Financial planners have always sought to adjust their strategies and communication techniques to the realities of client needs, although the increasing volume of behavioral finance research is now beginning to document exactly how we as human beings sometimes think in very irrational ways, which in turn provides insight about how to best adapt to deliver effective advice. One common challenge area regarding investments in particular is our tendency for mental accounting - where we break up and categorize assets based on various needs and purposes, even if the underlying investments are flexible or entirely fungible - which in turn has spurred the growth of so-called "bucket strategies" that seek to allocate portfolios based on various goals, needs, or time horizons.
Unfortunately, though, recent research has shown that stringent applications of bucket strategies can potentially result in less optimal retirement outcomes, not better ones, particularly due to the "cash drag" and portfolios that can dial down too conservatively too fast; in addition, the reality is that mathematically, most of the benefits of bucket strategies are captured simply from traditional rebalancing strategies, which already ensure that stocks are bought (not sold) when they're down and that cash and bonds are used for spending needs when appropriate.
Nonetheless, from the behavioral perspective, using bucket strategies remains appealing, if only to help clients stay the course during stressful times. But ultimately, perhaps the best solution is not just to weigh the trade-off between managing with buckets (even if the results are worse) versus helping clients psychologically (which is still better than having them bail out at the worst of times), but to accomplish both by improving performance reporting to overlay buckets and goals on top of the portfolio. In other words, maybe the key is not that we need to change how we invest for clients, but simply to more effectively frame how we report the results?Continue reading "Should Financial Planners ... »