Adding alpha by understanding your client’s money attitudes
If you want to stand out from the growing crowd of financial advice professionals, then your focus should be on managing and understanding client behaviour rather than picking shares or unit trusts. “Fund picking was never really the value proposition for financial advisers; most clients want to know if they are going to be okay, and whether the pot of money they are ‘growing’ will be enough to solve their problems,” says Paul Nixon, Head of Behavioural Finance at Momentum Investments.
Seeking guidance
Nixon was presenting to the ‘Minds and Machines 2024’ webinar, an event jointly hosted by the CFA Society South Africa, Global Association for Applied Business Sciences (GAABS) and Momentum Investments to explore the future of behavioural finance and financial advice. His revelation will not surprise the financial and risk advisers in FAnews’ audience. After all, your clients do not come to your office to ask how much you will outperform the JSE All Share index over five, 10 or 20 years. Rather, they want you to guide them through market uncertainty and ensure they achieve their long-term financial goals.
The trick, according to Nixon, is to administer financial advice armed with a deeper understanding of what financial failure or success looks like to each client. “Many of [your clients’ financial] goals are not linked to beating the market [and cannot be] expressed in portfolio returns,” he said. The observation here is that your advice mindset must accommodate your client’s dreams and nightmares in addition to the standard measures of risk and returns. Over the coming years, your challenge will be to leverage ongoing improvements in artificial intelligence (AI) and other emerging tech to give you an edge in the behavioural ‘dreams and nightmares’ realm.
The Minds and Machines 2024 webinar offered plenty of examples of the wave of innovation sweeping the financial and risk advice disciplines. Case in point, many independent intermediaries are now using a combination of generative AI application, Chat GPT, and podcast creator software, Podcastle, to take communication with their clients to the next level. “You can use this technology to generate content ‘on the fly’ and in a fraction of the time it used to take; and if you want to take things further, you can even create a digital avatar of yourself to deliver the message in person,” Nixon says.
Space and time to explore
The aforementioned technologies assist in the all-important financial education component of the adviser-client relationships; but that is just the beginning. Hundreds of new solutions come to market each month, spanning data-intensive tasks such as choosing the optimal mix of investments to achieve clients’ goals or ensuring tax efficiencies across clients’ portfolios. “As advisers, you now have the space and time to explore what really matters to your clients [including getting a better understanding] of their dreams and nightmares,” Nixon says, adding that financial product providers had a big role to play in this space.
Momentum Investments deserves praise for their multi-year research into the impact of emotion-based decision-making on investors’ returns, something they have branded ‘behaviour tax’. The aim of the research is to give financial advisers additional insights into the cognitive or emotional biases that could ‘push’ their clients into making ill-thought decisions that result in lower-than-optimal returns. Armed with this information, advisers can hopefully intervene before their clients perform the action that will incur the so-called behaviour tax. It is also important that the intervention you propose is a good fit for your client.
Citing a paper published in the Harvard Business Review back in 2018, Nixon points out that using AI or machine learning to identify high-risk behaviours would prove ineffectual unless you could design incentives or interventions that would resonate with specific clients. “The implications of this paper are quite significant; [advisers and providers] of the future could have multiple interventions designed to be more effective to the target groups they are aimed at,” he said. Put another way, you would use a different ‘carrot’ or ‘stick’ approach for clients in the market timer, performance chaser, stable investor or risk avoider categories.
Alarmingly high behaviour taxes
Psychology is playing an increasing role in financial advice and planning. “People tend to make mistakes when they are under stress, and particularly when they feel in danger of losing money,” Nixon says, commenting on the “alarmingly high” behaviour tax given up by South African investors in the years following the COVID-19 pandemic. Case in point, around 3.5% of clients’ annual returns are being sacrificed due to their attempts to time the markets – the highest level since Momentum Investments started tracking the metric. The question: What tools should financial advisers use to diagnose and guide clients with different attitudes to money?
AI will play a role in this space, possibly by assisting advisers and product providers to better categorise clients based on questionnaires. Nixon says his firm is already trialling something called a ‘money fingerprint’ to help advisers diagnose and predict their clients’ day-to-day money management behaviours. Early experiences have shown how different money mindsets introduce significant stress between couples, perhaps explaining the US CFP Board claim that ‘money conflicts’ contribute to more than one in five divorces in that country. Who knows, we might be on the brink of AI-powered ‘couple compatibility tests’ where money attitudes play a central role.
You should already have an inkling of what the future holds, dear reader. After all, your smartphone and ‘always online’ personal assistants like Alexa and Siri are already listening to your every wish, using AI in the background to serve up consumer solutions in real time. “In the future, we could very well see AI being successful in predicting your client’s personality and money attitudes from their social media footprint and smartphone sensors,” Nixon explained. He noted that smartphone location data could separate the club-going extrovert from a Netflix-watching introvert, as one basic example.
Could iTunes, Spotify hint at your personality?
The diversity of your client’s iTunes or Spotify playlist could predict their broad-mindedness or curiosity, which information could be further supported by Facebook and LinkedIn ‘likes’. The bottom line is that “regardless of the efficacy of AI in this arena, personality diagnoses and the application thereof in financial planning is likely to increase”. One example is to leverage AI and machine learning to assist financial advisers in advising their clients on the all-important life versus living annuity decision. According to Nixon, machine learning can make the choice simpler by combining health data, such as medical claims, and wellness data, such as activity.
The behavioural finance expert offered countless more examples of how technology is becoming ingrained in financial advising; but we cannot pack everything discussed into this short newsletter. Instead, we jump forward to the role of the financial adviser alongside AI, machine learning and other emerging tech. “While we have been talking about AI as an enabler of better decision-making, this is likely to empower financial advisers as the ultimate interpreter of the client’s unique decision context,” Nixon says. “The adviser remains an important cog supported by AI and not replaced by AI.”
Going 3x on financial advising outcomes
His concluding remark, lifted from a book titled ‘Money Mammoth’ was that behaviourally-informed financial advice that incorporates principles in financial psychology has proven more than three times as effective as using financial education alone in changing clients’ financial behaviour.
Writer’s thoughts:
It seems inevitable that data-intensive aspects of financial advising will slip increasingly into the AI and machine learning realm. Do you use AI and behavioural finance to assist your clients in reaching important financial decisions, or are you taking a wait-and-see approach to tech and psychology? Please comment below, interact with us on X at @fanews_online or email us your thoughts editor@fanews.co.za.
