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Advisors See Major Increase in Clients’ Behavioral Biases

Behavioral Finance

Over the past year, advisors have observed a more pronounced impact of behavioral biases affecting their clients, but they’ve also had success leveraging mitigation techniques. 

In fact, even as major equity indices hit new highs, many clients could not help but be concerned about how the turmoil associated with the ongoing pandemic might affect their financial security, according to the BeFi Barometer 2021, commissioned by Schwab Asset Management in collaboration with the Investments & Wealth Institute and Cerulli Associates. 

As such, in an environment where it seems that every decision was a challenging one, investors need help more than ever, the firms suggest in the resulting white paper, Addressing a Surge in Client Behavioral Biases. “Fortunately, advisors who employed behavioral finance reported better outcomes from ongoing communications with clients, helping them strategically approach the long-term pursuit of their goals, rather than potentially overreacting to every bit of bad news,” the paper states. 

Between 2019 and 2020, changes in advisor reported biases among clients averaged just 3 percentage points with a mix of increases and decreases. Yet in 2021, observations of each bias increased at least 11 percentage points, with an average gain of 18 percentage points across options, according to the findings.

Recency bias retained its position as the most widely observed client bias, growing from 35% in 2019 and 2020 to 58% in 2021. Similarly, instances of confirmation bias (50%) and framing (44%) each grew at least 25 percentage points in the past year, pushing them to the second and third positions ahead of familiarity (43%) and loss aversion (43%), which, the paper notes, grew at a slightly less rapid rate.

Behavioral biases affecting client investment decisions

2020

2021

Recency bias: Easily influenced by recent news events or experiences

35%

58%

Confirmation bias: Seeking information that reinforces existing perceptions

24%

50%

Framing: Make decisions based on the way the information is presented

26%

44%

Familiarity / home bias: Preference to invest in familiar (U.S. domiciled) companies

27%

43%

Loss aversion: Playing it safe or accepting less risk than they should tolerate

30%

43%

Fear of Missing Out

Such elevated growth of observed behavioral finance biases is likely attributable to a combination of factors, including the degree to which overall interest in investing exploded in the past year. Investors were also worried about missing out, even if they were not quite sure what they were trying to invest in, the paper further observes.    

For instance, behavioral biases and client interest in new types of investments were potentially driven by outsized media attention on “buzzy investing trends,” as well as social media and influencers. More than half of advisors (52%) said clients sometimes or frequently raised questions about stocks they saw on social media. Sixty percent said clients invested in cryptocurrency in the last year, while a third invested in special purpose acquisition companies (SPACs) and a quarter invested in so-called “meme stocks.” Yet, when faced with inquiries from clients about social media-driven investment ideas, most advised clients that these investments were unsuitable for their portfolios and did not invest in them (73%).

“There has never been a more critical time for advisors to incorporate behavioral finance techniques into their practices to understand and help clients stay on course to reach their long-term financial goals,” explains Omar Aguilar, Chief Investment Officer and Head of Investments at Schwab Asset Management. “The combination of pandemic-driven uncertainty, market volatility and speculative investing trends have culminated in an environment where behavioral biases thrive.”

In addition to reporting higher levels of biases, significantly more advisors pointed to the effectiveness of using several behavioral finance techniques to mitigate behavioral biases. The findings suggest that the techniques are resonating with advisors and investors more in the current market environment than in past market cycles, the paper notes. 

Most effective behavioral bias mitigation techniques

2020

2021

Taking a long-term view

62%

76%

Integrating goals-based planning

47%

75%

Implementing systematic processes

52%

66%

Cautioning investors to stay calm

35%

52%

Increasing portfolio diversification

37%

48%

The top five benefits of incorporating such techniques, as reported by advisors in 2021, were:

  • strengthening trust and relationships with clients, and increasing client retention;
  • keeping clients invested during periods of volatility;
  • reducing short-term or emotional decision-making;
  • bettering manage client expectations; and
  • helping improve clients’ financial decisions and prioritizing goals.

When it comes to how advisors are implementing behavioral concepts, 74% do it through client communications, predominantly to align their communications with clients’ emotional tendencies (68%). Additionally, 56% leverage behavioral concepts within the portfolio construction process to match risk tolerances (78%), as well as age (73%) and wealth (62%) factors, the paper notes.

“Advisors can always use behavioral finance techniques to their advantage, but in times of market uncertainty, such skills can be a true differentiator,” says Asher Cheses, Associate Director of Wealth Management at Cerulli Associates. “Our findings this year support that those who leverage behavior bias mitigation techniques were able to secure client trust and retain assets.”

The BeFi Barometer 2021 was conducted by Cerulli Associates in the second quarter of 2021 and reflects the views of over 300 advisors diversified among business models, including RIAs, wirehouse advisors and national/regional broker dealers. 

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