Applying Behavioural Finance to the Consumer Investment Market: Introduction

This is the introduction to a series giving our response to the FCA’s Call for Input on how to apply behavioural finance to help people make engaged investment choices more comfortably and confidently, and what role regulations can play in helping that to happen.

The series highlights four broad areas where better application of behavioural-finance insights can lead to better investor outcomes.

The full series is:

• ‍Summary
• #1: Failings of existing suitability
• #2a: Failings of non-existent suitability 1: behavioural capacity
• #2b: Failings of non-existent suitability 2: pension transfers, ESG, and adviser noise
• #3: Behavioural science applied to improving investor education
• #4: Behavioural science applied to breaking down barriers to investment advice

‍

It’s never been easier for people to invest. Both information about investments, and means of accessing them, were until recently locked-up with only designated professionals holding the keys. They’re now difficult to escape from.

This is great in some ways: openness is key to deposing investment tyrants. But it’s dangerous in others: investment anarchy can be just as costly, and much harder to control.

With this in mind, the FCA spotlight for 2021 is shining its attention on the ‘consumer investment market’ – the environment in which people save and invest for good things, and protect themselves from bad ones – with a view to helping people make engaged investment choices more comfortably and confidently.

How can the road to increased openness, clarity, and fairness be protected from anarchic attack? How should financial freedom be balanced with protection from unintentional self-harm? Which areas of lack of consumer understanding are most important to tackle? Where are the clearest and most present dangers to consumers? Where are the current regulatory blind-spots? Which potential changes offer the biggest bang for the regulatory buck?

In December, Oxford Risk responded to the FCA’s recent Call for Input on this topic, highlighting four broad areas where better application of behavioural-finance insights can lead to better investor outcomes.

1. Failings of existing suitability – Aspects of suitability that, while their importance is acknowledged, are typically poorly executed. For example: unscientific assessment of Risk Tolerance; lack of robustly quantifiable and dynamic approaches to Risk Capacity, and subsequent overreliance on Risk Tolerance in recommendations of the risk each investor should take; and onerous-yet-ineffective accounting for relevant Knowledge and Experience.
2. Failings of non-existent suitability – While some components of a suitability process are done poorly, some necessary elements aren’t done at all. The basic fact that investors are humans, not robots, is too often overlooked entirely. Financial ability may be assessed, but emotional ability is ignored, even though it can easily override the decision-making machinery of even the most financially able. Common hot-topics like pension transfers, ESG, and adviser ‘noise’ (unjustified inconsistencies in advice between advisers or even within the same adviser) are all hugely behavioural, yet treated as if they’re not.
3. Applications of behavioural finance to improve investor education – The consumer investment market is begging for applied behavioural finance. Huge strides continue to be made. But there’s still a long way to go. For example: education that focuses on engendering engaged choice over mere labelling, disclosure, or even nudges; and focusing as much on how products are presented as the products themselves.
4. Applications of behavioural finance to break down barriers to investment advice – Good advice is out there, but there are barriers to getting it to investors. For example, the proliferation of inconsistent and unhelpfully technical language; behavioural barriers to seeking and understanding advice; and the pros and cons of simplified advice options.

We’ll cover each of these in more detail in further articles in coming weeks.