A practical guide to aligning financial goals with personal values

05 Dec 2023

From AdviserVoice - this Best Practice article is proudly brought to you by Bennelong Funds Management

Taking a more behavioural view of risk in structuring portfolios around clients’ personal values and goals can result in clients being more focused and more resilient in the face of portfolio volatility.

Introduction

One of the most enduring narratives within financial advice is the question of value – what is the real value of financial advice?

Various individuals and groups have attempted to answer this question, each in their own way. Some have focused on the quantitative benefits that result from saving tax or maximising Centrelink entitlements. Others talk about the emotional benefits that accrue when one has a sense of control over their lives. And there are those who are able to bridge the two concepts, and attach a quantified benefit to emotions and behaviours.

Both Vanguard and Russell fall into this latter camp, each conducting research that allowed them to calculate the performance gains that result when the adviser mentors/coaches the clients out of bad financial behaviours. (Russell’s 2023 Value of an Advisor Report estimated behavioural coaching by financial advisers could improve the performance of client’s portfolios by as much as 3.4% per annum^[1].)

But whilst this may be true, it begs the question whether more could be done earlier in the advice process, to build client plans and portfolios in a way that was inherently more resilient and less susceptible to poor client decisions and behaviours?

This article will explore the idea that the traditional, textbook ways of assessing clients’ risk profiles – building portfolios around those profiles – are flawed, as they ignore the realities of human behaviour. It will propose that viewing risk through a more behavioural lens, and structuring client plans and portfolios around goals and values, will result in clients being more focused, and more resilient in the face of portfolio volatility.

Traditional risk profiling leads to unsuitable portfolios

Despite the assessment of a client’s risk profile being an obvious – compliant – step to undertake, historically the processes used to complete this assessment have proved problematic.

Indeed, 2015 data from FOS (from which AFCA was born) found that 70 percent of cases escalated through them were due to inadequate or incorrect risk profiling of clients^[2]. And in most of the cases, the adviser is likely to be found to be at fault, with more recent AFCA data^[3] suggesting roughly two thirds of their determinations relating to ‘know your client’ failures found in favour of the complainant.

One particular finding reinforcing that the biggest red flag for advisers is not the failure to complete a risk profiling or risk tolerance questionnaire (RTQ), but rather it is the inherent flaws in those questionnaires themselves, in terms of whether clients understand them and the extent to which they accurately reflect a client’s true attitude to risk.

A typical advice process involving a RTQ would see a client answer the questions and then be classified as having a certain risk tolerance (conservative, balanced, aggressive) on the basis of their answers.

That tolerance or profile would then be matched to an asset allocation (50/50, 80/20 and so on).

Even assuming the client had accurately answered the questions, this approach is problematic. Not because it is formulaic and ‘cookie cutter’ (which it is), but because it ignores the realities of human behaviour.

Humans don’t behave in the real world like they say they will in a questionnaire

In a nutshell, a client may indicate – via a risk tolerance questionnaire – that they could stand a 20% drop in their portfolio. But, when the rubber hits the road and they see portfolio losses of that magnitude – even unrealised ones – the fact is that many people suffer a significant, visceral reaction, sometimes so severe that no amount of coaching and mentoring by their adviser can avoid them reverting to bad behaviours and poor, value-destroying decisions.

What drives our money emotions and behaviours?

Human beings are complex, emotional beings who are notoriously bad decision makers, especially when it comes to money and investing. Indeed, JP Morgan data for the 2001 – 2020 period found the average US investor achieved an average annual return of just 2.9%, compared to the 7.5% pa achieved by the S&P 500 over the same period^[4].

There are two key drivers of our financial decision making. One is that bundle of mental shortcuts and biases that help us make the thousands of decisions each day without falling into a heap in the corner. The other is our deeply ingrained money mindset, typically formed during our earliest experiences with money and finance and often shaped by our parents.

Mental short cuts

Scientists estimate the human body sends 11 million bits per second to the brain for processing, yet the conscious mind can only process around 50 bits per second^[5]. Research suggests we make 2,000 decisions every hour^[6].

The only way we can cope with this torrent of data and decisions is to rely on mental short cuts (heuristics) and cognitive biases (defined by Investopedia as a ‘rule of thumb’^[7]).

Biases that commonly come into play in our financial decision making include:

Loss aversion: Research^[8] has shown, for any given amount, losses hurt twice as much as a gain of the same amount
Present bias: The present bias refers to the tendency of people to give stronger weight to payoffs that are closer to the present time when considering trade-offs between two future moments
Overconfidence: A tendency to overestimate our own ability to pick winners
Confirmation bias: People tend seek out evidence and opinions that confirm their existing beliefs, ignoring other information that challenges or contradicts their views
Availability bias: The availability bias sees investors base decisions on information and experiences that most readily come to mind.

Other biases commonly encountered by advisers include status quo bias, the endowment effect, the bandwagon effect, gambler’s fallacy, sunk cost bias, and anchoring.

The combination of biases, the presence and strength of which will vary between individuals, can drive a range of poor financial decisions, particularly our tendency to pay too much for stocks, panic in the face of a loss, chase winners and get our timing wrong.

Our money emotions

According to experts, our relationship with money is driven by a complex array of beliefs, attitudes, and behaviours, many of which were shaped early in our lives by the interplay between familial, ethnic, and cultural influences, and then further refined by our exposure to media messages. So powerful can these beliefs and attitudes be, they can effectively negate any financial knowledge we have acquired and contribute to us making sub-optimal financial decisions^[9].

Financial psychologists Bradley Klontz and Ted Klontz refer to the term “money script” to describe these core beliefs about money^[10]. These beliefs are typically unconscious and likely learned during childhood and adolescence, influenced by our parents’ own money attitudes and behaviours. For example, were they frugal? Were they judgemental about others based on how much money those people had?

The 4 money scripts

The 4 money scripts – akin to ‘money disorders’ – which were developed from the Klontz research, are money avoidance, money worship, money status and money vigilance.

Money avoidance

Money avoiders believe that money is bad or that they do not deserve it. They believe there is virtue in living with less money. Money avoidance is associated with ignoring bank statements, increased risk of overspending, financial enabling, financial dependence, hoarding, and having trouble sticking to a budget.

Money worship

At their core, money worshippers are convinced that the key to happiness and the solution to all their problems is to have more money. Money worshipers are more likely to have lower income, lower net worth, and credit card debt. They are more likely to spend compulsively, hoard possessions and put work ahead of family.

Money status

Money status seekers see net-worth and self-worth as synonymous.

They pretend to have more money than they do, and as a result are at risk of overspending. People with money status beliefs are more likely to be compulsive spenders or gamblers, be dependent on others financially, and lie to their spouses about spending.

Money vigilance

The money vigilant are alert, watchful, and concerned about their financial welfare.

They believe it is important to save and for people to work for their money and not be given handouts. They are less likely to buy on credit. They also tend to be anxious and secretive about their financial status. While vigilance encourages saving and frugality, excessive wariness or anxiety could keep someone from enjoying the benefits and sense of security that money can provide.

Measuring achievement against goals, not performance against benchmarks

The setting and achieving of goals are at the heart of financial advice.

Research^[11] has found that participating in activities aimed at developing goal setting can increase subjective wellbeing and personal growth over time (in particular, life satisfaction), either by bringing about changes in self-perception and/or self-confidence, or by positive changes in one’s circumstances. Even a perception of progress towards goals can provide a positive psychological boost, ahead of those goals being reached^[12].

This suggests the regular client review process itself has a vital psychological benefit. It also suggests that what is more important to clients is not how their portfolio has performed relative to an index, but how it has performed in terms of getting them closer to their goals.

A performance discussion framed around progress towards goals is likely to be easier, even in times of market volatility, provided that goal is grounded in deeply held client beliefs and values.

Framing goals purely in functional terms (e.g., achieve an annual income of $xx in retirement, fund grandchildren through university) can often mean the emotional link between a client and a goal is overlooked or minimised. Goals framed around personal values are far more powerful.

This alignment between goals and values makes it more likely that client will feel a sense of ownership over the make-up of their portfolio, and a greater understanding of why they are taking the risks they are, and how the journey to their destination (goal) might look.

Without this emotional link reminding clients why they are following a particular course of action (such as paying for insurance cover or investing in a particular way), they will be more easily knocked off course when conditions become challenging, for example if their portfolio suffers volatility and/or losses.

Using personal values to create goals

Our personal values are a central part of who we are. They are our deeply held beliefs about what is important in the way we live, the way we work, and the way we interact with others. They determine our priorities and the measures we judge ourselves against.

Living according to our values can make us happy, just as behaving in a way that is inconsistent with our values can be a source of discord in our lives.

In an investment context, we are likely to be more disciplined and focused on pursuing goals that are grounded in our values, where the emotional link is stronger.

From an adviser’s perspective, determining a client’s values is therefore critical.

Personal values models

There are many frameworks for personal values. The example below from website Musing Mind, which identifies 16 values, is fairly typical:

It is easy to see how these values can be translated into goals.

Freedom can be thought of as financial and emotional freedom, which saving for retirement, or financial independence generally, can be seen as.
Enjoyment of life explains the desire to travel, buy a car, or live a particular lifestyle
Achievement can also be a driver of the desire to travel, or take on particular pastimes or courses of study
Stability is essentially security and safety, one of our most fundamental needs as humans, and a key driver of the need to grow and protect wealth

Determining client values can be challenging

Talking to clients about deeply held personal values and emotions can be challenging for some advisers, either because the client is reluctant to be open, or because the adviser themself struggles with more emotional conversations.

Advisers thus have a number of ways they can approach this process.

Firstly, they can utilise one of the many methodologies developed by psychologists to help clients express and prioritise their values, including the examples below:

The life aspirations exercise, first found in the book Conscious Finance^[14], which involves clients writing down what they would do in a world without restrictions (financial, time, talent or other)
The values card sort, where clients are presented with up to 100 cards (widely available online), each depicting a value, and asking them to rank them based on an immediate reaction
George Kinder’s three ‘’life planning questions’ can help clients uncover priorities that may not be getting the attention they should be.

Closer to home, well-known advice software, such as Astute Wheel, incorporate questionnaires and other tools that can be used to capture, report on, then discuss client values.

Summary

This article delves into the perennial question in financial advice: the true value it provides.

It scrutinises the common practice of risk profiling clients and building portfolios around those profiles, arguing this is a flawed process, not just because of the formulaic nature of this approach but because it ignores the realities of human behaviour. The article emphasises the complexity of human decision-making, influenced by biases and deep-rooted money mindsets. It cites data revealing that inadequate risk profiling is a major source of complaints, highlighting the need for a more nuanced understanding of clients’ attitudes towards risk.

The piece advocates a shift towards a behavioural lens, proposing that aligning portfolios with clients’ goals and values can enhance focus and resilience against market volatility. It introduces the concept of “money scripts,” deep-seated beliefs about money, and explores four money scripts – money avoidance, money worship, money status, and money vigilance. The article contends that understanding these scripts is crucial for financial advisers to tailor advice more effectively.

Furthermore, the article underscores the significance of framing discussions around clients’ goals and values rather than benchmark performance, asserting that this approach fosters a stronger emotional connection to their financial plan. It suggests methodologies, such as life aspirations exercises and values card sorts, to help advisers uncover and prioritize clients’ values. Ultimately, it advocates an approach to advice that is more personalised and more emotionally resonant.