Measuring attitudes to financial risk, capacity for loss and investing experience allow a Financial Planner to be well informed about their clients’ levels of risk tolerance. Despite this, there can be inconsistencies with how a client behaves during difficult periods.
Academic research has begun to investigate useful measures that can provide further insight into expected reactions during market volatility. Financial self-efficacy – an individual’s belief in their abilities to manage their finances to achieve ultimate financial goals – has been demonstrated to be a good predictor and one which complements assessment of risk tolerance.
Having confidence in managing finances allows an individual to be more resilient when faced with adversity, where they are better able to handle stress and regulate their emotions. It is therefore imperative that techniques, conversations and forms of education for building financial self-efficacy and resilience begin before financial turmoil.
Research conducted at Dynamic Planner has shown that those experiencing a real-life market crash had lower levels of financial self-efficacy and higher levels of negative effect (emotions and feelings), illustrating the impact of market volatility on confidence and emotions. Despite this, it is encouraging to also find that retail investors who worked with a Financial Planner were more resilient and were more optimistic about hypothetical market volatility when experiencing a real-life crash than those who had not.
Engaging with clients during challenging periods is important, but it is even more essential to start this process when first acquiring them. Below are four strategies Financial Planners can use to develop clients’ financial self-efficacy:
- Enable performance accomplishments
Help clients to perform a financial task successfully. Cashflow planning is an essential activity and one that is useful for building clients’ levels of self-efficacy. By designing a plan with clients to manage their cashflow, you not only allow the client to be engaged in the process, providing them with autonomy, but also provide a sense of achievement, increasing confidence in their abilities to manage future financial tasks.
- Be the financial role model
Clients seek to observe good financial behaviours. However, reported clients' experience of this from their Financial Planner ranges from inspiring to absent. Despite current difficulties to communicate face-to-face and for clients to witness your behaviour, you can still regularly communicate good practice through a range of media.
- Hold encouraging conversations
Self-efficacy strongly relates to an individual’s self-esteem. While acting as a role model, you should also act as a coach, providing encouragement, praising achievements and not focusing on mistakes.
- Monitor emotional states
Confidence in managing finances can be affected by emotional states. Due to this, you should discourage actions from being taken when a client is not able to make decisions at an optimal level. Furthermore, it is important that you also help clients better regulate their emotions, not by suggesting that they suppress their negative emotions, but by encouraging them to reappraise their circumstances and directing their focus away from the emotion-eliciting situation.
Louis Williams is Head of Psychology & Behavioural Insights, Dynamic Planner. He holds a PhD in Psychology and has worked with Dynamic Planner since September 2019 when the business embarked on its long-term government-sponsored behavioural science and investment project with Henley Business School. He is an experimental psychologist having worked with a variety of university departments across the globe. https://www.dynamicplanner.com/