Optimizing Client Options for Peace of Mind

Journal of Financial Planning: December 2020


Eric Toya, CFP®, became a CFP® professional in 2007. He joined the Navigoe team out of a desire to be part of a full-service financial advisory firm, dedicated to delivering world-class wealth management advice.

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Like many financial planners, I love diving into the details of a situation when there is a decision to be made. There’s not a dilemma that can’t be made clearer by a good spreadsheet. And this isn’t just for clients. Like so many others, amidst COVID-19 lockdowns and gym closures, my wife and I decided to get an exercise bike and narrowed our choices to the ever-popular Peloton or the NordicTrack. As you can imagine, a spreadsheet with all the pros and cons, reviews and ratings ensued. Spoiler alert: we got the NordicTrack (not an endorsement).

You should see my itinerary spreadsheets when we go on a major trip (remember travel?). While planning a trip to England a couple years ago, I asked a friend for recommendations since she has family in London. She forwarded me her spreadsheet from her most recent trip. Let me tell you, I appreciated the restaurants and attractions, but I was most impressed with her well-designed spreadsheet!

When it comes to advising clients, I have always considered it my responsibility to consider the available options and help them determine which decision would give them the highest probability of yielding the optimal results. Pretty black-and-white stuff.

As an overly simplified example, consider the decision by an investor with a sudden windfall of cash to invest into a diversified market-based portfolio. This could be from the sale of a business, a pension lump-sum payout, an inheritance, SuperLotto winnings, or any number of other scenarios. Assuming the decision has been made to invest the funds into the diversified portfolio, the next decision the investor has to make is whether to invest the funds all at once or to dollar-cost average the investment over some period of time.

Any research into these two options is pretty clear about what the client should do. Given that markets, on average, go up more than they go down, dollar-cost averaging usually results in reduced returns, and the optimal strategy is to simply invest the lump sum all at once.

When I have faced this question, my natural inclination is to put on my green visor, become the ‘Well, actually’ guy and roll out the data. Early in my career, I would practically browbeat clients to ‘make’ them understand what the data showed. What I failed to realize was that working with actual people is very different from plugging numbers into a spreadsheet.

The most important question that I have learned to ask myself, rather than the client, is whether the decision is potentially life-changing for the client. In other words, is the suboptimal decision so detrimental that it will cause a reasonable probability that the client will be forced to reduce their lifestyle in a meaningful manner, continue to work longer than desired, or be unable to fulfill other important financial goals? I have found that, oftentimes, even the suboptimal decision may move the needle on the margins—meaning that if there was a good probability of the client achieving their goals when making the ‘optimal’ decision, then there will still be a good, though maybe slightly reduced, probability of achieving their goals with the less than totally optimized decision.

The next question for the client is simply, “How would it make you feel?” If the reply is, “I’m good either way, I just want to make a smart decision,” then let’s go where the numbers take us. Oftentimes, however, clients express that they would feel more comfortable with a certain decision. When this is the case, I see my job not in guiding them into the less comfortable but statistically optimal decision, but into a decision that will also yield a good (even if statistically suboptimal) result, but allow them to sleep better at night.

How about some examples? Of course, there is probably an endless list of situations that this applies to. However, here are some common scenarios that I have encountered.

Paying off a Mortgage

A common question from clients who are approaching retirement is whether they should take funds from their investment portfolio and pay off their mortgage (assuming funds are available). Objectively, most financial plans are optimized when the client maintains a large mortgage on their primary residence, even into retirement. This is because market return assumptions are typically greater than the cost of the mortgage. Additionally, paying off their mortgage leads to a substantial reduction in liquidity.

However, a paid-off mortgage is often viewed as a significant personal achievement and is accompanied by the peace of mind of housing security. Additionally, for retirees who are relying on their portfolio for their cash flow, having a house free and clear substantially reduces anxiety during major market downturns. This is a classic situation where the client’s peace of mind takes precedence over what the numbers might say.

Dollar-Cost Averaging

As previously mentioned, since markets go up more often than they go down, spreading the investment of a lump sum over some period of time usually results in reduced returns. Despite this, the reality is that when someone receives a lump sum of money to invest, it is quite likely a once-in-a-lifetime opportunity. Even after deciding on an appropriate investment portfolio, the decision to invest at any particular time can feel fraught. When markets have rallied, the client may fear that they are investing at a peak. Of course, in the midst of a market downturn, no one can be certain when we have seen the bottom. Regardless of the market conditions, it feels like market timing, and getting it wrong, could be costly.

Dollar-cost averaging does not remove the timing question, as you still have to agree on the frequency and length of time for the investment. However, for many clients, it reduces the anxiety involved with investing at a particular point in time.

Lifetime Pension vs. Lump-Sum Payout

Full disclosure here: I love doing pension versus lump-sum calculations, especially if the pensioner is married and there are multiple survivor options. Ultimately, the ‘correct’ decision is totally unknowable, right? In order to know the best possible option, you would have to know how long both spouses are going to live.

But in talking through the options, you might be able to determine which option brings the client the greatest peace of mind. For some clients, having the lump sum feels like cash in hand, removing any worry about the solvency of the institution paying the pension. For others, peace of mind is a check showing up every month for the rest of both their life and their spouse’s life.

Here are the key points that I always keep in mind, especially when I find myself wanting to push the ‘optimal’ strategy on a reluctant client.

Will the client stick with it? At the end of the day, whatever the recommendations, the client’s ability to stick with it is just as—if not more—important than the decision itself. This is not a behavioral finance piece, but making decisions with the goal of optimizing peace of mind, rather than simply maximizing potential dollars, increases the client’s likelihood of sticking with the decision.

But will it cause harm? The process is important. Before making a recommendation that prioritizes peace of mind over outcome probabilities or potential dollars, I always walk the client through the range of likely outcomes of the different decisions. In some cases, the decision that they feel most comfortable with will result in too high a likelihood of undesirable outcomes. If the decision will materially affect the client in an adverse way it should, of course, be avoided.

The Future is Not the Average

The process of trying to optimize client outcomes can generally be described as maximizing their odds of success given a set of likely outcomes. In other words, ‘on average, your best strategy is as follows … .’ When we run Monte Carlo simulations and see their outcomes over thousands of trials, the distribution of outcomes is informative. However, it’s important to remember that the client’s future is not a distribution of outcomes, but a single outcome. Clients are not average, nor are they the average of all outcomes; they are individuals with individual outcomes.

You can only make perfect recommendations with perfect information about the future. Absent a crystal ball, we make the best recommendation we can to give the client the best opportunity for success. This means both the statistically optimal decision, but more importantly, the one that brings the client the greatest peace of mind.