Behavioural Investing Series #2 – Transcript

Fraser Jack
Hello, and welcome to this topic series on behavioral investing, are we taking a deep dive into the client and advisor decision making process My name is Fraser Jack. And in this episode number two of five, we cover goals based investing from the advisor discussions with clients to help fund managers can take on a goals based approach. If you’ve ever thought about having these types of conversations with your client, this is a must. Welcome back to episode two in this series, I’m joined by Patricia and Catherine and in this particular episode, we’re talking about goals based investing into goals based advice in itself. Patricia, we’re going to start with you this time, tell us about what his goals based advice and goals based investing mean to you.

Patricia Garcia
I phrase it so you can mean a range of things. I’ll start with an easier example I think, which is what a lot of people are doing these days is the bucket strategy concept. So, for example, if you sit down with a client and you work out, you know, 510 different goals, what you then do is you work out the timeframe of those goals. So that’s something short term, medium term or long term. What are their minimum income requirements? What are their, you know, sort of wants versus needs. So there’s a range of different ways you can go about it. But the idea is that you want to first determine the amount of money that they need, and when and then potentially work backwards from that on the amount of risk that they should take with their portfolio. But it sort of doesn’t stop there. Because you then have to overlay that with can they actually withstand this level of risk and volatility where their behavior on make them do something that could actually lead to a worse outcome. So what I mean by that is you could have a client that only has longer term goals. So technically, you might say that you can invest in a high growth portfolio, because they’re not going to need the money for 1015 years. But then you find out that you have discussions with them, they’re they’re very risk adverse. And then even after a lot of education, you you can tell that if investments went down in value, even if it was 10, or 20%, that they would be very worried and probably would make the wrong decisions at that point in time. And so markets are low. So there’s a range of different ways you can go about it. But I think this example just highlights the fundamentals behind it. So it’s trying to work out their risk tolerance, that risk capacity, and then the different buckets and solutions that might meet that and trying to overlay one with the other in the best way you can.

Fraser Jack
Yep. Catherine, what are your thoughts?

Dr. Katherine Hunt
I’d like to hear more from Patricia about how you actually overlay that. So the challenge to me seems like you have someone’s risk tolerance there. That’s just their their personal site present bias overall, their tolerance for those the down movements in their portfolio. But at the same time, you might have a short term goal, which will end up with a completely different asset allocation to a long term goal. So from a compliance perspective, in particular, but also from a client engagement perspective. How do you actually overlay those two components? And I know this is heavily just focusing on the asset allocation side, but

Patricia Garcia
yeah, so there’s a couple of ways. I find that not often you find that you have a client that might just have only a short term goal, for example, and then everything has to be conservative. like there might be other things. And then overall, you could overlay their risk tolerance with different portfolios. But let’s give you a simpler, let’s say that a client only has a short term goal, like to buy a property in a year or two years. But then the risk profile or you know, the tolerance is quite high, because they’re young, and they want to invest for the future. Well, that’s essentially a conflict. So we explained that to clients, and we say, look, you’re, you know, you’ve got a long term view, and you’ve got, you’ve got the ability to sustain ups and downs you’ve had, maybe they’ve had some experience with shares in the past. But then we explain that you’ve got this goal and you need, you know, $200,000, to buy a property. And you want to say to that for the short term, so my question to you is, if you’re doing this high growth, and that goes down by 30 40%, are you going to wait longer to buy the property? And if the question is, the answer is no, then you explain to them well, that’s why you probably can’t invest like that, because you need to be able to sustain that. And then if the question is yes, is, do you want to do that, you know, is there more important is getting better returns? Now in the short term more important than getting the house sooner? And you essentially have those discussions and then agree on the strategy going forward? So even though their answers could have been like that, you might then end up having to do a different risk profile we go, okay. Now answer with that in mind. Now, with that in mind, where the main priority is to buy a house, and you’re not willing to delay that purchase, how would you answer this questions? And normally, that will lead to a different outcome? And then yeah, essentially, you just have to deal with the conflicts and work through those conflict until you get to a solution that is suitable.

Fraser Jack
Yeah, no, I, Catherine, I just wanted to throw to you in this particular moment now, because obviously, we’re talking about markets drop, you know, you invest in in markets drop, I know, you’ve done some research around this particular thing. To quickly tell us about the results from that.

Dr. Katherine Hunt
Just to clarify, I do a lot of research, which potentially, or researching or

Fraser Jack
I think you did some research around, around when people you know, that purchasing and then going in, and then and then markets dropping. So time in timing the market, as you know, or trying to time time the market for those types of investments?

Dr. Katherine Hunt
Aha, I say. So I’ve done research that looks at in particular, the effect of a good portfolio, compared to a non good portfolio. And the idea is, it kind of replicates a new client scenario, where generally there’ll be an initial investment, and it can either be a small investment or a large investment. And the good question is an interesting question. In general, for especially for clients with very high risk tolerance. But regardless of the gearing component of that, that particular research, and we looked at, going into the market in every single month, since 1976, which is when the data started, the data set started. And basically, the results of the research is, timing is everything. And you can’t predict, of course, because the previous few months don’t give you any indication of whether the next few years will be a good thing. And of course, a general investment portfolio of say, a five year timeframe is quite a long time to invest. So it’s all about the sequencing risk. And I’m sure that Patricia has this experience in especially with regards to goal Based Investing where each say, component of assets has a different timeframe to the other particular components of assets. So the sequencing risk almost becomes magnified in a way because you might have all of the all the investments going in at the same time. And then you have them all coming out at the time that’s associated with that particular goal. So in particular, say at the point of retirement, which traditionally, as soon as, as someone reaches retirement, they’ll often then convert their assets to more conservative asset classes, which just introduces a huge arbitrary sequencing risk of when you exit the market. So the sequencing risk is that entry and exit so that overlays obviously with gold goals based investing even more than traditional kind of one, one asset bunch approach.

Fraser Jack
Yeah, that was exactly that was exactly the conversation I was trying to get to. It’s probably a little bit off topic, but but I think it’s relevant to that particular story that Patricia, Patricia, I want to ask you about, you know, the five to 10 goals conversation now. You know, you mentioned it’s fairly simple for you to talk to your clients around having you know, those goals. You know, in the past that could be the the the profession could be accused of not finding enough goals for clients. How do you go about and how do you Having trouble with finding a bunch of goals for each particular client.

Patricia Garcia
So essentially, I’ll just prompt them with things that I’ve seen other clients. So I’ll give them ideas. And I say, as I know, some clients might have some people might want to leave, inheritances to their children, some people might want to go on, on holidays, or take time off work or live overseas or do you know, have an education fund for their children or, you know, so I’ll just essentially give them examples of other goals, because that will inspire them. The more you do it, the more they understand it. And then it’s the easier it becomes for them, like the beginning is the hardest. And I think the hardest is actually not finding the goals. The hardest is putting a finger and not tied to it. So you know, how, how much do I need for that? Or how much do I need for that, that’s the hardest part. But to be honest, I think our job is, I think the best thing we can do for clients is to just start with a foundation. And I always say to them, let’s try to get this as as accurate as possible, because that will help us manage it along the way. But even if it’s inaccurate, we’ll change it. That’s why we’ve got an ongoing relationship with you. But we’re gonna do our best to make it accurate, we’re gonna, you know, we’re not just going to accept that word that they spend $20,000 a year, I know that that’s probably unlikely I will prompt them. And I’ll, I’ll do calculations to show them that that’s probably not the case. And we’ll try to be as accurate as possible. But a lot of the times, things don’t happen the way that you expect them to happen. And that’s okay. The main point is just to be able to have the map, then have the business plan and then adjust the plan as you go. But I think the examples is what helps the most of the beginning.

Fraser Jack
Yeah, excellent. So the having a bit of a list or mouse list or conversation that can give them ideas. And I just wanted to quickly ask you to run the bucketing? How are you calculating the bucketing at this point? Are you having to go away and do it individual calculations, or if you’ve got tools that you use?

Patricia Garcia
Yeah, there’s a range of different ways. So for every client will be different. But essentially, again, you work through short, medium and long term goals, with the projections, and we look at how much we’re needing to take out of the different assets, different points in time. And then to sort of add on to Catherine was saying before, about sequencing risk in terms of their time of retirement moving from growth to to, to moderate or balanced, let’s say to more conservative allocation. Again, we educate clients about that. And we say, we can’t just wait until you retire to do it, we have to actually do it along the way before retirement. So I talk about like Retirement Risk Zone. So you know, we have to prepare for retirement. Or if we’re not preparing for retirement, like some clients actually don’t want to do it. Some clients, I’ve had a lot of experience with growth investments, they don’t want to I then do the calculation, I go, Okay, well, every other we delay, this is the risk this is what could happen. Are you prepared to delay your retirement? And they usually in the case would say, yeah, actually, we would, if the market crashed, right, then we would delay our retirement, because it’s more important for us to have a high growth portfolio now then to go more conservative earlier. So for me, that’s why I say to them, that’s why it’s important. Every year, it changes, those calculations changes, change, and the their behaviors will change. As they get closer to retirement, they will get more conservative majority of them will. And even they as they get closer to start going, oh, we’ll revisit this next year. I know, yeah, we’ll revisit this next year, or, you know, our next meeting six months. So they learn that because we preempt that early on. So it’s all about I think, explaining that it’s a long term strategy, and then revisiting it every year. And then it becomes ingrained. And they know what to expect.

Fraser Jack
And then how do you go about the investment side of it? Because sometimes I mean, when we say goals based investing, but sometimes it could actually mean goals, goals, spending, you know, spending the money, not just investing it, but tell us about your your thoughts around that now, from the next step of taking the portfolio and investing?

Patricia Garcia
Yeah, yes. So there’s different ways and again, we’ll talk about different ways to invest with them. But there’s a there’s a range of different calculations and things that we have to go through to make sure it all adds up, you know that that adds up from the amount that goes into the bucket as well as the overall risk that they taking. So there’s a lot of things that we need to look into. But let’s say to keep this simple that over the next 10 years we work out that they’re going to need to withdraw this amount from their investments each year. So we essentially might go okay, so we need one or two years in cash or three to five three to five years in conservative five to seven years in Madrid seven balance and high growth. So you you work them in with their minimum investment timeframes or recommended investment time. frames, also taking into account the fact that you get dividends, for example, that pop up the cash account and things like that. So there’s a range of different things. It’s not perfect. I don’t have the it’s something that I think that hopefully Katherine and people like her can actually help us. Because with because I think that also markets have changed significantly what, you know, when I started, the minimum timeframe, that was recommended for some high growth investments might have been five or six or seven years now can be 10. You know, interest rates are much lower bonds carry a lot of risk, it’s actually I feel, I still feel that we potentially have all the tools to address today’s problems, like we don’t actually have the tools to address today’s problems, because we haven’t had today’s problems before. You know, record low interest rates and, and record low bond yields and rising rates and, and overvalued markets, markets. So everything is just really, there is no safe asset. So again, we explained that to clients, you know, we don’t have a bulletproof approach. We just have tools to help us manage and have control when we need to make big decisions.

Fraser Jack
Did you want to add anything to that?

Dr. Katherine Hunt
It’s such a complicated scenario at the moment. And to me, I mean, normally, it’s a complicated scenario for when you look at goals based investing, because you’ve got the asset allocation discussion for every single goal. Right. So there’s no one discussion and one blanket approach. It’s a it’s a detailed, detailed discussion. And then of course, yeah, with the current scenario, as you mentioned, all of the conservative assets are now well, even more clearly risky assets, I suppose.

Fraser Jack
Yeah. I think the the danger in that is it starts to become confusing, right? Yes, I think if if a danger that is that becomes confusing, then that does that mean that the advice becomes a really long and complicated process?

Patricia Garcia
It can be? At the moment, I don’t think that we’ve made it more confusing, because I don’t think anyone has the answer to the problems they I’ve just raised and Catherine, you know endorsed is no one has a solution. What do you use for defensive when defensive isn’t truly defensive? So that’s really difficult. But we also know that we can’t predict or markets do, you know, I think we just need to continue to work on changing the way that we build portfolios and look in my office continue to learn, but no one has a bulletproof strategy. So as long as clients understand the risks, and we’re doing the best job that we can with the tool that we have today, but also, I think we need to continue to work on better tools to help with that. Yeah, I

Fraser Jack
really liked the way that you said earlier, you know, addressing, we don’t quite have the tools to address today’s problems, because we haven’t had this or these problems before. So I think that’s a really interesting point. Patricia, Katherine, thank you so much for joining us in this episode. I look forward to going a little bit deeper into these conversations, we’ll start tackling values based decision making in the next episode. At this point in the conversation, I’m welcoming Dan and David, back to the conversation where we’re talking about goals based investing dynamic has been off with you tell us what your sort of high level thoughts on goals based investing.

Dan Miles
I like to keep it reasonably simple, in that you want to invest your money to achieve it is kind of self explanatory, right? You want to invest your money to achieve a goal. The where I think it starts to get a bit nuanced is how do you go about doing that? I’m of the firm belief that people have multiple goals. Even if a client comes to you and says, No, my only goal is to be able to fund my retirement. Well, okay, that might be the case, but you might have been another 30 years to lead. And so therefore, you might have three different time horizons. And therefore, you may need to look at it in three different ways that you may have three different levels of risk tolerance, capacity and need to take on over those intertemporal periods. And therefore, it’s my belief that we should be building portfolios that are based around clients goals, which I think where we can, you know, bring back in the concept of, you know, mental accounting and marketing and saying, Okay, well, what are the highest priority and what are the shortest term? And how can we build portfolios that are based around the risk that you can that you’ve said that you can tolerate? You have the capacity for to take on for that? Yes, we want to maximize the return but we don’t want to breach that risk. And it’s really the it’s the breaching of that risk is what I think is key in goals based investing because it’s, it’s when clients experience something that they weren’t expecting that leads to what is generally that you destructive behavior. You know, if they go through, we’re going to talk about risk profiling later. So I won’t go into huge detail here. But, you know, a client has, has filled out a risk profile questionnaire, and they’ve got a certain score. And let’s say they’re balanced. And they put into a portfolio with a fairly steady static asset allocation. And in theory, the amount of risk that they receive over a very long time horizon should average out at about that. But we know that that’s not how markets operate. And that risk changes and is volatile throughout time. But given that the amount of risk that they can tolerate is reasonably fixed, at least at the point in time in which the strategy is said, I think that a goals based investment should be made benchmarked to the amount of risk associated with what it is that they have said that they can tolerate. Because if you breach that, that is when you’re going to get these behavioral responses that can be very destructive. They and you know, there’s lots of people that say things like, capital losses don’t count unless they’re, they’re realized, and you sell them. Well, let’s be honest, human beings, when they see if they see negative things on the screen, it leads to a visceral response that can equate into a behavior that leads to a you know, a realization of that capital loss, because they were not expecting that that result. And so if we can manage portfolios to, you know, fairly strict risk parameters, I think we go a far we get a lot closer to what are his goals based investment, then setting it up based around, you know, capital market relative return associated portfolios, which may or may not have anything to do with achieving their goals and what their own personal biases and behaviors can tolerate. Anyway, that’s, that’s my opinion.

Fraser Jack
Excellent. I’ll get your initial thoughts. Yeah, sure.

David Bell
Sure, Fraser. Yeah, Dan’s really called out some interesting points, their range of outcomes around the goals when designing that framework is really important. And I might get back to that later. But I just wanted to maybe start with the amazingly interesting, difficult, fascinating jobs that financial advisors have, because, yeah, here they’re trying to marry the theory with how do they find this and engage with retail clients, it’s just amazingly challenging problem. So, you know, on the academic side, the whole foundations of, of savings investment is the lifecycle model of savings, consumption, investment, it’s been around for, it’s just gone past its 50th anniversary, Merton, Samuelson, both now but Nobel Prize winner sort of frame that up, it’s all about, you know, through your whole life, you know, generally smoothing lifecycle consumption through time, you then have to add in all the the peaks and troughs to that, which is where goals come in. Yeah, people don’t spend the same amount every they save up for a nice holiday, or they have school fees for a period of time. And I have all these issues that come through the journey of life. And so if you start with something that’s completely theoretical, it’s just not going to connect. And if you don’t connect, you know, people won’t stay the course with a plan, it all starts to fall apart because it’s actually yeah, my view their strength and commitment to that plan to hold on to it to work through the the ups and downs of that plan, which which allows people to stay the distance and realize longer term risk premia as I as I get realized, so you can start to see the amazing challenges faced by advisors have to sort of convert into something that is feels more tangible, can relate, get get past some of these time horizon effects where it goes from the present to the future. How do you visualize the future, we put some goals there like I here’s a picture of European river cruise in 15 years time, here’s a picture of my son graduating in 10 years time where I have no more school fees, right, that’d be nice. And all these things which would start to come around and say, even though I love the theory of it, yeah, I think goals based is sort of a frame that I get, I understand I think it’s a it’s a really neat one for advisors to use as as that bridging mechanism. It’s how it’s applied, which is some of the things which I think Dan’s talked to which, which is where the rubber hits the road, it does get quite challenging

Fraser Jack
yet and I love it. I love the weak connection that you used, just in tune and the clients connecting with the plan and connecting with the goals and the outcomes. And I’m a big one, as you mentioned, Dan for having a lot of goals under under advice or got a lot of goals under management, I call them I actually call it Gam goals under management and I like the idea of, of the the advisor really getting into that, you know, like getting into that scenario where they’re there to achieve the outcomes of the goals not just to achieve a percentage return or any of the benchmarking we talked about in the previous This episode, but understanding and you know, having a bucket list of things on the goals list, and as you take them off you, you know, you bring others in. And so you really managing that goal process. But then from, you know, investment point of view, you know, I think a lot of advisors struggle to then realize or connect that if I’m having a conversation with the client about their goals and on their, you know, to help them bucket those things, how do we then translate that into the investment world should not just be just finding a normal investment? Or what are your thoughts?

Dan Miles
Well, no, I, that’s where I think it comes down to understanding and having a greater appreciation and more technical tools to understand the amount of risk that can be associated, that the client can take, so that you can instead of just concentrating on risk tolerance, which you know, is a, you know, some, I guess, a psychological measure. And you can take on things such as, you know, risk capacity, which is an objective measure, and also goal risk, you know, the possibility of achieving those goals. And, and, David, as you said, you know, it’s also the sequence of how these things occur throughout time. It’s everything is partly dependent. And, you know, if it’s all well and good that you might be in 10 years time, you know, the top decile performer in something, but if three years into it, something occurred that clients were not pre positioned for or aware of could occur, and they divest away from a trip, you know, three years into the, in the thing that Who cares where you are, where you are 10 years later, because the clients already left. And so that’s, that’s where I agree with you, it’s, it’s fascinating challenge for advisors, to try and translate that back. And my belief is that is the use of some of the new tools that are available to understand, you know, clients financial literacy, it’s, it’s to expand upon the the understanding of risk to move beyond just tolerance, but also capacity on to need onto, you know, the, the ambiguity around the the likelihood of achieving those goals and the prioritization of those goals, and then associating levels of risk with them that they may either need to take on or that they are comfortable to be able to take on. And that portfolio managers provide solutions that fit that, that framework, so that the client knows why they own what they own. And then unless the portfolio does something that you, you know, doesn’t say it should do on the box, they really shouldn’t worry, because they know why they own what they own, and where it’s therefore. And I think that he’s going to increase the likelihood that they will stay the course for the long term. And I’m a firm believer that, you know, clients are not most clients, some will, but most clients are not going to achieve their long term goals unless they have someone like a financial advisor, to be able to help them, you know, with everything that goes on in life and all the changes that occur, not just markets, but everything else that goes along as well, if that’s I mean, that’s just, I mean, that’s one of our taglines is, you know, returns matter, but behavior matters more. I mean, that’s really where the advisor can add so much value.

Fraser Jack
Yeah. So what I’m hearing you say, is a lot of the stuff around managing the risk, even more so than managing the returns? And, and, you know, it’s an interesting thought about, you know, managing the risk, or the conversations that the advisors are having with the client. But then to have that to spill over into the investment portfolio, also, working with the advisor to manage the risks as well as the returns, I guess.

David Bell
Yeah, it’s exactly right. And if I just take vans, conversation there, it’s really was insightful, just on now down to one specific example. I think of goals as a great framing agent, they really connect the advisor to the client. And then you got to work with those goals to really build out the plan. And you have to think of just like Dan was saying, that range of outcomes, and the likelihood of achieving those goals how much you might miss by or exceed by which is what use of the non client word would be stochastically. Thinking about the outcomes, and having systems to support that became the right language. And then once if you can do that, you’re really setting yourself up for a rich playing. So if I just go like the retirement decision, and planning for retirement, yeah, if you can picture it out a long way out. Yeah, put the nice picture of the holiday there at that time. Well, then you sort of can say, well, if you invest your retirement savings in cash, you are certain or near certain to not achieve your retirement goal. If you put it in a higher balanced portfolio, then this is the range of outcomes it’s more likely you’re achieved because we expect to get higher expected returns as a result is a there’s a variability of outcome is ups and downs. But our our view is that these things will add a little bit over time and this is your range of outcomes. So it can’t just be about Yeah, that the challenge for advisors there have the technical skill and the tools in support to really be able to frame you know, do the grunt work behind the scenes, but then that communication challenge to sort of say, well, this is what its gonna look like for you, yeah, it’s not assured that you’re going to achieve your goal. But we’re giving you this way pre play something that has this range of outcomes to achieve that goal. And we think that’s the right range of outcomes for you. The other thing I just throw in is that, you know, goals based financial planning starts to feel more like a partnership, because you have your financial assets working for you. But there’s also this opportunity to maybe save a bit harder if things aren’t going well. And, yeah, and having that sort of engagement that you can have with a with between the advisor and the client says much more of a partnership model with a with a shared goal that’s coming through.

Fraser Jack
Yep. I’ve visualized that when I say that as when you say that as a target on an xy axis, so you’ve got time and money on the on the axis, and you’re going to end up with a lower high or an early or late depending on where where it is rather than an exact number of exact time.

Dan Miles
Yeah, I love that you brought in the word stochastic. And because the, you know, the linear modeling that tools that have been made available to advisors, or maybe it’s the industry’s fault that advisors have, have had, you know, I’ve had to use these sorts of tools were provided in a stochastic stochastic modeling system to show variability, you can have far more meaningful conversations with clients where you say, Okay, well, you know, you might want to invest your money in this way. But, you know, there’s a 90% chance that you’ll run out of dough by the time you’re 70, like, are you comfortable with that, we can increase the variability of the outcomes, but the probability of you achieving, you know, whatever this goal may be, or when, you know, this financial amount of money that you need, could be, you know, greatly expanded, and then the ups and downs of the market become, hopefully less, less relevant. And it’s more about, let’s understand the variability of the outcome, or either the risk associated with the outcome, and how comfortable you are with it. And it’s, it’s, I think the real value is not just in the initial conversation and setting that up with the client. It’s the ongoing conversation. But you mentioned, David, I think that’s where you can come back and say, like, are we on track? And you know, what has changed? And you know, are we are we are we ahead of schedule? Or are we behind schedule? And what can we do to change it to make sure that we’re on track, I think it’s that ongoing review piece becomes even more valuable. I think it first of all, it creates a fantastic first interview with the client, and the ongoing engagement is just so much more powerful, I believe. Yep.

Fraser Jack
They were talking about projections here. We’re talking about the tracking, which is amazing. I love this conversation, and was talking about staying inside the tracks. Now for those listeners that that this stochastic modeling, versus deterministic modeling. Essentially deterministic is your basic spreadsheet, think about that you put the number and you put the return and it does the same return every year. But stochastic is talking about adding some variables in it could be it could be up this year, it could be down this year, and that’s going to have a big determination on what it might be in 20 years from now. Gentlemen, thank you so much for coming on and talking about this particular episode we’re talking about goals based investing. The next episode we’re going to start talking a bit more about values based decision making which we’re going to put these two together basically basically the the biases we came from the first conversation and the goals based investing and start talking about values based decision making. We look forward to catching you in the next episode. Thank you, cheer Fraser.