Search for “behavioural bias” in Murray’s Financial System Inquiry (FSI) Final Report and you’ll find 20 references. Why? Because according to the report, how we behave can have big implications. If advisers didn’t have enough reason to tailor their advice to accommodate human decision-making biases already, it seems regulation will force them to pay attention.
Advisers should look out for clients making biased decisions where the following risk factors are present: complex products, complex decisions, risk and/or uncertainty. This covers almost every significant wealth decision! Clients’ unwillingness to purchase an annuity, despite it leaving them exposed to longevity risk, is a good example, and one that is addressed in the FSI Report.
So, what are the implications for advisers?
1. More prescription
If clients systematically make the wrong decisions in some circumstances, we should expect more prescribed processes where strong biases exist. We have seen this historically, with the introduction of compulsory super contributions to overcome our bias to short term rewards. Murray suggests that, to help overcome our bias against annuities, we should require superannuation trustees to pre-select a comprehensive retirement income product for members.
2. A different view of fairness
In the future, with an expectation to consider behavioural biases, will an adviser be able to say they acted in their client’s best interest if they recommended a strategy that would assist them in reaching their goals, but presented it in such a way that the client was unlikely to act on the advice? For example, recommending an inflation-inked annuity without first framing the decision away from investment returns and towards income and lifestyle outcomes.
3. Effective disclosure using technology
We know that providing a lot of information often does not lead to better decisions. In fact, it can lead to clients taking simple mental shortcuts or making no decisions at all. Behaviourally aware regulation is moving away from the more-is-better approach, towards a framework that will encourage disclosure that is layered, engaging and relevant, and probably facilitated by technology.
4. Positive and negative behavioural biases
Regulators may expect advisers to use behavioural biases in two ways. Firstly, to help clients overcome common decision making traps. This is intuitively sensible, but can be hard to achieve. Secondly, in a positive way, to create a cognitive tailwind to help clients make the right decision.
5. Products and distribution practices
The changes don’t only impact advisers. Murray’s report recommends that product providers factor biases into their product design and distribution practices. By making “issuers and distributors more accountable for design and distribution of products” it expects to “reduce the number of cases where consumer behavioural biases and information imbalances are disregarded”. Expect a visit from your friendly business development manager soon, bearing shiny new products tailored to your clients’ biases, and yours!
6. Competency requirements
Competency requirements are much discussed, but less so in the context of behavioural biases. Advisers without a background in psychology or behavioural finance may find they need additional training. This can provide insight into what biases affect clients; which clients are most affected; when they are affected; and how investment decisions are impacted.
