Financial advisors have an important role to play in helping investors make decisions and take actions that may initially seem counterintuitive. Research has shown that behavioral coaching—acting as an emotional circuit-breaker—is one of the most important services an advisor can provide. Through behavioral coaching, advisors help their clients stay committed to their long-term financial plans in both good and bad markets, thus helping to give them the greatest chance for investment success.

For most of life’s decisions, past performance and relative rankings can be reasonably linked to future performance and outcomes. As such, relying on past performance to predict future outcomes is a rational framework—it’s the right mindset. However, when it comes to most investing decisions, this same process does not work nearly as well—it’s the wrong market.

Understanding Investment Decision-Making
Understanding that the majority of people use past performance, relative ratings, and ranking systems as the basis for decisions in their lives—from something as inconsequential as choosing a restaurant to something as life-altering as picking a surgeon—as well as why this approach does not hold when selecting investments, is critical to the success of clients and advisors.

In most cases, prior experience provides valuable data that informs rational decisions. It both works and persists through time. For example, many people reasonably assume that going to a top-rated university will result in positive outcomes (higher paying jobs and/or admittance to graduate schools). The rankings of top-rated universities shift only minimally over 10-year periods. In fact, our research finds strong persistence and durability of relative rankings and resulting outcomes for most decisions we make. Given that, it is entirely rational that investors would use the same data-driven process to inform their investing decisions.

However, when transferring this decision process which has served us so well elsewhere to investment decisions, the results are less than optimal, leading to remarks such as “investors are their own worst enemies.” Realistically, however, the difficulty inherent in investing is due to the nature of the capital markets, not the nature of people. In fact, research from Vanguard Investment Advisory Research Center finds that the performance of the capital markets and professional asset managers often lacks the persistence and durability found with other services and products. This distinction is critical. Recent sub-asset class, sector, style, or fund performance—short-term or long-term—have a lower bearing on future performance. This is where understanding what makes investment markets different and working with an investment advisor who embraces this different mindset can really pay off—and not just for clients, but also for the advisory practice.

Though the field of behavioral finance has been around for a long time, behavioral coaching grounded in empathy and understanding is a newer concept. In 2017, Vanguard’s proprietary risk speedometer metrics were showing signs of improvements in investment behavior. Since then, we have gone through two very different bear markets in 2020 and 2022 in which aggregate asset allocations have largely stayed the course and cash flows have closely matched what would be expected for rebalancing. While the jury is still out on whether this is a cyclical or secular improvement, our hypothesis that advisors have successfully helped their clients tune out the noise has held strong.

Earning Trust Through Behavioral Coaching
According to a Vanguard Investment Advisory Research Center survey, trust is the primary driver of advisory practice outcomes, as defined by new client acquisition via referrals, client retention, and asset consolidation. 94% of respondents indicated that when they highly trusted their advisor, they were “extremely likely or likely” to refer them to others. Only 2% were open to switching advisors (and even then, it was often due to retirement of their advisor).

So how do advisors earn trust? The components of trust are all tied to, and demonstrated by, behavioral coaching—ethical (“my advisor acts in my best interests”), functional (“my advisor does what they say they will do”), and emotional (“the advice I receive gives me peace of mind”).

Advisors can sometimes unintentionally undermine their own value proposition when they limit client communication to infrequent meetings that center on assessing the latest portfolio statement. Enduring trust, earned from relationship-oriented services such as behavioral coaching, is likely the biggest driver of success for an advisory practice.

Good For Clients And Good For Your Practice
Advisors who understand the “why” behind investment decision making, communicate with empathy, and embrace behavioral coaching, in contrast to those who rely primarily on market outperformance, position their clients for success and their practices for growth. Those who effectively reframe their clients’ mindsets, tempering their euphoria in good markets and maintaining optimism in bad markets, can help drive superior outcomes and earn trust. This is a true win-win!

Fran Kinniry is head of Vanguard’s Investment Advisory Research Center.