Amid ongoing investor unease, a new study suggests that advisors should pay increased attention to clients’ emotional biases through the lens of behavioral finance to help them engage in prudent investment decisions.
According to findings from Cerulli’s U.S. Retail Investor Advice Relationships 2021: Navigating Perpetual Unease report, availability (91%), confirmation (80%), and recency bias (71%) are the most frequently cited biases from investors, and all three focus on information gathering.
Overall, Cerulli found that 55% of investors indicate that they are subject to confirmation bias in addition to at least one other behavioral bias. As such, advisors seeking to counsel investors affected by these biases frequently need to grapple with more than one simultaneously, the report notes, adding that the combined effect of the biases can amplify each other.
“The fact that investors realize they rely on things that they just read, that were easy to find and reinforce what they already think underscores the challenge with investor ‘research,’” explains Scott Smith, Director of Retail Investor Advice Relationships. “Instead of seeking out a variety of inputs from independent experts, consumers are predisposed to choose the path of least resistance.”
Identifying these biases is becoming increasingly important, as the firm estimates that U.S. investors accounted for nearly $55 trillion in total financial assets as of year-end 2020, up from $46 trillion in 2019.
Biases with Age and Wealth
The research draws attention to the evolution of investors’ behavioral biases with age, finding that younger investors are more likely to exhibit the tendencies that affect them. Overall, investors ages 40–49 report the highest incidence of acute behavioral bias: confirmation bias (47%) and overconfidence (42%).
In addition, 37% of these respondents admit to being strongly affected by recency bias, agreeing that they are influenced by recent news events or experiences when making investment decisions. Recent market gains have in many cases created excessive confidence in these investors. As advisors seek to establish relationships with an emerging affluent investor, acknowledging this underlying bias is important, the report advises. “Advisors must start early to help investors understand their biases and nudge them toward better outcomes—even going so far as to embrace a somewhat paternalistic approach when possible,” the report suggests.
Across the wealth spectrum, Cerulli found that investors at the highest wealth levels—those with more than $5 million in investable assets—report elevated levels of confirmation (39%) and availability (39%) bias.
“These investors have frequently made long-term decisions about the direction of their portfolios and are reluctant to be swayed by new information,” says Smith. “While they should not overreact to short-term changes, they should also be open to the reality that the landscape of finance is one of constant evolution and refinement, necessitating ongoing portfolio oversight.”
When addressing the impact of behavioral biases, Cerulli suggests that advisors are best served by attempting to educate their clients on a more academic or historical level initially, before citing any specific suboptimal actions the clients themselves have taken. What’s more, as investors’ advice requirements change with age, wealth accumulation and life experience, advice providers should consistently offer guidance to serve those who eventually recognize that accepting advice is wise, the report suggests.
Meanwhile, despite increased volatility in 2020 and renewed economic optimism in the second quarter of 2021, Cerulli found that household preferred investment risk levels have remained relatively consistent compared to past years, with 67% choosing a moderate risk level while conservative risk tolerance rose to 26%, a six-year high.
As such, the report suggests that advisors should use this opportunity to engage with clients about not just their risk profiles, but how they approach their financial goals and make planning adjustments as necessary to preserve gains made and address any lifestyle changes that may have become priorities.
“Advisors need to ensure that investment decisions are being optimized for the financial betterment of the investor,” says Smith. “Understanding their underlying biases and mitigating suboptimal investment decisions is critical for advisors in a digitally pervasive environment.”