The financial advice industry needs more Jedis, but fewer mind tricks

Simon Russell


November 6, 2015

Why are there seemingly constant enquiries into the advice industry? Why do policy makers feel the need for constant regulatory change? Despite these efforts to improve, why do Australians still fail to plan adequately for retirement? And why do we often make poor investment decisions?

The answer to all these questions is simple – we need more Jedi financial advisers – advisers with a well-drilled understanding of the mind.

“These aren’t the investments you are looking for,” Obiwan Kenobi (if he was a financial adviser)

For Star Wars fans, behavioural finance is much like Jedi training. However, it’s not about deceiving people with Jedi mind tricks – our brains are already good at doing this without any assistance. Rather, it’s more about using insights into how the brain works to help clients achieve their goals.

It’s about unlocking the hidden influences on our decisions. One example is our disproportionate and sometimes debilitating aversion to losses. It makes us prone to a range of investment decisions that cost investors dearly. Daniel Kahneman won a Nobel Prize for his work in this area, but the perils of loss aversion were actually discovered a long time ago, in a galaxy far far away.

“Careful you must be when sensing the future … the fear of loss is a path to the dark side,” Yoda says to Anakin in Episode III: Revenge of the Sith

Back on planet earth, loss aversion and the regret that accompanies it mean we are more likely to stick to default options rather than making pro-active decisions about our retirement. Hence the number of disengaged super members in default super plans. It also means we are prone to hold onto losing investments too long, or worse, to throw good money after bad in the hope of recouping our losses. These effects contribute to investor underperformance.

DALBAR has been analysing investor returns compared with market averages in the US for a long time. Since it started researching in 1984, equity investors have underperformed the market average by about 7.5 per cent per annum. To put that in perspective, $500,000 invested in 1984 and accumulating at the market average rate for 30 years would now be worth about $11.8 million. In contrast, the average equity investor would have achieved $1.5 million – a staggering $10.3 million less. Perhaps even enough to buy a new hyperdrive!

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