This is the fifth post in a series giving our response to the FCA’s Call for Input on how to apply behavioural finance to help people make engaged investment choices more comfortably and confidently, and what role regulations can play in helping that to happen.
The series highlights four broad areas where better application of behavioural-finance insights can lead to better investor outcomes.
This post covers applying behavioural-science insights to improve investor education and in-the-moment financial decisions.
The full series is:
- Summary
- #1: Failings of existing suitability
- #2a: Failings of non-existent suitability 1: behavioural capacity
- #2b: Failings of non-existent suitability 2: pension transfers, ESG, and adviser noise
- #3: Behavioural science applied to improving investor education
- #4: Behavioural science applied to breaking down barriers to investment advice
We’ve so far looked at applying behavioural science to suitability – the process of matching investors to investments. We now turn our attention to the context in which this matchmaking takes place, namely, consumer understanding of the retail investment industry, and how to improve it.
Guided by the questions in the FCA’s Call for Input, this covers three main areas:
- Helping consumers make better decisions with just-in-time education.
- The role of both products and their presentation in meeting straightforward consumer needs.
- The messages sent and received by financial product labels.
‘The worth of sights,’ wrote Alain de Botton, in How Proust Can Change Your Life, ‘is dependent more on the quality of one's vision than of the objects viewed’. These topics are united by requiring a shift in focus from changing how investment products are viewed, rather than the products themselves. As long as the industry (and regulatory) focus remains on what is for sale rather than the humans doing the buying, progress in improving consumer outcomes will remain unnecessarily slow.
Investor education
The FCA asked: What role could or should ‘just in time’ consumer education play in helping consumers make more effective investment decisions?
As detailed in this talk (especially from 06:00) the story of attempts to improve investor education follows a path of:
- disclosure – for example, Terms and Conditions and Risk Warnings, to
- traditional education – for example, seminars and workshops, to
- nudges – for example, auto-enrolment and defaults, to
- engaged choice.
Just in time education is an example of engaged choice. Give the consumer all potentially relevant information well in advance of when they need to use it, and it will likely not make much difference. However, give them precisely relevant information at the time they are making their decision, and you’ve got a fighting chance of helping them towards a better outcome.
We strongly support the primacy of ‘just in time’ education (and other forms of engaged choice) over other more traditional forms of education in helping consumers.
In those limited cases where traditional education is effective at all, when we consider the costs and resource constraints of doing so at scale, it starts to look like a very costly way of achieving not very much.
Even environment-control ‘nudges’, excellent as they have undoubtedly proven to be in many scenarios, do little to improve people’s internal comfort and confidence with investing, so much as simply providing better shields from potentially discomforting complexity.
Using a combination of data analytics, behavioural design, and technology to hyper-personalise communication, engagement, and just-in-time education in decision-support systems offers far more potential to improve investment decisions, and in a far more cost-effective and scalable way. This is where the focus and resource commitment should be.
This is true not only in isolated investment decisions, but also more generally in the ongoing financial decision-making required for individuals to navigate the irreducible complexity of their whole financial existence. Financial well-being benefits from finances being well-understood, in a relevant and timely manner.
Products and their presentation
The FCA asked: What more can we do to help the market offer a range of products and services that meet straightforward investment needs?
Again, the focus on the range of products available is misplaced. There are ample products already available to meet straightforward investment needs.
The shortfall lies in services that make it clearer and easier for investors to identify the simple set of products most suitable for their (holistic) needs, avoiding any unnecessary complications, and – more importantly – for them to acquire the understanding and emotional comfort to invest and stick with those product solutions already out there.
The problem is much more one of behavioural engagement and emotional comfort than product availability – indeed there are strong arguments that broader product ranges are part of the problem, rather than the solution.
To suggest that the problem is a lack of products is to suggest that everyone with a garage full on unused gym equipment isn’t fitter because they are lacking the latest gadget, rather than because they’ve not learnt to get comfortable using the ones they already have.
Labelling of financial products
The FCA asked: Could clearer, consistent labelling of investment products help consumers make effective decisions?
The question of labelling is in many ways a combination of the previous two questions. Labels are a form of disclosure, and their focus is traditionally on describing what a product does rather than how its prospective owner will interact with it – acting as an ingredients list, rather than a user manual.
Clear, consistent labelling is always preferable to the opposite. However, this is unlikely by itself to lead to much improved decision making.
For investment decisions to be effective we should always prioritise principles over products, and portfolios over investments in isolation. Product labelling, on the contrary, risks encouraging consideration and comparison of investments in isolation, potentially at the expense of the more important question of holistic portfolio suitability.
Where product labelling might be most useful is where it focusses investors on the role of the investment product in the broader portfolio context. For example, labels that help investors to consider their exposure to particular risks or concentrations (e.g. to single stocks, geographies, sectors, currencies, etc.) when added to other investments in their portfolio against reasonable concentration limits for that investor at the portfolio level.
More important than investment product labelling is a clear mapping, with coherent methodology, from the investor to the overall investible assets of the investor, focussed on long term needs. This mapping from investor to investments often lacks any coherent foundation, leading to considerable inconsistencies between the asset allocation or portfolio risk given to investors with the same identified suitable risk level.
Consider how many products are labelled as ‘balanced’ versus how many owners of those products could explain what that means and why it’s suitable for them? Consider also how much divergence there is in the products bearing such a label.
One specific point is that labelling of investment portfolios (or, a fortiori, their component products) should use a measure of risk that is aligned to the long-term needs of the investor, and thus be forward-looking, stable, and with a long-term investment horizon in mind.
We frequently see short-term historical/realised volatility being used as a risk measure (often driven by KIID requirements) to match investor needs to portfolio risk levels. These measures are highly unstable and extremely dependent on the backward-looking performance in the recent past. They are entirely unsuitable for determining the appropriate risk level of a portfolio suitable for investor needs in the future.
