Using behavioural insights to empower better financial decision making

Professor Greg Davies is a globally recognised expert in applied decision science, behavioural finance and financial wellbeing, as well as a specialist in both the theory and practice of profiling. He is the Head of Behavioural Finance at Oxford Risk and explores the common South African investing personalities.

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In order to get someone good investment outcomes, you can’t just hand clients a technically correct investment portfolio for them to invest in. In order for people to withstand the investment journey, they have to be comfortable enough to get into that portfolio in the first place and comfortable enough to stick with it as markets fluctuate. We’ve been trying to measure aspects of people’s personality that relate to their emotional comfort with a portfolio and investment journey, which could influence how they respond emotionally to the volatility inherent in the investment journey.

Investment archetypes
There are multiple dimensions to how individuals experience investing. There are identifiable client archetypes or personas and certain common patterns that individuals tend to cluster around. This is useful in order to segment your clients and understand how to help each of them. In order to give someone the right portfolio, you need to understand their risk tolerance and long-term willingness to trade off risk and return. Composure is someone’s tendency to be emotionally engaged with the short-term and has been identified as an important factor to consider. If we can identify people who are inclined to be more emotionally engaged, it means we should be doing something different for these people – they need more handholding and guidance.

Six investment archetypes were identified in the South African context, which were classified into two groups – low composure and high composure. The low composure group is more emotionally distracted by news about their investments than the high composure group that is more cool, calm and collected and capable of keeping their eye on the long-term goal.

The low composure group was divided into three groups. 25% were classified as stressed, i.e. they have low confidence, are not comfortable with investing at all, are stressed about their finances, not comfortable making financial decisions and want guidance. 17% were skittish, i.e. they are financially comfortable at present, but worried about the future, uncomfortable with investing and want advice. 12% were sensitive, i.e. they want guidance on investing, want to make a social impact with their investing, specifically want an adviser to support them because of being unsettled by news about their investments, and financially comfortable.

The high composure group was also divided into three groups. 24% were settled, i.e. not particularly interested in or emotional about investing, financially comfortable, not interested in social impact. 11% were secure, i.e. interested in investing, have high confidence and composure, but still interested in getting guidance from professionals, high interest in impact, very financially comfortable. 11% were secluded, i.e. believe they know what they’re doing, and really don’t want guidance from anyone else, not interested in social impact or how other people are doing, very financially comfortable.

By understanding your clients’ composure, you can provide them with the appropriate portfolio and product suggestions, have the right conversations and send them communication that aligns with their individual levels of composure and personality measures.

How advisers map to the archetypes
Low composure groups generally include fewer financial advisers. Financial advisers tend to be composed, confident and comfortable in the financial space. There are a lot more financial advisers in the high composure groups than there are clients are and this is even more severe when you look at advised clients. This suggests that the type of people who go to financial advisers and the type of people who become advisers are quite different.

Aligning a low composure client with a high composure financial adviser
We often think that people around us are more like us than they actually are. Most clients will be less confident and composed than their financial adviser, which means that advisers are likely to underplay the client’s need for financial comfort during a market blip and may be systematically underestimating their client’s level of anxiety. One of the key benefits of having a financial adviser is having someone to provide that financial comfort. Profiling tools that provide objective measures of who the client is enables the adviser to give their client the solution and communication that is right for them. The system that advisers use to identify the right risk level for clients and choose the products to go into the portfolio should be driven by a deep understanding of who the client is. The big issue with anxiety is that low composure people tend to have shorter emotional time horizons than high composure people. We need to start matching portfolios to personalities as well as communication and optimal handholding.

Where does the Big Five fit into these personality profiles?
Many of the traits that we use map onto other personality measures like the Big Five. The difference is that the Big Five is trying to describe the person as a whole with every aspect of their personality, while we are trying to zoom in on the more granular features that are particular to their financial and investing decisions.

How to reach the investment goal while managing low composure investors
With low composure investors, there is a risk of a trade-off between chasing the financially right thing to do and making people comfortable. While you can make people comfortable by dialling down risk, this increases the risk of not reaching their goals and lowering their returns. Most of the work should be done not by changing the risk level, but by changing the communication and client engagement. Instead of sacrificing the goals or too much of the returns, rather put your energy into educating, communicating and building your client’s confidence. With low composure clients, slow your communication down and focus on the long-term, the portfolio as a whole and the total wealth, and stay away from unnecessary details. If you start with a high-level, long-term message, you are effectively setting the emotional frame for that conversation, which can be extremely valuable for low composure people.