6 common mistakes when applying behavioural finance to financial advice

March 8, 2023


Globally recognised expert in applied decision science, behavioural finance, and financial wellbeing, as well as a specialist in both the theory and practice of risk profiling. He started the banking world’s first behavioural finance team as Head of Behavioural-Quant Finance at Barclays, which he built and led for a decade from 2006.

6 common mistakes when applying behavioural finance to financial advice

The more behavioural finance is applied to financial advice, the more it’s misapplied by firms prioritising shortcuts over science and surface sheen over depth of understanding.

Personal finance has always been behavioural finance. Now, in its approach to both knowing and serving its clients (and staying compliant with increasingly behaviourally inclined regulations) personal financial advice is recognising this, often enthusiastically.

However, in the ensuing enthusiasm to embed investor insights into investment advice, mistakes are – understandably, but unnecessarily – being made.

Here are six common errors to look out for:

1. Beware applying 'on average' insights to individual cases

Most behavioural interventions are driven by studies testing the effectiveness of different approaches to encouraging a certain behaviour.

In practice, whichever is the most effective choice on average is often universally applicable. There’s no need to personalise how you encourage hotel guests to reuse their towels.

In personal finance, however, the whole point of behavioural interventions is to improve individual outcomes. The most personally resonant recommendation for a given individual can lead to a wildly different outcome than the one that works best on average.

Without a way to identify the population a particular application is for, you quickly limit how effective it can be.

2. Beware bolting-on behavioural techniques rather than building them in from the beginning

There’s a common temptation to see behavioural techniques as an ‘add on’ to a core process.

For instance, Oxford Risk once reviewed a major company’s website which aimed to provide information about a key financial choice to its users. It ticked almost every box on the behavioural-technique checklist. A ‘read more’ button here, a colour-coded icon there, and so on. However, the user journey was a mess. All the bolted-on techniques did nothing to help guide the user to the best choice for them.

This is an all-too-common story, albeit rarely told so starkly. Real life requires moving behavioural finance from the fringe to the core of decision-making systems. Effective behavioural tools are an integral part of the investment process not an incidental part of its presentation.

3. Beware accidentally promoting disengagement

The best behavioural tools guide investors towards better, engaged decisions; they don’t make those decisions for them.

The aim of a behavioural intervention is to make somebody a more comfortable and confident investor, not merely to make it momentarily more comfortable to be ignorant of what’s happening with their finances.

Many behavioural techniques rely on ‘nudging’ someone fairly blindly towards a better decision. There’s often a lot to be applauded in these approaches. Better decisions are better! But when they encourage investors to turn off, rather than tune in, they go too far, and can even inadvertently nudge people towards more serious psychological traps in future.

4. Beware prioritising initial interventions over ongoing support

Perhaps because of both how sales of financial products have been typically incentivised and how the regulation of financial advice has evolved, there remains a heavy upfront bias towards assessing the suitability of the match between an investor and an investment.

However, humans do not turn into robots the second they start to own investments. The behaviours that matter most – for which behavioural insights are most effectively applied – tend to happen along the journey, away from the most frequent interactions with an adviser and after the inescapably engaging initial part of the investment process has passed.

5. Beware using gamification at the expense of science

Gamification can be great for engagement… but it needs to be grounded in science.

For example, there are tests that claim to measure risk tolerance using gamification techniques to make the process more visually and viscerally appealing than a plain questionnaire. However, measuring a psychological trait like risk tolerance with a gimmick is not a good idea. Because you’re invariably measuring something that may look a bit like risk tolerance, but really isn’t.

Form should follow function, not replace it; if you’re not measuring what you’re supposed to be measuring, the playfulness of your polish doesn’t matter. Data need to be reliable and relevant, tests need to be tested, and interpretations need to be accurate.

The best behavioural applications do more than just look like they know what they’re doing; they’re grounded in evidence that suggest they should work, and embedded in a scientific process that regularly and reliably checks that they do.

6. Beware inauthenticity

Koko, a provider of digital mental health services, ran a trial providing mental-health support to 4,000 people using GPT-3. In their words:

‘Messages composed by AI (and supervised by humans) were rated significantly higher than those written by humans on their own (p < .001). Response times went down 50%, to well under a minute. And yet… we pulled this from our platform pretty quickly. Once people learned the messages were co-created by a machine, it didn’t work. Simulated empathy feels weird, empty. Machines don’t have lived, human experience so when they say “that sounds hard” or “I understand”, it sounds inauthentic. And they aren’t expending any genuine effort (at least none that humans can appreciate!) They aren’t taking time out of their day to think about you. A chatbot response that’s generated in 3 seconds, no matter how elegant, feels cheap somehow.’

The whole point of applying behavioural finance to financial advice is to understand investors… and to help those investors feel understood. Behavioural interventions are supposed to strengthen understanding, not simulate it.

As the popularity of behaviourally based interventions rise, so too does the risk they come across as inauthentic… and therefore become ineffective.

Each of the preceding points – speaking to individuals, as humans along a journey, focusing on their engagement in an iterative, dynamic, scientific process – are key to avoiding this.

The how of behavioural finance is more important than the what

The way in which you apply behavioural finance is far more important than what techniques you apply.

Tech has a key role to play in this, remembering that in personal financial advice, tech and humans play best when they play together. Tech should be leveraged to help humans navigate complexity, not add another layer of it. As simple as possible, but no simpler; beware both the simplistic and the overengineered.

Well-designed digital platforms can deliver information to clients that is personalised, easy to use, and both shaped and continually refined by their behaviours. By taking the legwork out of the profiling process, for example, tech can save human energy for appreciating the ambiguity inherent in its interpretation.

Our software provides a bridge between investment-risk analytics and the suitable risk for an investor to take. We help advisers distinguish between the investor who needs to change their investments, and the investor who needs to change how they view their investments… and we highlight the ways in which this is most effectively done for each individual’s recipe of psychological traits, tendencies, and preferences. We help clients move from unengaged and unmotivated acceptance, to active and engaged choices; to more meaningful and trustworthy relationships; and to better client outcomes. Click here to find out more about Oxford Risk’s award-winning Risk Suitability solution, Investor Compass or download our Ultimate Guide to Applying Behavioural Finance in Financial Advice.

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