Q&A: Behaviourism and the investor post-Covid

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Q&A: Behaviourism and the investor post-Covid

Both quantitative studies from investment specialists and qualitative insights from advisers indicate various trends starting to take shape over the course of the pandemic. 

On the one hand, as markets tanked and then rallied sharply, advisers have seen more prospective clients asking for help with what were previously do-it-yourself portfolios. Investment platforms, meanwhile, saw an influx of money from people keen on putting more money aside each month to plump up their financial cushion.

On the other, many investors - mostly the non-advised - have had their interest whipped up by stock market trends or lured into more speculative investments by promises of higher returns.

Some investors have even followed the money trail into the world of Bitcoin and similar non-regulated investments. But there are also those concerned over valuations, and all investment decisions are now being made in the context of a much more uncertain world.

So have behaviours been driven by fear, or by greed - or both? And are these perfectly normal, short-term responses to the pandemic, or indicators of underlying financial behaviours that could work against investors?

FTAdviser In Focus caught up with Louis Williams, head of psychology and behavioural insights at Dynamic Planner, and his colleague Chris Jones, Dynamic Planner's proposition director. 

FTAdviser: Are we all vulnerable investors now, thanks to Covid-19?

Louis Williams: There is no doubt that if you took a snapshot of people before the pandemic and today, it will have completely changed.

While many have become more vulnerable, many have become less so, while others become vulnerable in a different way.

People with affordability issues may have found themselves with positive cashflow. People with job security may have income today but concerns about their future.

Perhaps we have all always been vulnerable. -- Louis Williams

It’s hard to imagine that many have better physical or mental health, but they may have become more resilient having come through a difficult period.

Sadly, many will have experienced bereavement while having an unexpected inheritance and perhaps having to make large financial decisions for the first time.

Perhaps we have all always been vulnerable and, of course, we are all individuals.

Chris Jones: The important thing about the concept of a vulnerable client is to ensure that when financial professionals deal with anybody, they think about what might make that person vulnerable.

They should make sure they consider any consequences and the impact of their advice to ensure a good client outcome and suitability.

As we have written before, the very act of seeking advice and making a plan can reduce vulnerability by increasing self-efficacy.

FTAdviser: What sort of negative behaviours should advisers be looking out for when it comes to their clients?

LW: In a crisis like the pandemic there is a tendency to put on a brave face for a period of adversity until you can revert to normal.

This can lead to clients subconsciously saying what they think you want to hear, or acting in a way that is not necessarily their true nature.

Life can feel unreal and a client can feel further detached from their present life. Many people intended to use this period for self-improvement; learn a language, to play an instrument or get fit; few did.

As we begin to see the end of the pandemic, people’s attention is turning towards their goals and what they will do when lockdown and the pandemic is over.

There are behavioural and cognitive biases that can be amplified in this period.

When our time is filled with social and traditional media, and if that is our only connection, then herd mentality can be increased. Growing interest in certain stocks or trends, and the news around them, is a sign of this.

Bestowed with new information and perceived knowledge, a client can be susceptible to overconfidence bias, either in themselves or in their one source of information. This can go hand-in-hand with recency bias.

FTAdviser: In that case, how can advisers help turn these into positive investment behaviours?

CJ: Encouraging the client to take a longer-term view of the situation using cashflow planning and risk-based indices can bring useful context, particularly where the adviser can share experiences of similar, past scenarios.

Using the additional time available from increased efficiency, to talk to clients to understand and explain to demonstrate empathy and understanding, is key.

Advisers should also try to be self-aware and recognise these biases in themselves.

Bestowed with new information and perceived knowledge, a client can be susceptible to overconfidence bias. -- Louis Williams

By reframing the problem and looking for positives, an adviser can redirect a client’s focus towards things that will improve their outcome.

The act of making a plan with a cashflow planning tool can allow the client to achieve a state of flow by immersing themselves in the task and forgetting the moment.

The activity increases the relationship with the planner and also refocuses on their relationships as part of the planning process and investment purpose.

LW: During this period, many people will have reflected and reassessed their life goals, which brings a sense of achievement.

This in turn increases confidence in the client’s ability to control their life and take action to overcome adversity and make good decisions.

Advisers can seek to understand their client’s personality traits and characteristics - such as extroversion, neuroticism, agreeableness, conscientiousness, trait anger, intolerance of uncertainty, resilience and of course self-efficacy.

These traits have an effect on the extent to which behavioural biases impact investors, so tailoring communications to ensure clients respond in a manner consistent with their long-term best interests is essential.

FTA: Studies have shown that savers have put more aside than ever before; but those who have never saved are more likely to be in debt. How do we balance this equation?

LW: Deferred versus immediate gratification is a big challenge; we have increasingly lived in a world where everything is faster, more immediate, more material and more superficial.

Even in lockdown, you can have goods delivered to you the next day and almost any kind of cuisine within the next hour; what does that subconsciously teach us about immediacy?

[Yet] during the pandemic it seems people have become more reflective and had the opportunity to contemplate their life choices and plans.

Many have also found that they have surplus income and thus saved more. The question is whether this accidental savings habit will stick, or whether the exuberance of post-lockdown spending will overcome the habit and [use up] the money saved.

The low interest rate, low inflation environment has become a breeding ground for scams. -- Louis Williams

During lockdown, savers will have felt a sense of security and even self-congratulation for past deferred gratification, while those in debt or with no savings will have wished they had saved or at least had more savings to fall back on.

There is, of course, structural bias against saving that favours taking on debt and spending. It is much harder to begin and increase savings, particularly long-term savings than it is to take on or increase debt.

It is significantly easier to gamble than it is to invest, especially as the financial promotions and sponsorship rules are hardest for long-term savings.

CJ: The low interest rate, low inflation environment has become a breeding ground for scams and ultra-high risk investments, a fact identified by the Treasury and the Financial Conduct Authority.

We can hope that they and the various government agencies act to balance this equation. Within the industry, advice is the key.

We can continue to become more client-focused and less performance focused.

We can also use cashflow planning more, increase collaboration between mortgage advisers and financial planners, and streamline our processes through technology to enable advice to become more accessible and affordable to more people.

FTAdviser: You've mentioned risk and a proclivity towards 'easy wins'. Is the GameStop saga evidence that people do not understand markets or risk, and are in danger of jumping on a populist investment bandwagon?

CJ: I was around for the Dotcom boom and I guess it is a bit like that. The important thing is to separate investing from trading.

There is a reason why equities grow as the economy grows over the long term and why they can inherently correlate with our future spending requirements, everyone can win if they are patient and realistic.

Trading is for the most part a nil-sum game hardly any different to gambling. Most people who bought in were trading options rather than the stock.

I don’t know at the end of the day whether the hedge fund managers and their investors will win or lose or whether the individuals who traded on RobinHood will win or lose.

The romance and the reporting of it will no doubt seduce more people to try this again. Most will lose, then feel those losses far more than the excitement and the gains.

People often worry more about providers going bust and losing it all, rather than thinking about the market risk that they could tolerate. -- Chris Jones

We have a responsibility to ensure that our industry is as accessible as it is relevant and engaging.

We need to extol the value of advice and the vast majority of client success stories rather than obsessing over the tiny number of scandals or mistakes.

We must always consider risk when discussing return. When we talk about the headline equity indices or star manager performance, it can seem the risk is no worse, and the best returns are lower than trading, Bitcoin and gambling.

But most investors are recommended diversified solutions with significantly less risk and more sustainable and predictable returns. 

FTAdviser: How can advisers explain 'good' and 'bad' risk to their clients? 

LW: The concept of good and bad risk is an interesting perspective. Ultimately there are two ways that you can measure this.

Firstly, does the client have the tolerance, capacity, knowledge experience or need to take the risk? Secondly, does the potential return [of the investment] fairly compensate you for the risk you are taking?

What may by all reasonable measures be a good investment, with risk fairly compensated by potential return - so a good risk in itself - can be a bad risk for the individual because of who they are.

The problem is we tend to begin with the potential return and then follow with the risk, which diminishes the first part of the risk/return trade off and anchors the client to a high expected return.

This makes it difficult for them to accept the realistic return that comes with the risk that they are willing and able to take.

We need to stop focusing on returns like they are a game or the Holy Grail, and spend more time understanding the client in order to begin with the risk that is right for them. 

CJ: When we talk about risk we generally mean falls in capital value from market risk. Credit and default risk is usually factored into the market value and market risk.

The general public often focus more on the kind of absolute loss from default or credit risk because of the scandals that are highlighted in the media and conversations with friends.

The kind of binary lose-it-all or win-it-all is familiar from betting. People often worry more about providers going bust and losing it all, rather than thinking about the market risk that they could tolerate.

Of course, with market falls, there is always the opportunity to remain invested. In this context, credit and default risk could be seen as 'bad' and market risk as 'good risk'.

Educating people about these differences, and that they can get better value returns (without risking it all) with advice and diversification, is a good start.

Simoney Kyriakou is senior editor for FTAdviser