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Adding value by improving investor behaviour

Curtailing client biases can help boost performance.  

Nearly three decades ago, in 1994, DALBAR Inc. released its first Quantitative Analysis of Investor Behavior (QAIB), which clearly demonstrated that the average investor underperforms investment markets. The most recent QAIB report, published in March 2023, shows once again that investor behaviour can be a liability: the average equity fund investor in 2022 achieved returns 3.06 per cent lower than those of the S&P 500 Index of U.S. equities (–21.17 per cent vs. –18.11 per cent). 

Fortunately, advisors can play an extremely important role in educating investors to help them resist decisions that could hurt their long-term returns. A report from the Investment Funds Institute of Canada notes that, on average, people who invest with the guidance of an advisor have almost three times the net worth and four times the investable assets of those who do not – an outcome that is reflected across all age groups and income levels. When surveyed, 61 per cent of investors strongly agreed that their advisor had a positive impact on the value of their investments and their investment returns.1  

And what turned out to be the largest value-add? Advisors increased their clients’ returns through behavioural coaching. To maximize the value they contribute in this area, advisors need to start with a solid understanding of their clients’ behavioural biases and financial pressures. 

Behavioural biases 

 A Manulife toolkit entitled Using behavioural economics to help clients make better financial decisions identifies seven behavioural biases that, without intervention by an advisor, frequently influence investment decisions:  

  1. Overconfidence makes people believe they’re more knowledgeable or capable than they actually are.
  2. Loss aversion makes people feel the pain of a loss more acutely than the pleasure of an equivalent gain. 
  3. Representative bias makes people infer likelihood from similarity – for example, assuming recent returns will continue.
  4. Illusion of control makes people believe they can control outcomes, often leading them to act when they shouldn’t.
  5. Confirmation bias makes people pay undue attention to, or even actively seek out, information that confirms existing beliefs.
  6. Herd bias makes people follow the crowd rather than basing investment decisions on their own analysis.
  7. Present bias makes people focus on immediate needs at the expense of future needs. 

Any of these biases can persuade investors to act against their own interests, but there are specific strategies advisors can use to combat them. Many of the most effective approaches help slow down the mental shortcuts we all use to make faster decisions. This provides the time and space to be more analytical and less emotional, which is critical when making complex decisions related to investing. 

Financial pressures 

Behavioural biases are always there in the background, influencing investors’ perceptions and actions. But today, many investors are also under significant financial pressure, and that’s compounding the risk that they could act in ways that diminish their long-term results.  

Canadians are enduring a stretch of higher inflation and interest rates than they’ve encountered in some time. Pretty much everyone has had sticker-shock moments at the grocery store. People who are already burdened with high debt loads are now bearing the weight of significantly increased carrying costs on mortgages, lines of credit and other loans. 

A study conducted in December 2022 found that Canadians were at their most pessimistic about the economy in 14 years; the word most people used to describe how they felt about the economy was “worried.” Most (52 per cent) also worried about their financial situation, with many describing food costs, housing expenses and gasoline as “major sources of stress.”  

Strikingly, more than one in three (38 per cent) felt they were losing ground on their personal finances, and 70 per cent felt at least one negative emotion when thinking about their personal financial situation – compared to 54 per cent the previous year. 

Without question, this is a stressful time for your clients. They need you to cut through the noise and put the current situation in perspective. Specifically, you can help them understand how everything they’re seeing in the news and online affects (or does not affect) them and their family – and how the plans you’ve put in place together are helping to insulate them from the negative effects of current conditions. 

Financial planning improves outcomes  

An important piece of good news comes from a recent Ipsos poll conducted on behalf of Manulife Bank, which reveals that financial planning has the potential to enhance both financial and emotional outcomes, especially in uncertain economic times. Canadians who have a financial plan say it has helped them improve their:  

  • Overall financial health and wellness (79 per cent) 
  • Overall happiness (78 per cent)
  • Relationship with their spouse (73 per cent)
  • Ability to cope with the current economic environment mentally (75 per cent)
  • Ability to cope with the current economic environment financially (79 per cent)  

A large majority of those who have a financial advisor think their advisor is giving them good financial advice (88 per cent). Equally important, 79 per cent feel better about their financial situation because of their advisor, and 72 per cent believe their advisor turns financial negatives into financial positives.  

It’s clear that advisors are trusted and appreciated – and in an excellent position to reach out proactively to clients and share their experience, disciplined approach and good judgment as antidotes to behavioural biases. Those same characteristics can help you work with your clients to create solutions that relieve financial pressures and enable clients to achieve their financial goals regardless of the economic environment. 

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