Paul Nixon, head of behavioural finance at Momentum Investments
The centerpiece of Sigmund Freud’s study at home in London and a symbol of psychoanalysis, in general, is the iconic chaise longue (pronounced ‘shayz long’ which is French for ‘long chair’). Relaxing on the couch helped the patient access thoughts and emotions often rooted in the past that provided critical behavioural insights.
When it comes to financial services, behaviour of investors matters.
However, the industry in South Africa finds itself at a crossroads. The journey to advice-led and advice-paid financial advice (fee-based) has stalled short at advice-led but predominantly product-paid. A significant barrier to this transition was illustrated in a study from Morningstar revealing that clients simply don’t value financial coaching. At least not yet. When asking investors to rank 15 attributes in order of importance, ‘helping me to reach my financial goals’ was, encouragingly, rated at the top. Concerning, however, was that ‘help me maximise investment returns’ was near the top (4th), while ‘helps me stay in control of my emotions and ‘acts as a coach/mentor to keep me on track’ were dead last and 13th respectively. There is a faulty belief that maximising investment returns results in the achievement of investment goals.
German military strategist Helmuth von Moltke is renowned for this quote: “No battle plan survives contact with the enemy.” The Momentum Investment Sci-Fi report for 2021 demonstrates that investment plans often don’t survive contact with financial markets either. In fact, 2021 saw a record number of investment switch transactions exceeding 28 000 and an 80% increase in the number of investors actively engaging with their portfolios (switches). Ultimately, this resulted in over R90 million paid in behaviour tax at an average cost of 3.5% to investment returns.
Behavioural coaching and a deeper understanding of the investor’s psychological tendencies and the roots thereof is an undervalued skillset but one that is vital to the transformation to an advice-led and advice-paid financial planning world.
An important step towards this future was taken by the Certified Financial Planner Board of Standards (CFP Board) last year. Psychology has been added to the syllabus and will require knowledge of client and planner attitudes, values, and biases; behavioural finance; sources of money conflict; principles of counselling; general principles of effective communication; and crisis events with severe consequences (see the Momentum Investments COVID-19 investor behaviour case study here). These topics have been integrated in the education requirements for CFP certification and assessed on the CFP exam starting in March 2022 in the United States.
Russell Investments calculated the value of investment advice at 4.83% per year. Four of the five elements of advice reside in the more traditional technical competencies of tax planning, product alignment, portfolio rebalancing as well as customer experience and together amount to an estimated 2.81% per year in value. Financial advisers, however, have focussed far too much on the numbers leaving clients to fend for themselves when it comes to the psychological roots of how they got to these numbers in the first place. One element, behavioural coaching, adds the rest and was estimated to add 2.02% in value to clients annually. When considering the effects of the behaviour tax Momentum Investments has studied, this figure is not far off.
Investing is personal, and the survival of a financial plan demands an understanding of investor behaviour. However, the future looks bright, as the importance of psychology in investment decision-making begins to take its rightful place in the armoury of a good practitioner. Producing results in managing and eliminating the behaviour tax of investors will improve the perceived value of this important skill in the eyes of clients.
Perhaps it’s a good time to consider a chaise longue in the consultation rooms of the new age financial planner.