Address clients’ emotional biases to improve investment decisions

Behavioural finance principles can help advisors better find and serve clients, especially during this period of investor unease related to the pandemic, says Boston-based Cerulli Associates.

In a release on Thursday, the global research and consulting company suggested that advisors pay increased attention to clients’ emotional biases as a way to help them set goals, maintain investment discipline and reduce decision fatigue.

“Advisors need to ensure that investment decisions are being optimized for the financial betterment of the investor,” said Scott Smith, director of retail investor advice relationships with Cerulli, in the release.

“Understanding their underlying biases and mitigating suboptimal investment decisions is critical for advisors in a digitally pervasive environment,” he added.

The firm’s research, published in a report called U.S. Retail Investor Advice Relationships 2021, found that investors most frequently identified with having availability (91%), confirmation (80%) and recency (71%) biases. With those three, investors base decisions on, respectively, readily available information, information that reinforces existing perceptions, and information tied recent events.

“The fact that investors realize they rely on things that they just read, that were easy to find, and reinforce what they already think underscores the challenge with investor ‘research,’” Smith said. “Instead of seeking out a variety of inputs from independent experts, consumers are predisposed to choose the path of least resistance.”

Smith noted that advisors should help investors understand their biases as early as possible in the relationship, especially because today’s research suggested that younger investors were more likely to exhibit the biases that affected them. Overall, investors ages 40 to 49 reported the highest incidence of confirmation bias (47%) and overconfidence (42%).

Investors at the highest wealth levels (more than US$5 million in investable assets) also had “elevated” levels of confirmation (39%) and availability (39%) bias, the release said.

“These investors have frequently made long-term decisions about the direction of their portfolios and are reluctant to be swayed by new information,” Smith said.

As investors’ advice needs change based on factors such as age, wealth and life experience, advisors also should consistently offer guidance — that will result in clients recognizing over time that accepting advice is wise and can help combat biases, the release said.

The report is part of an annual series of investor-focused research, based each year on dozens of surveys done across the globe as well as analyst-led, hour-long interviews that supplement findings.

Staff

The staff of Advisor.ca have been covering news for financial advisors since 1998.