Helping your clients to overcome their behavioural biases

Behavioural scientists acknowledge that our environment, the way information is presented, and other subtle hints alter our behaviour regardless of any logic. These factors can combine to affect our decision-making processes, leading to less-than-ideal choices by clients. When this happens, an advisor’s job is to help them get the better of these deep-seated biases.

What are the big behavioural biases affecting investors’ decisions?

Behavioural biases, in layman’s terms, relate to our instincts, emotions, and predispositions.

Sometimes they’re useful – for instance, when faced with danger – but when they’re followed without questioning, they can derail a client’s plans. The latest #fintok video or a compelling news story may grip their attention and cause them to depart from an agreed-upon wealth strategy. As an advisor, it’s important to understand this risk and guide clients appropriately.

Which client biases can derail their investment strategy?

Consider loss aversion. We have a tendency to over-emphasise losses. In other words, the disappointment and memory of losing R100 are bigger and stronger than the sense of achievement of gaining R100. Because of this, investors tend to panic at the first sign of a market downturn, and many are tempted to sell or switch portfolios to try and beat the market.

Another important bias is herding. We are all highly social beings, but too often investors follow the herd off a cliff. The herd certainly doesn’t know your client’s individual circumstances, goals and long-term financial plan. A topical example is the phenomenon of the meme stock. Social media posts by just a few influential users can set off a bout of herding behaviour. Clients might be tempted to join the boom or escape the bust. Cooler heads should prevail.

One we can all relate to is present bias. We can get caught up in the here and now. This is particularly dangerous for younger investors. Current consumption is enticing, but every rand spent today is one that can’t grow for the future. Advisors are in a constant battle to orientate clients towards their future selves and to make decisions that are good not just for now but for the future, too.

Finally, a challenge that is growing with the technological revolution is the choice overload. In the investment space, the number of products available has proliferated. This can lead to superficial understanding and poor asset allocation. Clients are exposed to a torrent of ways to make (and lose) money. Helping them to understand the different investment products and the value of time in the market can help them to make informed decisions based on tried-and-tested investment principles.

How to steer clients away from biased decision-making

Being able to identify these biases is the first step. Once you’ve done that, there are ways to guide the client appropriately.

Starting with the end in mind is key. Make the benefits of long-term investing tangible. For example, rather than highlighting the potential performance of a product, relate it to a specific goal like a dream holiday, a new home, or a child’s education. When reminded of these targets and the people they will benefit, clients are better able to balance current needs with future desires.

How you frame the options also matters. Richard Thaler (a Nobel Prize laureate) and Cass Sunstein call this “choice architecture”. We can design financial decisions to encourage better behaviour. A good example is a behavioural commitment device, like automatically investing some portion of all bonuses. By doing this today in a moment of calm, we avoid the risk of emotion or simple lethargy leading us astray later on.

One “hack” I like is a 24-hour rule. All of us have rash thoughts from time to time. Whenever I’m tempted to depart from a financial plan, I sleep on it. Encouraging a client to give it at least a day provides the space to return from a biased mindframe to a more logical state. Or, in the language of Nobel laureate Daniel Kahneman, to move from “thinking fast” to “thinking slow”.

View all 1nvest ETFs, unit trusts and TFIAs and see how they could help your clients meet their investment goals. Our products’ simplicity, transparency and cost-effectiveness all help to give clients the comfort that their long-term strategy is working for them, regardless of biases that inevitably emerge from time to time.