Easing emotion in client investment

Given the volatility in domestic and international markets, retail investors can be forgiven for becoming a bit emotional about their portfolios. But emotional comfort comes at a price.

Tuesday, March 28th 2023, 12:01PM

by Andrea Malcolm

Behavioural finance software company Oxford Risk estimates the average investor forgoes around 3% a year in lost returns annually due to short term behaviours and emotional decisions.

Over a lifetime the lost returns from money sitting on the side-lines pile up and investors make avoidable losses from timing mistakes such as buying high when times are good and selling low when times are bad.

Greg Davies, head of behavioural finance at UK-based fintech Oxford Risk, says financial advisers are ideally placed to help people cope with the emotional and psychological investing roller-coaster. However, managing the investor is just as, if not more, important as managing investments themselves, he says.

Oxford Risk believes many wealth managers and financial advisers need better systems and tools to support clients particularly, in light of recent events such as the financial impact of COVID-19, rising inflation and high levels of volatility.
Recently, the software company conducted an online survey of 50 Kiwi wealth managers (collectively managing $145 billion in assets), finding that 58 per cent believed there will be pressure over the next five years to compensate clients for not doing enough to understand risk profiles.

Bianca Kent, Oxford Risk head of New Zealand client and strategy says, the impact of the last three years’ volatile markets on returns will inevitably disappoint many clients.

“It is worrying however that so many wealth managers fear they will face compensation claims over their advice and particularly worrying that it will focus on a poor understanding of client risk profiles.”

The results found nearly three-quarters (74%) of participants are sometimes surprised by the investment decisions clients make, with the most common mistake identified as evaluating returns over too short a time period (34%). Other common client errors include having a home bias in their portfolios (32%), and making impulsive decisions to the detriment of long-term plans ( 32%).

Up to 80% of those surveyed expect action from regulators over the next five years to require them to better understand risk tolerance and suitability.

“There is a widespread expectation from wealth managers that there will be tougher regulation on the issue and we would urge them to act now and get ahead of any changes in Regulation,” says Kent.

Robust capture of client data

Oxford Risk, which launched in Australia and New Zealand nearly two years ago, has one New Zealand client; Sage Wealth implemented Oxford Risk’s Investor Compass when it launched in 2022 and customised the software with its own branding.

Sage senior wealth advisor Aga Krzeczkowska says the firm uses four modules; financial personality assessment, financial circumstances and goals, knowledge and experience, and sustainable investing to capture information on clients’ financial situations, objectives and goals as well as their knowledge of investing, attitude to risk and sustainable (responsible) investing.

“We are required to capture this information for regulatory reasons and in order to be able to create a suitable long-term financial plan and recommendation for a client.”

She says the tool offers a robust way of capturing a client’s understanding of risk, markets and their general knowledge and attitude to investing.

“It prompts the client to think about their responses rather than it just being a ‘box ticking exercise’, allows us to identify the level of client’s understanding of investing and helps us spot any areas that need further clarification or discussion.

“We especially like the sustainable investment section which prompts some interesting discussions with clients around their attitude towards responsible investment versus charitable gifting. It is a very difficult area to discuss due to its various layers, motivations and objectives. The questions help clients understand their reasoning behind responsible investment and whether it is important to them, if at all.”

Krzeczkowska says good advisers have been preparing clients for a lower point in markets for a while so hopefully their clients have not been surprised by the lower returns and volatility.

Tags: investment