Emotional decision-making reduces investor returns
More than 73 per cent of wealth managers believe emotional decision-making costs investors returns, according to European research from behavioural finance experts Oxford Risk.
The study of wealth managers across Europe, who collectively manage assets of around €327bn (£282bn), found that nearly two-thirds (63 per cent) believe emotional decision-making costs the average investor more than one per cent of investible wealth each year. Around 15 per cent believe the cost is more than two per cent on an annual basis.
The research was conducted by independent research company PureProfile, which interviewed 150 wealth managers in the UK, France, Italy, Spain, and Ireland during September 2022.
Of the wealth managers questioned, 65 per cent said their clients frequently make investment decisions based on their emotions, compared to just 11 per cent whose clients don’t do this. One in four (25 per cent) were neutral on the issue.
Despite this, just three-quarters (75 per cent) of wealth managers surveyed said it is part of their role to help their clients manage their emotions when making investment decisions. Just three per cent said they don’t believe this is part of their role.
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Oxford Risk builds software to help wealth managers and other financial services companies assist their clients in making financial decisions in the face of complexity, uncertainty, and behavioural biases.
However, it says that many wealth managers and financial advisors aren’t properly equipped to help clients with the emotion of recent events – the financial impact of Covid-19, rising inflation and high levels of volatility – all of which have impacted their investments.
“Recent global events affect all investors, and we know common behaviours and anxieties surface during times of crisis,” said Oxford Risk’s head of behavioural finance Greg Davies.
“Investors are likely to focus too much on the present and on the detail, and despite their better judgement many feel compelled to do something. Often that ‘something’ leads to underinvestment, selling low, or decreased diversification – and as our new research shows, it can cost them dearly.”
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Davies added that managing the investor is as, if not more, important than managing the investments themselves.
“A carefully composed portfolio management strategy can be undone very swiftly if behavioural traits provoke the wrong actions. It’s vital that wealth managers not only understand this and their important role in achieving this but are equipped with the right tools to effectively do so”, he said.
Oxford Risk’s behavioural tools assess financial personality and preferences as well as changes in investors’ financial situations and, supplemented with other behavioural information and demographics, build a profile.
It believes the best investment solution for each investor needs to be anchored on stable and accurate measures of risk tolerance. Behavioural profiling provides an opportunity for investors to learn about their own attitudes, emotions, and biases, helping them prepare for the anxiety that is likely to arise. Although, this should be used to help investors control their emotions, not define the suitable risk of the portfolio itself.
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