Clients' Behavioral Biases Turn More Extreme - Study

Editorial Staff October 4, 2021

Clients' Behavioral Biases Turn More Extreme - Study

The tumultuous events of 2020, and episodes such as the GameStop share trading frenzy of early 2021, suggest that behavioral biases among investors became far more pronounced over the months.

A survey of more than 300 wealth advisors in the US found that investors’ behavioral biases became more pronounced this year after the stock market plunge and recovery in 2020 as the pandemic took hold.

For example, “confirmation bias” – seeking information that reinforces existing views – more than doubled in severity, according to the BeFi Barometer 2021. Recency bias – in which people are easily influenced by recent news events or experiences – also rose sharply. 

The report was conducted by Cerulli Associates in the second quarter of this year, and commissioned by Schwab Asset Management, in collaboration with the Investments & Wealth Institute.

Behavioral biases and client interest in new types of investments were potentially driven by outsized media attention on buzzy investing trends, as well as social media and influencers. Just over half of advisors said that clients sometimes or frequently raised questions about stocks they saw on social media (52 per cent). Sixty per cent said that clients have invested in cryptocurrency in the last year, while one-third invested in special purpose acquisition companies (SPACs) and a quarter invested in so-called “meme stocks.”

When faced with inquiries from clients about social media-driven investment ideas, most advisors advised clients that these investments were unsuitable for their portfolios and did not invest in them (73 per cent).

For several years, wealth managers have been urged to harness insights from behavioral finance to help educate and guide clients over their own biases that are, according to theory, rooted in evolutionary psychology. Booms and busts, and other dramatic financial events, have been in part explained by reference to cognitive biases, such as over-confidence in one’s investment talents. 

Earlier this year, sagas such as the retail investor attack on hedge fund short-sellers of GameStop, the video games business, the surge in prices of bitcoin – and subsequent gyrations – and other sagas have reinforced concerns about frothy and emotion-driven financial behavior. A decade and more of ultra-low/negative official interest rates in certain countries has arguably fueled the flames.

“There has never been a more critical time for advisors to incorporate behavioral finance techniques into their practices to understand and help clients stay on course to reach their long-term financial goals,” Omar Aguilar, PhD, chief investment officer and head of investments at Schwab Asset Management, said. “The combination of pandemic-driven uncertainty, market volatility, and speculative investing trends have culminated in an environment where behavioral biases thrive.” 

In addition to reporting higher levels of biases among clients, significantly more advisors pointed to the effectiveness of using several behavioral finance techniques to mitigate behavioral biases. 

“Advisors can always use behavioral finance techniques to their advantage, but in times of market uncertainty, such skills can be a true differentiator,” Asher Cheses, associate director of wealth management at Cerulli Associates, said. “Our findings this year – a year of unprecedented challenges, uncertainty, and volatility – support that those who leverage behavior bias mitigation techniques were able to secure client trust and retain assets.”

The top five benefits of incorporating behavioral finance techniques, as reported by advisors in 2021, were strengthening trust and relationships with clients/increasing client retention; keeping clients invested during periods of volatility; cutting short-term or emotional decision-making; managing client expectations more effectively; and helping improve clients’ financial decisions and prioritize goals.

When it comes to how advisors are implementing behavioral concepts, 74 per cent do so through client communications, predominantly to align their communications with clients’ emotional tendencies (68 per cent). Fifty-six per cent leverage behavioral concepts when they are constructing portfolios in order to match risk tolerances (78 per cent) as well as age (73 per cent) and wealth (62 per cent) factors.

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