Author Archives: FP Performance Lab Staff

Happy New Year from the Lab

This past year has been exciting and productive. Faculty and students published 10 peer-reviewed journal articles on topics ranging from physiological stress reactions during planning sessions to the determinants of financial risk tolerance. Dr. Grable’s latest book–the Case Approach to Financial Planning–was also published this year. A highlight for the year is that the following students graduated with their doctoral degree:

Abed Rabbani (now at the University of Missouri)

Wookjae Heo (now at the University of South Dakota)

Jorge Ruiz-Menjivar (now at the University of Florida)

Stephen Kuzniak (now at Cannon Financial)

We will highlight their dissertation work in 2017.

We are so thankful for the support of colleagues, students, and sponsors. This year, the work of the Lab would not have been possible without the generous financial support of Data Points. We look forward to working with Data Points and Sarah Fallaw in 2017!

 

 

Why Do Your Clients Collect Things?

Lab staff recently published a ‘fun’ paper documenting the value of collecting. The paper documents the extent to which collectors—specifically, those owning collectible classic US postage stamps—experience an opportunity cost associated with expenditures on their collection. Results show, based on stamp price, S&P 500, bond, and T-bill rate data over the period 1969 through 2013, that collectible stamps tend to underperform stocks and bonds on a risk-adjusted basis. Using estimates based on the Modigliani measure (M2), it was determined that collectors incur an opportunity cost when selecting collectible stamps over more traditional investments. However, it is known that collecting as a hobby provides sociological and psychological benefits. This paper adds to the literature by illustrating how collecting also provides psychic return benefits that can be valued similarly to investment returns. In this study, the foregone return rate of stamp collecting for those who allocate 100% of available resources to their collection equates to between 3% and 13% on an annual basis.

You can find the paper here: value-of-collecting (click to download)

Data Points Visit

We were thrilled to have Sarah Fallaw of Data Points visit the Lab earlier this week. While she was on campus she met with students and talked about the role financial socialization as a child can influence later life wealth accumulation.

grable4

New Research from the FPP Lab

A new paper from Lab researchers was recently published in the Journal of Financial Planning: The Intertemporal Persistence of Risk Tolerance Scores.

This paper looks at the stability of financial risk tolerance attitudes over time. Financial planners will be happy to learn that, for the most part, client risk attitudes stay relatively constant across time. You can read the entire piece at:

https://www.onefpa.org/journal/Pages/AUG16-The-Intertemporal-Persistence-of-Risk-Tolerance-Scores.aspx

Congratulations to the Lab’s Newest Ph.D.s

May 2016 marks a significant milestone for three colleagues who are affiliated with the Lab. We are proud to announce the graduation of the following individuals from the financial planning program at the University of Georgia:

Dr. Wookjae Heo: South Dakota State University

Dr. Abed Rabbani: University of Missouri

Dr. Jorge Ruiz-Menjivar: University of Florida

Their work in the field of financial planning is groundbreaking. Dr. Heo’s research into the determinants of life insurance demand has the potential to change the way insurance firms conceptualize the marketplace. Dr. Rabbani’s work advances the field’s understanding of how feelings influence risk-tolerance attitudes. Dr. Ruiz-Menjivar’s research will prompt new discussions about the way risk attitudes are assessed. We wish these three scholars well in their new positions!

Data Points Visit

Sarah Fallaw, the founder of Data Points, visited campus to meet with graduate students enrolled in the financial planning Ph.D. program at the University of Georgia. Her presentation on the value of incorporating psychological tools and techniques into the financial planning process confirmed many of the research ideas being studied by the students. A lively discussion about the interplay between theory and practice emerged from the discussion.

UGA Graduate Students with Sarah Fallaw

Sarah with the students.

The Value of a Hobby

Is this situation familiar? You have a client who makes a good living and has amassed a nice net worth over time. The client could do even better if they allocated their discretionary cash flow more effectively. After reviewing their situation, you discover that the client is involved with a hobby. As an outsider who is not particularly interested in the client’s hobby does it sometimes seem confusing when you learn how much is spent on the pursuit? After all, the client could allocate the same amount of money towards their retirement or other financial objective.

This was the question we asked ourselves in the Lab; basically, why do some people allocate a large percent of their cash flow and net worth position to hobbies where the actual return on any assets purchased is relatively low? When viewed with an economic lens, making hobby expenditures just does not make a lot of sense.

It turns out, however, that from a client’s perspective, hobby expenditures are worthwhile. Our study looked at those who collect postage stamps. Hobbies provide clients with a psychic return. In our study, we found that a hobby may provide a return equal to at least 3% annually. The key financial planning takeaway is this: Work with someone who has a hobby in ways that help the client understand the process of purchasing, insuring, and ultimately selling a collection. Know that the client is likely receiving a value from their activity that does not show up on a traditional cash flow or balance sheet statement.

Paper Abstract:

“This paper documents the extent to which collectors—specifically, those owning collectible classic US postage stamps—experience an opportunity cost associated with expenditures on their collection. Results show, based on stamp price, S&P 500, bond, and T-bill rate data over the period 1969 through 2013, that collectible stamps tend to underperform stocks and bonds on a risk-adjusted basis. Using estimates based on the Modigliani measure (M2), it was determined that collectors incur an opportunity cost when selecting collectible stamps over more traditional investments. However, it is known that collecting as a hobby provides sociological and psychological benefits. This paper adds to the literature by illustrating how collecting also provides psychic return benefits that can be valued similarly to investment returns. In this study, the foregone return rate of stamp collecting for those who allocate a significant percent of available resources to their collection equates to between 3% and 13% on an annual basis.”

Grable, J. E., & Watkins, K. (2015). Quantifying the value of collecting: Implications for financial advisers. Journal of Family and Economic Issues, 36(4). (DOI) 10.1007/s10834-015-9471-2

Social Work Treatment Plans

Frequently, financial planners experience the frustration of clients failing to follow recommendations. A planner might spend hours reviewing the tax code, filling out paperwork, developing meeting materials, analyzing information, and developing a comprehensive financial plan. Sometimes a planner presents the plan only to have a client nod and agree but later fail to implement recommendations. This can be annoying and confusing for both the financial planner and client. It is reasonable to ask why this sometimes happens. When implementation stagnation occurs it may be time to help a client think about the ways behavioral and relational problems impact the household financial situation.

Financial therapy provides one way to help financial planners start complex behavioral questions with their clients. Financial therapy draws from research and practices in the fields of financial planning, marriage and family therapy, social work, and other fields to address complex problems that can devastate a client’s financial situation. For example, a planner may notice clients with marriage problems that are bringing the couple to the brink of divorce. Not only will divorce devastate the financial plan, it may tear apart the family as well. In this situation, a financial planner could address the financial implications of the impending divorce while a marriage and family therapist could address the relational and psychological issues present in the situation; however, a financial therapist might address the broader spectrum of issues rather than focusing only on financial or relational issues.

This semester, the Lab team has been hosting a monthly seminar series where a small group of faculty members, practitioners, and graduate students meet to discuss current research and develop innovative research ideas based on connections between allied fields.

During the most recent seminar, a group from the fields of financial planning, marriage and family therapy, and social work gathered to discuss the application of social work treatment plans to the fields of financial planning and financial therapy in order to address financial, behavioral, and relational issues simultaneously.

Social work treatment plans are frequently used to develop an effective strategy to treat problem behaviors identified by a social worker and the client. As in the financial planning process, social workers help their clients identify goals, the problem behaviors preventing the achievement of their goals, and the steps that need to be taken to reach goals. Treatment plans, like targeted financial plans, must be adapted to account for changes in circumstances and attitudes. Social work treatment plans tend to be very strategic and goal oriented. These plans leave enough room for creative development to accommodate changes needed over time. Financial planners and financial therapists can learn a lot from the way social workers interact with their clients using treatment plans.

Treatment plans have four elements: problem statements, goals and objectives, interventions, and duration of treatment. Problem statements should concisely state the problems that are identified by both the client and the social worker in a full assessment of the client’s needs and circumstances. Problems that are most urgent or have the greatest short term impact (i.e., crises) should be listed first. Problems which are the root cause of other problems should also be prioritized. Second, treatment plans list the treatment goals that address the specific problems which have been identified. Underneath each goal are the objectives, which are broad descriptions of desired outcomes. Finally, the treatment plan describes which interventions will be implemented to accomplish the desired outcomes and outlines the duration of the intervention’s implementation.

When financial planners need to address stressful situations when working with clients, the traditional financial plan may not be as useful as a treatment plan. Thinking about interventions to address behavioral issues during the planning process can help planners better serve their clients and make a more meaningful impact. Future research is needed to address the lack of evidence-based financial planning interventions available to planners. Future research should endeavor to find and test interventions and solutions which can help clients achieve lasting behavioral change and address both their financial and relational problems. Lab seminars are one way we hope to launch some of these efforts.

Michelle Kruger

2015©

Much to be Thankful for this Year

As 2015 comes to an end, and as we take a day to express our gratitude for all the good things that have happened this year, everyone in the Lab would like to say thank you for all the comments, input, and ideas that have come our way. We are particularly thankful to the following organizations for their support this year — without these firms our work would never be as strong as it is:

DataPoints — thank you for supporting our graduate students

Merrill Lynch — thank you for supporting the next generation of students entering the profession

Finametrica — thank you for allowing us to conceptualize risk tolerance in unique ways

TDAmeritrade Institutional — thank you for providing a space that our students can use to become better scholars

We know that 2016 will be even more exciting and productive. Keep an eye out for new research coming from those working in the Lab! Happy Thanksgiving.

Zeta: Measuring the Value of Financial Planning

The field of financial planning has grown exponentially in the last 15 years based on the premise that a person can expect better financial outcomes by hiring a financial planner. Is this assumption, in fact, true? Surprisingly, very little research has been focused on answering this question—until recently.

Researchers working in the Financial Planning Performance Lab are focused on answering the following question: “What is the ultimate purpose and value of financial planning?” This question is at the core of all research efforts at the Lab. This lead Drs. Grable and Chatterjee to develop a measure of financial planning value called Zeta.

Zeta is a measure of the relative volatility of wealth at the household level. Some might wonder how measuring wealth volatility is relevant in the context of determining the ultimate purpose and value of financial planning.

In the past, Alpha was the primary tool investment managers used to measure the value of their advice. Alpha captures how much an investment has outperformed a comparable investment, such as a benchmark index. Investors expect higher potential returns when a portfolio is exposed to greater risk and uncertainty. They also expect two investments with similar levels of risk to provide similar levels of return. Some of the excess in the expected performance of a portfolio can be attributed to the skill of the investment manager.

The problem, of course, is that few investment managers actually outperform relevant indexes. Most underperform. Using alpha and similar portfolio measures, it would appear that the value of financial advice is lacking. However, is this actually correct? The reality is that comprehensive financial planners do much more than manage client portfolios. Among other things, financial planners provide recommendations related to cash flow, tax-efficiency, insurance, estate, and retirement planning. Researchers working at Morningstar (Blanchett and Kaplan) noted that alpha fails to account for the value of this type of advice. They developed a measure called gamma to estimate how much value these types of planning activities create. Although the development of this measure took a great step toward discovering how much value professionals create by following the financial planning process, gamma, as originally conceptualized, did not take into account the value created by wealth management skills provided by most financial planners.

Zeta was developed as a more comprehensive measure of well-being by combing the best of alpha and gamma. At its core, Zeta shows that financial planners create value by reducing wealth volatility (risk) in times of financial stress such as the Great Recession. Rather than measure portfolio returns or gains from topic specific recommendations, Zeta attempts to estimate value created by minimizing the change (volatility) in total wealth over time.

Based on data from the Great Recession, it was determined that people who met with a financial advisor accumulated more wealth with less wealth volatility. This was true holding other relevant factors constant. Clients of financial planners exhibited 6.25% greater performance on a risk-adjusted basis than people who did not meet with a financial advisor.

While there is certainly more work to be done, initial results do suggest that financial planners are helping their clients in meaningful ways. Lab studies demonstrate that financial planning creates better financial outcomes through a combination of financial planning advice and skilled investment management.