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Financial advisers are finding a new competitor in providing counsel to investors: the social media. Studies show that investors’ decision-making is influenced increasingly by blogs, peers within the same networks, and virtual worlds.

Social media has come to dominate the internet as a new tool to communicate, collaborate, participate in a community and spark creativity. By converging many technologies, social media offer videos, text, podcasts, and real-time dialogue. “Enterprise” capabilities push out desired and unwanted information to computers and cell phones.

Roughly one-fifth of internet users in the UK visit social networking sites, compared to about one-fourth in the US, according to a Forrester Technographics 2007 survey. Participation in discussion forums and both reading and providing ratings are some of the most common types of activities.

After surveying 17,000 internet users worldwide earlier this year, Universal McCann found that social media is "becoming a more important part of global media consumption for internet users than some traditional media channels." Video clips are the quickest growing platform. The world’s biggest social network is MySpace, with a 32-percent weekly reach, followed by Facebook with 23 percent.

60 per cent of UK internet users of ages 16 to 54 have created a social network profile, more than double the 27 percent who reported having one in 2007, according to this study.

Social media are attractive due to their utilisation of the four ‘I’s of engagement: involvement, interaction, intimacy and influence. Technology has created tools that appeal to humans’ innate need to seek out contact and connect. Our brains are “wired for reciprocal exchange”, according to one researcher.

Privacy concerns, though, are a main barrier to using social networks cited by respondents ages 40 and over in a JWT Boom/ThirdAge study.

Despite these concerns, Charlene Li and Josh Bernoff of Forrester Research see a “groundswell,” the title of their new book. “Relationships are everything,” they write. “The way people connect with each other – the community that is created – determines how power shifts.” Social media technologies feed on our impulses – altruistic, prurient, creative, validation, and affinity.

Social media, such as blogs, are popular, too, Ms Li and Mr Bernoff contend, because they threaten institutional power. Online consumers can post their reviews and learn about their peers’ ratings. Lists of the most frequently visited stories, videos, or websites reinforce “people power,” creating even more traffic from those wanting to know what the buzz is. Blogs break news, forcing companies to come from behind “no comment” defences. People have a high level of trust in “recommendations from consumers” and “consumer opinions posted online.”

That said though, Ms Li and Mr Bernoff see most users of social media as being passive. Most will neither write their own blog post nor post a comment on a blog. Instead, they will simply consume the content and move on to the next interesting thing that they find.

Social media is playing a “rapidly growing and influential role in individual investors’ financial decision-making,” Cogent Research concludes. From its May survey findings, the firm contends that high net-worth investors, defined as having $100,000 in investable assets, are highly engaged in social media and influenced by peer opinion for the majority of their investment decisions. For example, 58 per cent of these investors have increased investments while more than a third have reduced investments in a specific fund or company as a result of other consumers’ opinions.

Social media leads them “to question the accuracy of information delivered by official sources (advisers and investment firms).”

Christy White, chief of operations for Cogent Research said: “Purchasing decisions are being influenced by what investors are seeing on blogs, message boards and videos, and financial services companies will increasingly feel the impact on their bottom lines. The question firms should be asking is not ‘if,’ but ‘how quickly’ they can engage in social media.”

Bill Doyle of Forrester Research is more sceptical. “Investors are less likely to use social technologies such as blogs than the general online population. And the more affluent an investor is, the less likely he or she is to use social media.”

Age is a defining factor, Mr Doyle notes in his report. Affluent investors tend to be older and use social technologies less than young investors who are just starting to build their investment portfolios.

For this reason, he argues that “there is no strategic imperative yet, generally for firms to launch social media initiatives. Right now, it is enough for e-business executives to ask the question, ‘how can social computing support my firm’s larger business objectives?’ Soon, though, they will need a strategy.” They cannot ignore how social media are expanding and the power that work-of-mouth marketing is having as a new brand awareness vehicle.

The firms, Mr Doyle says, who need to respond the quickest are those with younger investors, a high percentage of self-directed customers and a high percentage of such social media users as “creators”, “critics”, and “collectors”.

Traditional firms, observes Rodney Nelsestuen, research director of the Tower Group, are watching developments closely but have yet to launch a public initiative. The kinds of activities that give social media their appeal are things that firms find uncomfortable because of branding and regulatory constraints and concerns.

Three sites that offer insights into the opportunities available for firms are Mint, Cake, and Zecco. Cake and Mint allow users to aggregate information about their financial accounts from several financial institutions into one place. Investors can monitor their investment performance against others who also use the site to learn about the strategies behind top-performing portfolios. Zecco is a socially-oriented online trading service that provides low or no-cost trades and caters to younger investors. All of these sites augment their services through social networking, including blogs, where recommendations and analyses are shared by participants and not a cadre of professional experts as in traditional companies.

Traditional firms, Mr Nelsestuen notes, have invested heavily in brands identified with a coat-and-tie image, in-person advice and distinct expertise. He said: “It will be hard for them to permit aggregation of accounts, provide platforms for unlicensed people with top-performing portfolios to provide peer-to-peer advice and manage the flood of information to protect against misinformation, fraud, and financial engineering. So, frankly, the industry is really perplexed about what it should do.”

Mr Nelsestuen said regulatory concerns are another roadblock. The US Securities and Exchange Commission is far behind in updating regulations to reflect the internet’s evolution. The regulator is just beginning to understand how social media affects investors’ behavior and capital markets. Christopher Cox, chairman of the commission, said his enforcement division is particularly concerned about stock price manipulation facilitated by bloggers. More clarity and guidance is needed to help firms navigate social media and meet compliance obligations.

Use of social media, though, is inevitable in Mr Nelsestuen’s view. The client base of traditional firms will dwindle as baby boomers die and pass their wealth to Generations X and Y. Unless firms understand how to interact with these investors on their terms, which is markedly different from the way that their parents do business, their future is limited. Either acquiring or building such sites as Mint, Cake, and Zecco must be part of their business model. A different mindset is critical, too, one that fosters innovation.

James D Spellman runs a strategic communications agency in Washington DC