WM Market Reports

Wealth Advisors Increasingly Use Behavioral Finance To Win, Counsel Clients

Tom Burroughes Group Editor September 9, 2020

Wealth Advisors Increasingly Use Behavioral Finance To Win, Counsel Clients

Recent sharp selloffs to equities have only underscored how volatile conditions have given the insights of behavioral finance new relevance. A study conducted by three organizations probes how advisors use these ideas to win business, retain clients and make their firms more resilient.

Wealth managers increasingly use behavioral finance insights to win and counsel clients, with recent market selloffs reinforcing the value of this intellectual toolbox, according to a new report.

A study of more than 300 advisors by Charles Schwab Investment Management, Cerulli Associates and the Investments & Wealth Institute, has found that 81 per cent of advisors now use behavioral finance techniques when talking to clients, rising from 71 per cent in 2019. 

The study, issued yesterday, found that advisors using this body of ideas say that it aids client retention and acquisition. Some 66 per cent of those questioned said that they gained clients in the first three months of this year – the time when COVID-19 struck. (Fieldwork for the BEFI Barometer 2020, as the study was called, was conducted in May and June this year.) 

Insights of behavioral finance, such as how people mistake portfolio gains for pure skill rather than also accept the role of chance, or treat losses more emotionally than they do with gains, and follow crowd behavior, have become more widely appreciated. The ideas draw on views about how humans have evolved from pre-history, and are used to explain events such as stock market booms and busts. 

As advisors compete for new clients and try to retain existing ones, new ideas can give an added edge.

The field is about “creating a choice architecture for people in advance”, Devin Ekberg, chief learning officer and managing officer of professional development at the Investments & Wealth Institute, said in a video conference about the report yesterday. This “choice architecture” term referred to how behavioral finance ideas can guide people on how to behave in advance of a market event – such as the March selloff in equities when the pandemic and lockdowns struck. “I’m excited to see people using that,” Ekberg said.

Ekberg said the discipline also reinforced the need for advisors to show clients that they are competent to handle investment issues, as well as to foster trust.

Big gyrations in markets, as seen in the March equity selloff, followed by the recovery, and now the tech-led selling of recent days, are reminders of how emotion as much as hard fact can drive developments. Panelists in the webinar yesterday said, when asked by Family Wealth Report, that an era of what are effectively zero interest rates have made people even more hungry for income wherever it can be found – and this can affect market valuations. 

Some 55 per cent of advisors who used behavioral finance said it helped keep clients invested when markets were choppy; 48 per cent said it fostered strong client relationships and improved client retention; 40 per cent said they were able to manage client expectations more effectively, and 37 per cent said it cut short-term or emotional decision-making. 

“Advisors are guiding clients through an unprecedented market environment and emotions are running high,” Omar Aguilar, PhD, chief investment officer of passive equities and multi-asset strategies at CSIM, said. “Keeping clients focused on long-term plans and goals while mitigating their own biases through the uncertainty we are experiencing today is no small task. Keeping a disciplined approach and a clear communication plan are critical elements to helping clients achieve their financial goals. It is exciting to see that advisors are recognizing the value of putting behavioral finance concepts into their practice.”

“Behavioral finance is always relevant, but this moment really brings to life the impact it can have on advisor’s practice,” Asher Cheses, research analyst, High Net Worth at Cerulli Associates, said. “The results of this study bode well for increased adoption of behavioral finance programs going forward.”

Asked how advisors said client investment activity changed since the first three months of 2020, 53 per cent of advisors using behavioral finance said that clients used the market opportunity to use tax-loss harvesting, while 44 per cent of non-users said clients did so; 28 per cent of BF users raised allocations to active managers who might outperform in current conditions, while 22 per cent of non-BF users did so. 

The most common bias noted among clients by advisors was what is called “recency bias”, which is when a person is easily influenced by recent news or experience. In 2020 there was a rise in “loss aversion” among clients (playing it safe or accepting less risk than they should tolerate), and an uptick in home bias (preference for investing in familiar, domestic companies). The report also showed a rise in framing (making decisions on how information is presented), and mental accounting (splitting wealth into different buckets based on financial goals, rather than thinking of wealth as a whole).

The discipline harnesses what is known about human psychology to understand that the decisions people make with savings, investments and spending aren’t as coolly rational and objective as one might think. Humans don’t, so the argument goes, start off in life with a mental “blank slate” but instead carry habits and tendencies that are products of millions of years of human evolution. (Some of these notions can be controversial – the field known as evolutionary psychology, drawing on ideas from Darwin and others, can carry political implications such as male/female differences.)

BF practitioners in this area generally seem to argue that the more humans understand how they think, and how they can be biased, paradoxically, the more rational their choices could be. For example, a person who knows that they have a short temper in certain situations might be more careful about avoiding such situations; a person with an addictive personality might take care to avoid getting into environments where temptations exist, and so on.

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