Policy-Based Financial Planning

Policy-based financial planning is a technique that Elissa and Dave have been developing since their first article on the topic appeared in The Journal of Financial Planning in 2006. The approach has received a lot of attention in the press lately, in no small part because of a book called Investor Behavior: The Psychology of Financial Planning and Investing to which Elissa and Dave contributed a chapter on the topic of financial planning policies.

Financial Planning Magazine
Carol J. Clouse from Financial Planning Magazine wrote an article about client behavior that discussed policy-based financial planning (free registration required) as a system for developing compact decision rules that make it easier to take appropriate actions in a rapidly changing environment. Carol did a great job of capturing the essence, notwithstanding the article’s unfortunate title, “When Clients Behave Badly: What to Do,” which would, of course, never apply to Yeske Buie clients!

Carol opens her article with a humorous example of how our natural propensities can be channeled by a simple policy:

You know that friend who always arrives 15 minutes late, so you tell him the movie starts at 7:15 when it really starts at 7:30?

Advisors who use a strategy they call policy-based financial planning do something like that. A good advisor knows that, while you cannot change human nature, you can use a client’s habits and behavioral biases to craft a financial plan that works for him.

POLICIES: CLEAR BUT FLEXIBLE

A good policy should return an unambiguous answer for clients even if circumstances change, so it should be structured around percentages and other adaptable targets. For example, a young client (or a client’s adult child) who needs a strategy for saving might have a four-part policy that sounds something like this:

• I will save the first 10% of every paycheck.
• All of that will go into my emergency fund until I amass three months’ wages.
• After that, the savings will go into a retirement vehicle up to the maximum contribution.
• Any remaining savings will go to a supplemental retirement account.

Yeske’s observations on policy-based financial planning are among the insights he has developed with his wife and business partner, Elissa Buie. They appear in a recent book, Investor Behavior: The Psychology of Financial Planning and Investing, by H. Kent Baker and Victor Ricciardi.

At more than 600 pages, the book has 30 chapters written by investment professionals and academics. “The majority of the content focuses on the decision-making process of the individual investor,” says Ricciardi, a finance professor at Goucher College in Baltimore.

The book tackles a wide array of subjects, including the effects of religion on investment decisions; the neuroscience of financial decision-making; post-crisis investor behavior; and the real world of trader psychology.

Investment Advisor Magazine 

Bob Clark wrote a review in Investment Advisor Magazine saying that while the 30 articles in the book were fascinating from an intellectual standpoint, he singled out the policy-based financial planning chapter as particularly useful for practitioners in their work with financial planning clients.

Finally, one of the dynamic duos of the financial planning world, veteran planners Yeske and Buie, wrote: “Practitioners not only need an understanding [of behavioral finance concepts] but also practical tools. Policy-based financial planning is one such tool, offering a framework and approach that allows practitioners to craft decision rules that can keep clients committed to a consistent course of action.”

Based on their 2011 paper, Yeske and Buie provided a six-step process for creating effective financial planning policies for each client:

1. Engage in the discovery process in which the financial planner learns about the client’s personal history, values, beliefs, goals and resources.
2. Identify planning areas and best practices required by this client.
3. Combine goals with best practices to create a proposed policy.
4. Test the policy: Is this a good policy?
5. Test-drive the policy with the client and listen to their feedback.
6. Conduct periodic reviews and updates checking for changing circumstances.

The couple concluded: “Financial planning policies are structured decision rules that can act as a touchstone for both clients and their advisors and allow for rapid decision making in the face of a changing environment.”

While Yeske Buie has found Policy-Based Financial Planning to be very helpful in developing policies for risk management & insurance, investments, charitable giving, and when and how to refinance, financial planning policies can also be extremely helpful in the work we do with the adult children of existing clients, some of whom are just launching themselves in their career. In most cases, these young people will experience many significant changes in a relatively short period of time, including multiple job changes, significant changes in pay or benefits, and multiple living arrangements, from shared apartments to buying homes. Policies can help them deal with all of these changes without requiring them to “reinvent the wheel” with every move.

In conclusion, policy-based financial offers a framework and approach that allows practitioners to craft decision rules that can keep clients committed to a consistent course of action in a seemingly chaotic and unpredictable world.