The right advice: improving client outcomes using behavioural economics

This article summarizes the findings of our “2021 value of behaviourally informed financial advice study.” For a more complete analysis of the study and the results, see our research white paper.

Planning your financial future is incredibly important, but it can be complicated, time-consuming, and costly if mistakes are made. So, why do less than half of all Canadian investors look for professional financial advice¹ despite evidence that shows investors who receive professional advice have almost four times more assets after 15 years than those without advisors?²

Humans are often irrational — we don’t always behave logically, even when it comes to our own self-interest, due to emotional biases. Decisions based on emotions can throw us off the best path, and when it comes to our finances, they can be disastrous. We know that behavioural economics (BE) can help uncover and fight these biases, but can BE principles help improve Canadians’ financial portfolios as well? We looked to answer that question in our “2021 value of behaviourally informed financial advice study.”

BE is a field of research that seeks to understand why people make the decisions they do, specifically, in areas related to money. It takes a holistic view of the social, psychological, cultural, and emotional factors that play a role in the attitudes people have and, ultimately, the financial decisions they make. BE researchers accept the fact that people don’t necessarily act in their own best interests due to emotional biases. Based on this idea, BE researchers look for ways to ease or eliminate those biases, and guide people toward making more beneficial decisions.

In our study, we targeted four specific biases that we believed were at the heart of the tendency of investors to not seek financial advice.

We gave nearly 3,000 online participants from North America a hypothetical $250,000 to invest with a five-year timeframe. We divided them into groups and gave them advice on how they should invest the money (in the form of a video from an advisor), as well as a list of 36 equity, fixed-income, and money market mutual funds they could choose from to build their portfolios.

All participants received the same asset allocation advice, recommending that they allocate 60% of their hypothetical portfolio to equity, 30% to fixed income, and 10% to money market. But the language used to deliver the advice to each participant group was altered, as the table below explains, so we could study the effects of different styles of behaviourally informed advice. We wanted these behaviourally informed tactics to increase the likelihood that respondents would follow the asset allocation advice proposed in the video — advice meant to help investors pick the best asset allocations and, therefore, create better portfolios.

Types of financial advice given to different groups

Clients are more likely to follow behaviourally informed financial advice

The first takeaway from our experiment is that using behavioral economics principles in the communication techniques led to participants following the advice given to them more closely. In fact, participants who received behaviorally informed advice were nearly twice as likely to follow financial recommendations than those who received conventional advice.

Not only did people follow the advice more often, but when BE was used to tailor the advice, people tended to follow it more closely. Our control group deviated from the advice they received between 13% and 36% more often than those who received the BE advice.

BE can help increase adherance to advice

Percent of investors who followed advisor recomendations exactly

Source: BEWorks research, Manulife Investment Management, 2021.

Behaviourally informed advice improved diversification

Our study showed that BE-modified advice led participants to choose a far more diverse and optimized portfolio of funds. They invested in a greater number of funds and more diverse fund types, thereby spreading their risk.

BE-influenced participants chose more funds and more types of funds

Source: BEWorks research, Manulife Investment Management, 2021.

Behaviourally informed advice improved portfolio risk/reward

Participants who received BE-modified advice created portfolios with significantly better risk/reward ratios than those who received generic advice. Specifically, the types of BE advice that gave the highest Sharpe ratios³, compared with those in the control group, were the “Social norms” advice (0.63) and the “Integrated BE” advice (0.61).

BE can help improve portfolio risk/reward

Sharpe ratio of participants' portfolios

Source: BEWorks research, Manulife Investment Management, 2021.

Client perceptions of financial professionals improved

Compared with traditional advice, our study found that participants’ perception of financial professionals improved in those participants who received BE advice. Certain forms of BE advice made people feel more comfortable working with a financial professional, increased trust in them, and made participants feel more likely to consult a financial professional in the future.

BE can help improve perceptions of financial professionals

Likelihood of consulting with an advisor in the future

Source: BEWorks research, Manulife Investment Management, 2021. The results are based on three questions regarding the likelihood of consulting with an advisor in the future, in which the participants rated the likelihood from 1 (Extremely unlikely) to 7 (Extremely likely).  The Y axis is thus a restricted range of the possible values of answering 3 on all three questions to 21 . The latent variable is not an average of all three but is instead acalculation based on correlations of the items and patterns between groups.

We know that encouraging investors to seek and follow professional financial advice creates better outcomes for those investors. Our study revealed that the way in which that advice is delivered can have major outcomes for financial professionals and their clients, including their ongoing relationship. In short, incorporating behavioural economics tactics into the way financial professionals interact with their clients has the power to create better outcomes for these clients.

We set out a list of recommendations based on our study in a full-length report. We encourage you to learn more about the behavioural biases that can affect your clients and their financial outcomes from our behavioural economics page. You can also dive deeper into the psychology that influences financial decisions by taking the “Behavioural economics for financial advisors” training course.

1 www.canada.ca/en/financial-consumer-agency/programs/research/canadian-financial-capability-survey-2019.html, 2019. 2 http://aeconf.com/Articles/ May2019/ aef200115.pdf, 2019. 3 The Sharpe Ratio is a measure of an investment’s return relative to its risk. Generally, the greater the Sharpe Ratio, the more attractive the risk-adjusted return.