How educating clients can benefit a practice

Register now

Helping build and protect clients’ wealth is what the best advisors do. But in addition to investment strategies, there's another lever to pull for better outcomes: teaching financial literacy.

Advisors have the expertise and opportunity to provide a holistic perspective to clients, which includes an education in finance that will help them make smarter decisions and promote healthier money habits.

A recent study by Spectrum Group found only 15% of affluent Americans said they felt “very knowledgeable about financial products.” Even among the ultra-high-net-worth set, less than half said they felt “very knowledgeable” and high-income women reported even less confidence than men. The world of finance can certainly be murky.

Overall, the nation's wealthy are expected to add to their growing fortunes in the years ahead.
1 Min Read

Financial literacy impacts almost every level of investing, from stock market participation rates to retirement planning to portfolio diversification. It even influences whether someone utilizes financial advice in the first place. As you might have guessed, the greater the client’s financial acumen, the more likely they are to delegate at least part of their portfolio to an expert.

An important aspect of financial literacy is behavioral finance. Most investors have inherent biases and without a financial expert to detect and correct these biases, clients may inadvertently derail their long-term financial objectives. Broadly speaking, there are two types of behavioral biases observed in investors: cognitive biases, caused by faulty logic, and emotional biases, caused by acting on feelings rather than facts.

Biases have potentially far-reaching consequences for clients. Researchers call these consequences household portfolio choice puzzles. Behaviors include:

• Non-participation in equity markets

• Low portfolio allocations to equities

• Home-country bias

• Overweighting own-company stock

• Portfolio under-diversification

All five of these puzzles can be solved, in part, through utilizing a financial expert and having the appropriate financial education. For example, mentioning to clients that the average American investors’ portfolio is almost 75% U.S. assets can provide an illuminating example of home-country bias. Another example is the concept of under-diversification. It’s important to explain that inherently, a single stock has more risk than a basket of stocks.

How can advisors help clients improve their knowledge but also change their behavior?

In general, research shows that attempts to teach financial education are only weakly linked to positive changes in behavior, which is where financial advisors can play a pivotal role in this process. By providing small, manageable tidbits of education to clients at the moment they are making an investment decision, the odds of achieving behavioral change increase.

Less is more. Information should be delivered in small parcels. Research has shown that small, timely interventions can have a greater impact than a large amount of information.

Keep it relevant. Information should relate to what the client is trying to achieve. For example, explain how inflation erodes the value of cash if the client’s best interests are not being served by large cash holdings. Or discuss the idea of diversification when looking to incorporate international fixed income or equities into the portfolio.

Timing is everything. Education affects behavior most when it occurs close to the moment a decision must be made. The impact declines steadily from there. Have the discussion six months earlier and it may be all for naught: any halo effect will be lost.

A key overarching practice is to link financial knowledge with the corresponding behavior that needs to be changed. For example, teach about the benefits of diversification and follow up with an example or proposal to invest in different asset classes. Another example is showing clients how compounding only works when one is invested, and how it works better over long periods, to help them get cash off the sidelines and into the market.

Although research shows that individuals find it difficult to change behaviors on their own, an advisor can help through explaining the idea and helping the client follow through.

So be bold when trying to educate clients on crucial financial topics — those efforts could pay dividends for clients and advisors alike.

For reprint and licensing requests for this article, click here.
Financial literacy Continuing education Client strategies High net worth Ultrahigh net worth JP Morgan Asset Management