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Practice Development

Feelings and Finance: The role of behavioural economics in advice

We humans don’t like uncertainty. Consider a simple scenario: choosing something from the menu at a new restaurant. It's an inherently uncertain decision, compounded by the time pressure of the waiter returning. While the consequence of a poor choice is merely a subpar meal, the anxiety over not picking the safe option – yet another Hawaiian pizza – is very real.
3 min read

This scenario is a useful analogy for financial advice, especially in today’s uncertain global economic climate. Investments can feel like the ultimate leap of faith, amplifying anxiety and reluctance to stray from tried-and-true options, thus lowering clients’ risk appetite. 

Behavioural Economics and Emotional Impact 

Emotions influence our daily decisions, and financial choices are no exception. As Investopedia notes, “Decisions are not based on strictly rational behaviour. Yet, the overwhelming number of economic models is based on precisely the assumption that they are.” 

Many financial models fail to consider the emotional aspects of decision-making, leading to potential erratic behaviour from investors when stability is needed. According to Adam Hayes, Ph.D., CFA, “The efficient market theory, which states all equities are priced fairly based on all available public information, is often debunked for not incorporating irrational emotional behaviour.” 

Neurofinance: A New Field 

Emerging research in neurofinance combines economics, neuroscience, and psychology to understand the neural mechanisms behind financial decisions. Krystle McGilvery, a chartered accountant, and money-psychology expert, explains, “Neurofinance confirms scientifically that a large portion of our financial decisions are made with our automatic mind (below our consciousness). This means we are making financial decisions with our subconscious emotions.” 

The Importance of Trust 

Given the significant role of subconscious emotions in financial decisions, the trust between adviser and client becomes paramount. Advisers need to guide clients towards rational, mindful investment decisions, especially in uncertain times. 

Building this trust with a new generation of investors is challenging. Our latest whitepaper, INSERT NAME AND LINK, highlights the inherent scepticism in this demographic. Highly informed and wary of misinformation, they value honesty, dynamism, and a holistic approach tailored to their specific needs and goals. 

The Value of Advice 

Advisers play a crucial role in navigating the investment landscape’s uncertainties. They act as rational filters, tempering clients’ emotional financial decisions to ensure appropriate responses that maximise positive client outcomes. 

As noted in our whitepaper, Advising a New Generation: Adding Value in Investment and Retirement Planning: “No matter where the world finds itself in the economic cycle – whether expansion, peak, contraction, or trough – clients will always pay a price when hot-headed, knee-jerk decisions triumph over level-headed, informed moves. Only by building real, hyper-personalized relationships with your clients will you, as an adviser, be strategically positioned to support them throughout the wealth transfer process.” 

Understanding the influence of emotions on decisions demands attention and analysis. As Warren Buffet wisely said, “True power is restraint. If words control you, that means everyone else can control you. Breathe and allow things to pass.” 

Read more about hyper-personalised advice, including the impact of behavioural finance, in our latest publication, Advising a New Generation: Adding value in investment and retirement planning. Download here.

Tips to Help Temper Emotions 

  1. Active Listening: Understand the fears and motivations behind clients’ decisions through active listening. 
  1. Educational Engagement: Educate clients about common behavioural biases like loss aversion, overconfidence, and confirmation bias. 
  1. Goal-Framing: Collaboratively help clients articulate their long-term financial goals. 
  1. Scenario Planning: Use scenario planning to help clients visualize potential outcomes of their decisions. 
  1. Behavioural Nudging: Implement nudges that encourage better financial behaviours without restricting freedom of choice. 
  1. Decision Aids: Tools like decision trees or cost-benefit analyses can help clients process information systematically. 
  1. Stress Testing Decisions: Encourage clients to stress-test financial decisions under various emotional states. 
  1. Personalized Communication: Customise communication styles to fit each client’s emotional and informational needs. Some may require more frequent reassurance during economic downturns, while others might prefer detailed reports or infographics. 
  1. Build a Supportive Environment: Create an environment that encourages ongoing dialogue about financial fears and aspirations. 

Incorporating these strategies can help advisers guide their clients through the complexities of financial decisions, ensuring a more secure and confident financial future.