Morningstar Magazine - April/May 2018 - 37

Coaching to Mitigate Panic
Helping clients manage emotions has a
significant impact on portfolio returns.

outcomes that target-date funds have achieved.3
3 To alleviate loss aversion, investors and their
advisors can avoid frequent price updates.4
3 To avoid predictable mistakes, the industry can
educate investors on common issues like
confirmation bias and the availability heuristic.5
Measuring the Impact

TOOLS

Stephen Wendel

What is the value of behavioral coaching?
The frequently cited "Advisor's Alpha" study by
Vanguard estimates that the annual financial value
of behavioral coaching for investors is 150 basis
points, based on observed investor behavior with
target-date funds.1 In a recent Journal of Financial
Planning article, I take a deeper dive into the
dollars and cents of behavioral coaching-and
how it can help investors succeed.2 Here, we'll
jump straight into the results and what they mean.
Why Do We Need Behavioral Coaching?

One of the benefits is obvious: It can mitigate
panic during market downturns. Advisors can help
clients avoid selling at the wrong time and missing
a subsequent upswing. Beyond the obvious
answer, behavioral tools to help investors avoid
panic are needed because the industry's current
approach of matching investors to investments
is well-intentioned but incomplete. We are putting
two competing demands on the investing process
by trying to select investments that will both
a) deliver the returns that investors need to reach
their goals and b) avoid volatility that might lead
them to abandon their investment plan.
To manage these competing demands, advisors
generally apply one, or both, of two approaches:
a risk-capacity approach that focuses on goals

and generating the required returns and a
risk-preference approach that seeks to decrease
volatility exposure for those who are deemed
more sensitive to it. In isolation or in combination,
these two approaches may fail both to help clients
reach their goals and to forestall their panic.
For many investors, these two demands simply
cannot be met at the same time using assetallocation alone. The returns they need to reach
their goals may require risk exposures that they
would prefer not to have. Mixing the two
approaches-for example, by calculating a stock/
bond glide path based on time horizon and then
shifting it up or down based on risk preferences-
seems reasonable in principle. Unfortunately,
splitting the difference may mean fulfilling each
need less well. A better approach is to address the
two issues using tools designed for each purpose.
Divide and Conquer With New Behavioral Tools

Asset allocation is an appropriate and powerful
tool, but on its own, it may not be enough to
help investors handle risk. Behavioral tools-that
help investors prepare for and respond to volatility
when it comes-are more appropriate. The tools
can address the discomfort directly, or provide
other ways to manage volatility. Here are some
potential techniques from the literature:
3 To reduce panic selling, the financial-services
industry can better package long-term investments
as "set it and forget it" tools, learning from the

To better quantify the value of using behavioral
tools alongside asset allocation, my paper presents
results from a novel simulation model of investor
behavior. In short, the model simulates various
scenarios under which investors might panic and
determines the effect on long-term outcomes.
The model demonstrates how investor panic can
result in a loss of between 8% and 15% of assets
over a 10-year period when standard approaches
are used-such as risk-capacity-based asset
allocations and risk-preference-adjusted glide
paths. The results are robust to a range of model
specifications and assumptions: No matter
how you slice it, panic can be highly destructive.
By also incorporating behavioral tools (alongside
risk-capacity asset allocations), investors can
receive a net increase of 17% to 23% in assets over
10 years, or roughly 170 to 225 basis points per year
in returns. Some of that return comes from
avoiding panic, supporting the analyses by
Vanguard and others. The rest comes from freeing
up asset allocation to better serve the financial
needs of investors and removing the tension
between the two competing demands outlined
above: achieving an investor's financial goals
while avoiding uncomfortable volatility.
Advisors know that investors struggle during times
of volatility. This paper helps point the industry
toward a new set of behavioral tools to ease the
struggle and help investors reach their goals. K
Stephen Wendel, Ph.D., is head of behavioral science
with Morningstar.

Kinniry Jr., F.M., Jaconetti, C.M., DiJoseph, M.A., Zilbering, Y., & Bennyhoff, D.G. 2016. "Putting a Value on Your Value: Quantifying Vanguard Advisor's Alpha." Vanguard white paper, September.
Wendel, S. 2018. "Using a Behavioral Approach to Mitigate Panic and Improve Investor Outcomes." Journal of Financial Planning, Vol. 31, No. 2, pp. 48-56.
Holt, J. & Yang, J. 2016. "2016 Target-Date Fund Landscape." Morningstar white paper. http://corporate1.morningstar.com/ResearchArticle.aspx?documentId=748739
Larson, F., List, J.A., & Metcalfe, R.D. 2016. "Can Myopic Loss Aversion Explain the Equity Premium Puzzle? Evidence from a Natural Field Experiment with Professional Traders." National
Bureau of Economic Research working paper.
5 Perttula, M. 2010. "Debiasing Overconfidence of Finnish Investment Advisers." Aalto University thesis.
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