For financial advisers, financial planning is a strategic and considered activity. However, for investors who are making decisions that will impact their lives, livelihoods and futures, investing and making financial decisions are complex and often motivated by feelings and emotions.
Expecting investors to base all their financial decisions on logic alone is unrealistic and leaves people vulnerable to the effects of unplanned or hasty actions – something IFAs need to prevent as much as possible.
Behavioural finance as a thought model can help advisers to understand what motivates their clients’ thinking, behaviours and reactions in the interest of building better financial health presently and in the future.
What is behavioural finance?
Behavioural finance branches off as a subfield from behavioural economics. It combines principles of psychology and neuroscience with economic principles and its primary position is that financial decision making is not nearly as rational and calculated as older financial theory models suggested.
Traditionally, market theories suggested that the financial markets were efficient and that investors make rational, informed decisions regarding their investments and financial planning.
Behavioural finance was developed in response to this line of thinking and argues that, instead of being informed and calculating, people are more commonly emotional and more likely to make impulsive financial decisions.
Not only does behavioural finance purport that emotion and impulsive behaviour are the key driving forces influencing investor behaviour, but it also seeks to better understand how these thoughts and feelings play a role in driving big financial decisions, to help mitigate the risks associated with knee-jerk and reactive financial behaviours.
Behavioural finance biases
At its core, behavioural finance studies the underlying cognitive biases that inform and influence human decisions surrounding financial behaviour. These biases include:
- Confirmation bias
- Recency bias
- Herding mentality
- Aversion bias
- Familiarity bias
How can behavioural finance improve IFA services?
As advisers, we (generally) don’t come from a psychological background however, we can’t deny the very real emotional and psychological attachments that people tie to investing and financial decision-making.
For this reason, it’s become vital for IFAs to be their clients’ financial therapists just as much as their financial advisers. Advisers need to go beyond number crunching and assessments to establish the emotional factors underlying and driving clients’ financial decisions.
Advisers need to listen to a client’s financial fears, anxieties and hopes to better serve them over the long term and behavioural finance can equip IFAs with the tools to do that.
By incorporating behavioural finance into your client management strategy, you can:
Understand clients’ emotional reasoning
Being able to understand your client’s emotional reasoning will help you to mitigate any risks arising from emotionally-driven decisions. The more you’re able to understand your clients’ emotions, the better you can pre-empt any decisions they might make with level, considered advice.
Understand client behaviour
When you understand their motivations, both positive and negative, you can better understand your client’s behaviour. This will enable you to see things from their perspective and help them to make good decisions, manage their expectations more efficiently and build better relationships with them.
Understand client biases
Client biases can cause clients to make less-than-ideal decisions and requests regarding their financial portfolio. Knowing and being able to identify these biases in our clients can help us to ensure clients are taking the best-possible action regarding their finances and investments.
Of course, potentially pointing out biases may upset or offend clients, which is why advisers need to be empathetic and broach the topic in a sensitive way that focuses more on the solution than the problem.
What practical behavioural finance techniques can you implement immediately?
While studying behavioural finance at greater length is beneficial, there are a few behavioural finance tactics you can implement without any study required. It’s all linked to better understanding your client and what makes them tick to try and predict and mitigate potential future decisions they might make in certain situations.
Get to know your clients well from the beginning
Anytime you onboard new clients, make sure you talk to them at length about their lives, their goals and aspirations and fears. The more you know and understand about your clients, the more capable you’ll be to guide them and positively influence their behaviours.
Be their financial therapist and emphasise open communication
Don’t just collect information about your clients at the beginning – keep updating your understanding throughout the relationship. As time goes on, people and their circumstances change, influencing their financial choices. Make it clear to your clients that they can talk to you at any point about any interests, worries or concerns they might have so you can prevent them from possibly making impulsive decisions that could hurt their portfolios.
Talk to clients about their existing biases and behaviours
When clients come to you as their adviser, they’re trusting you to leverage your expertise and guide them to making the best possible financial decisions. Sometimes this might require having conversations about their past or current habits or biases.
Framing the discussion from the perspective of helping the client improve their financial situation, instead of their bias being a problem, can help to smooth this out and ultimately lead to better outcomes.
