

In fact, some of these investors are so predictably illogical — entering and exiting the market at precisely the wrong times — that they represent a major challenge for advisors. How can you get clients to follow winning long-term investment strategies?

“If you can somehow create a portfolio acknowledging that you’re not going to be like that — you’re not going to sell when the price goes down, you are going to take on more risk than the market — then when everyone else does these things, you’re going to benefit,” says Gregg Fisher, founder of New York–based advisory firm Gerstein Fisher and another contributor to the book.

Fisher recommends watching mutual fund flows and other market indicators and making counter moves. In 2009 and early 2010, in the middle of the financial crisis, his firm cashed in its clients’ gold exposure (as the precious metal was soaring), trimmed bond exposure and bought assets that had declined the most during the correction: U.S. growth equities.

“You could think of it as simply rebalancing, but that’s not quite elegant enough,” Fisher says. “It’s contra-trading and looking for sources of risk — the idea of investing in areas that investors themselves would not normally enter, embracing the risk others won’t.”

Easily said, but most investors find this psychologically difficult. So how do you persuade leery clients to tilt into the risk rather than pulling out?

Fisher recommends laying the groundwork during calm times. Instead of stating opinions or beliefs, do the research and present facts and evidence. Finally, he says, share experiences rather than giving advice. An advisor offering concrete examples of what has worked, or not worked, for other clients can be very effective.


A clear understanding of a client’s personality and personal history with financial risk is essential for gauging tolerance. Defaulting to a set portfolio — like a 60/40 mix of stocks and bonds, for instance — provides advisors with an easy out.

But individual investors don’t necessarily fit a portfolio neatly. They have conflicts that can be emotional, historical or even relationship-based, stemming from disagreements between husband and wife, says CFP Douglas Rice, an assistant professor of business and management at Notre Dame de Namur University in Belmont, Calif., who wrote a chapter with Ricciardi on investor risk.

And tolerance can change over time, influenced by a variety of factors: economic shocks, such as the financial crisis; important life events such as the birth of a child or the loss of a job; or even a person’s mood. People who suffer from seasonal depression avoid financial risk during the cold, dark winter months but are more willing to accept riskier financial choices in the spring and summer, according to a 2012 study done by Lisa A. Kramer of the University of Toronto and J. Mark Weber of the University of Waterloo.

Advisors must therefore adjust clients’ budgets to match their risk tolerance — rather than vice versa, Rice says.Remember, he adds, there will always be a conflict between a client’s goals and the degree of risk he or she is willing to take to reach those goals; the advisor’s job is to help clients resolve that conflict.

“Start with the goal that you’re trying to accomplish with the portfolio,” Rice advises. “Determine the rate of return needed to meet that goal, and then explain to the client what risk they would have to take on to get that return.

“Then back into whether they would accept that,” he adds. “If not, then you need to adjust the goal down to a level where that risk is acceptable to them.”FP

Carol J. Clouse is a financial writer in New York.

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