Welcome to a guest blog, based on recent, original research conducted among over 300 investment advisers by Newcastle University student Jessica Fox for her dissertation. (If you would like to know more about Jessica’s research, please do use the link to contact her via LinkedIn.)
The content is entirely Jessica’s but she has kindly allowed me to re-produce her summary, below. The difference between advisers’ attitude to risk and their clients’ poses some interesting challenges. Jessica presented these at an event I attended and they lead to a lively discussion – you might like to read more comments on Adviser Lounge.
The Financial Services Authority (FSA) has stipulated that understanding a client’s attitude to risk is essential if an investment adviser is to give the right advice. However, there is still debate as to whether this is being done effectively.
Some major wealth management firms, such as Barclay’s Wealth, are now employing psychologists to help them understand the psychology of investing clients, their decision-making process, and their attitude to risk.
The issue has been further confused by the impact of the financial crisis that started in 2008. Clients had to face up to the fact that the value of their investments rapidly fell by 30-40%. This was painful and a shock for many, as in reality no one saw this coming. As most investors are older, rather than younger, this was particularly alarming, as there was little time for them to recoup their losses, if they were working.
Fear replaced greed as the main emotion driving the investment market. Clients became significantly more cautious, and so missed the market upturn when it came. It also significantly impacted advisers, who found it hard to explain the losses and build back trust with their clients. This meant that they were more cautious in their investment advice to clients.
These experiences have distorted attitudes to risk in investment decision-making. Investment is generally a long term process, but it is important to understand the short term psychological influences on this.
The research that I have undertaken looks at the impact of the crisis since 2008 on investment advisers, and to what extent this might impact on their recommendations to their clients.
The research was undertaken in November 2012, via a questionnaire to investment advisers.
A total of 387 advisers took part in the survey, and after allowing for incomplete responses, the research is based on 332 completed questionnaires.
The demographics of the sample
Of the 332 participants, 300 were male and 32 female. This correlates to the industry average for investment advisers. Of these 59% were educated to degree level or above.
The age profile was:
- Under 30 7%
- 30-40 26%
- 41-50 36%
- 51-60 25%
- 61+ 6%
The key findings from the research
- 98% of advisers who completed the survey felt that their emotions are involved in their financial decision-making. This means that it is essential to understand how this will impact on their advice to their clients. It also means that if their personal risk profile is dissimilar to that of a particular client, there will inevitably be a tension over what influences that advice.The higher the risk score of the adviser, the bigger the difference between adviser and their clients. Males had higher risk scores than females, and those that had higher emotional stability and intellect are correlated with greater risk propensity.
- The tensions between the attitude to risk of advisers and their clients is further demonstrated by the fact that over the past four years, despite the economic difficulties, only 10% of advisers have been pessimistic or despondent, yet in their view 51% of their clients have felt this way. Similarly, 34% of advisers have felt optimistic over this time and only 5% of clients.
- The discrepancies in approach between advisers and their clients are further illustrated by the contrasting approaches between personal investing by advisers, and professional investing on behalf of their clients. 39% of advisers are more adventurous with their own money than with clients, and only 9% are more adventurous with client money. This is due to a number of factors, including the fact that the adviser does not have to explain their recommendation to themselves, and there are no compliance issues with their own investments.
Implications for the industry
- Advisers tend to have a higher risk profile than typical clients. This means that they may make riskier recommendations to their clients than clients are comfortable with.
- The financial crisis had a significant impact on clients. They became more cautious in many instances. It is essential that an investment adviser regularly reviews their clients’ attitude to risk, particularly after major influencing events, to ensure that the recommendations and advice being given to the client remain consistent with the client’s changing attitude to risk. This is particularly important as a client gets older, and approaches retirement.
- Advisers should be aware of the fact that an investor feels the effects of a loss more than the effect of an investment gain, as this will affect their approach to financial decision-making.
- Advisers need to understand that the natural psychology of clients is to become cautious when the market has fallen, and to hang on to investments too long when things are going well. In fact advisers could encourage their clients more to be counter cultural, if they are really to take advantage of market movements.