Journal of Financial Planning: June 2021
Brandon Renfro, Ph.D., CFP®, RICP®, EA, is a professor and practicing financial planner specializing in tax-efficient retirement distribution. He serves as a volunteer exam developer for CFP Board, writes for a variety of personal finance publications, and is an Infantryman in the Arkansas Army National Guard.
A client’s confidence can have an effect on their well-being and financial security.
That’s what the two research articles I have chosen to recap for this column both delve into.
The first article, by Sunwoo Lee and Sherman Hanna, Ph.D., discusses how overconfidence can work against a client who tends to take early withdrawals from retirement savings. The second article, by Matthew Sommer, CFP, CFP®, HanNa Lim, Ph.D., CFP®, and Maurice MacDonald, Ph.D., suggests that confidence in one’s ability to meet investment goals can positively affect clients’ well-being.
“Financial Knowledge Overconfidence and Early Withdrawals From Retirement Accounts” by Sunwoo Tessa Lee and Sherman D. Hanna, Ph.D., Financial Planning Review
Retirement savings adequacy is a significant concern for most households in the United States. Although pre-retirement withdrawals can be a rational response to shocks—medical expenses, job losses, divorce, or other reductions to household income—they can have a negative and potentially detrimental impact on retirement adequacy.
While many studies focus on the accumulation of retirement savings, this article approaches the problem of retirement adequacy from the perspective of pre-retirement withdrawals.
Financial knowledge can affect the likelihood that a household will take pre-retirement withdrawals, with lower levels of financial knowledge being associated with a greater likelihood of doing so. Lee and Hanna have extended the discussion of financial knowledge to include an element of one’s perception of their personal financial knowledge—which they call subjective financial knowledge—and contrast that with actual or objective financial knowledge.
They studied responses to the 2018 state-by-state National Financial Capability Study, restricted to non-retired households with a retirement account other than a defined benefit plan since these do not allow for early withdrawals.
Lee and Hanna assessed—separately and jointly—the effects of objective and subjective financial knowledge on pre-retirement withdrawals. Particularly interesting is the joint test. They found that of overconfident respondents, 37 percent had taken a hardship withdrawal, and 40 percent had taken out a plan loan in the previous 12 months. Overconfidence is determined by a high subjective financial knowledge score. The respondent thinks they have a high degree of financial knowledge coupled with a low objective score, meaning they don’t actually have the level of financial knowledge they think they do.
For comparison, in one of the study models, of respondents who had an appropriately high level of confidence (high objective and subjective score) or who were underconfident (high objective but low subjective score), only 5 percent had taken a hardship withdrawal. After controlling for other demographic factors that may affect the likelihood of taking early withdrawals, Lee and Hanna found that overconfident respondents had a 35 percent likelihood of taking a hardship withdrawal, whereas those with appropriately low confidence had a 16 percent likelihood of taking a hardship withdrawal, and both underconfident and appropriately high confidence both had a 9 percent likelihood of taking a hardship withdrawal. Results were similar in another model.
A key issue here for the practicing financial adviser to consider is whether clients have appropriate subjective knowledge, or whether they may be overconfident when considering early withdrawals from retirement accounts. Identifying this trait in clients could help guide discussions appropriately. With guidance, clients could decide for themselves to pursue alternative actions.
“An Investigation of the Relationship Between Advisor Engagement and Investor Anxiety and Confidence,” by Matthew Sommer, CFA, CFP®; HanNa Lim, Ph.D., CFP®; and Maurice MacDonald, Ph.D., Journal of Personal Finance
The use of financial advisers by the investing public is growing. This is at least partly due to a belief that advisers have tools, training, and expertise to help clients make decisions regarding more complex financial matters.
But does retaining a financial adviser actually make clients any better off? That question isn’t particularly new. Many studies have addressed it and most have shown that a qualified adviser can, in fact, improve a client’s outcomes. Most often, these studies address the question from the perspective of portfolio management and the result is measured by returns. This paper in the Journal of Personal Finance addresses the question regarding non-technical factors of financial anxiety and investment confidence.
The study was conducted using an online survey through the Research Now SSI National Online Panel in January 2018. The sample consisted of approximately 1,000 individuals with investable assets of at least $250,000 (with 200 having investable assets over $1 million) who either currently use a financial adviser on a recurring basis or plan to within the next two years.
Regarding financial anxiety, respondents were asked to select one of four statements:
- Describes me completely—I rarely worry about my finances.
- Describe me somewhat—I rarely worry about my finances.
- Describes me somewhat—thinking about finances fills me with anxiety.
- Describes me completely—thinking about my finances fills me with anxiety.
Ultimately, the study authors grouped the first two and second two responses together to create a binary variable of “Has financial anxiety” or “Does not have financial anxiety.”
To assess investment confidence, respondents were asked, “Overall, how confident are you in your ability to meet your investment goals?” and given choices of very confident, somewhat confident, not too confident, or not confident. Again, responses were grouped into “Has investment confidence” or “Does not have investment confidence.”
Controlling for gender, marital status, education, employment, age, income, investable assets, and ethnicity, two regression models were formed for financial anxiety and investment confidence.
The research found no relationship between the use of an adviser and financial anxiety, but it did find that the use of a financial adviser increased investment confidence. Respondents with an adviser were twice as likely to report they were confident in their ability to meet their investment goals.
A key finding of the study was that couples who shared in financial decisions equally, rather than when one partner is the primary decision maker, were more likely to express confidence. Given that couples often delegate financial decisions to one partner, this finding suggests that advisers may better serve clients by informing them of the potential advantages of making financial decisions jointly.
Increased confidence (and reduced anxiety) can lead to improved satisfaction and should be incorporated into a client’s cost-benefit analysis when deciding to use or retain a financial adviser. While financial advisers should be mindful of overconfidence, helping improve a client’s confidence in their ability to meet investment goals can improve their well-being and positively affect the client’s decision.
