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Damon Riscalla:
Hi, I’m Damon Riscalla and I’m here to bring you the Betashares Practice Management Series.
So I’m here today with Simon Russell from Behavioral Finance Australia, and this is a topic that I find absolutely fascinating. So Simon, firstly, thank you so much for joining us today. I don’t want to steal your thunder so I’ll let you do it, but can you tell me a little bit about your background and what you do on a day-to-day basis?
Simon Russell:
Sure. Okay, so behavioral finance is my thing. So behavioral finance is the psychology of financial decision making. So I’ve got a background in psychology. My first degree, undergraduate degree was in psychology, and the rest of my studies and career have been in financial services and investments. So what I’m doing now is I have a business focused on how can we use the research around the psychology of financial decision making to help super funds, asset managers and financial advisors.
So on a day-to-day basis, if you look at the advice part of that, it’s presenting at conferences, running workshops, talking at off sites. For example, there’s a training piece. We’ve got some online tools and stuff that people advisors can use, and there’s a consulting piece. So people might say, “Well, how can you use this? How can we put this into our advice documents to make them more engaging? Or we’ve got a new price change coming through, how should we communicate to clients? Or we need to write some articles.” So there’s a whole bunch of things I guess that I’m trying to… It’s all around the psychology of financial decision making, but how do you then apply it and help advisors use it with their clients?
Damon Riscalla:
And talking about psychology, one of the things that comes into that, I guess, is motivations. And when we think about that from a financial planner’s perspective, how would a financial planner perhaps help motivate their client to achieve their goals? But then along that path, I guess there’s trade-offs that need to be made. How would an advisor help the client go through and make those trade-offs?
Simon Russell:
Yeah. I think it’s a fantastic question because those trade-offs are everywhere. So they are, should I spend more time at work for which I might get more chance for promotion, more pay rise? Or should I spend that time with my family, for example? Should I spend now versus save and spend in the future? And even when I spend now, should I buy that new car? Or should I go on my overseas holiday? So that you’ve got all these trade-offs, and I think from an advisor’s perspective you can look at that and go, “Well, that’s hard for me to talk to my clients about, because they’re subjective and it depends on their preferences and their values and all that sort of stuff.” For which I would say, “Yeah, yeah, that’s completely true. It does depend. Some people might like the car versus the holiday. That’s true.”
However, we do have quite a bit of research now around the types of things that lead to subjective wellbeing, if you like, or happiness or positive emotions. And so for example, if you look at that income versus time trade-off, should I spend more time at work, for example, for higher income versus at home? Or even should I spend money to get someone to mow the lawn so I don’t have to mow the lawn? So there’s those time versus money trade-offs there. So what does the research tell us? Well, it tells us that you get this curve of happiness for income where probably people have heard if you get to a relatively modest or medium/moderate level of income, maybe in the order of a $100,000 or thereabouts, well your level of happiness tends to peak at that level and doesn’t tend to improve.
Having said that, it depends on how you measure it. So sometimes if you look at those studies, what they’re doing is you might have on your phone a little app might beep at you and say, “How happy are you right now?” And I have to get my phone out and go, “Oh yeah, not too bad. I’m doing this interview. It seems like it’s going okay. Fine, I’ll give it a seven.” Whatever. All right. And then an hour later I get another beep at more random time and I’m doing that. So if you measure it that way, that’s in the moment subjective wellbeing, it doesn’t really matter if I’m earning $150,000 or a million. It doesn’t really make much difference. I’m still going to answer those questions the same. But if you ask me, “Hey Simon, how do you feel about your life overall?”
If I’m earning a million bucks, I go, “Oh, well that’s pretty good.” So it depends on how you measure it. But I think the point here is that advisors shouldn’t be, I guess, railroading their clients into goals without really the client’s goals. However, we can look at some of that research to try and help, I guess, nudge or guide clients towards the types of trade-offs that tend to work for most people. Or you can understand the circumstances which they’re more likely to work. So that’s the stuff I think advisors can perhaps use some of those pieces of research for.
Damon Riscalla:
Absolutely. One of the other things that I found really interesting is when advisors are talking to clients, the whole advisor client relationship is really built on trust and commitment. The client trusting the advisor and clearly the client having the commitment to follow through with and implement a financial plan. I think most advisors think that they have that nailed, but there may be some evidence that suggests otherwise. In your view, how would people tighten up and improve that trust and commitment element?
Simon Russell:
Yeah. Well let me say, first off I completely agree. I mean, trust underpins advice in so many ways. If the client doesn’t trust their advisor, they’re not going to open up, they’re not going to disclose information, they’re not going to rely on the advice, they might not become a client in the first place. And that impacts the client, of course, if they don’t get the advice, don’t take the advice, don’t get the outcomes and impacts the advisor. So it’s pretty critical to get it right.
So following through with your question then about, are advisors really as trusted as they think? And yeah, there is some evidence to suggest, well, maybe they’re not, but again that evidence is a bit nuanced. So if you were to look at, do people trust advisors? So if you ask me, well not me, but if you ask the general person on the street, do you trust financial advisors? You wouldn’t get such a great answer.
And it’s because people often have incorrect perceptions about advisors. They listen to what they saw on A Current Affair the night before or whatever. It’s all… Fine, we don’t think much of advisors as a general population. However, if you ask people, what do you think of your advisor? Oh, you get a much better response. So there’s a disconnect at that level for a start. The individual advisor tends to be more trusted than the category of advisor. But then if you ask clients of a particular advisor, how much do you trust your advisor? And then you ask the same advisor, how much do you think your clients trust you? And then you compare those two sets of results, well, you get a lower response from the client than you do from the advisor. So there is a gap. The advisor can overestimate… On average overestimates, at least from the research, overestimates how much their clients trust them.
Okay, so if that’s the problem, if there is a bit of a deficit between how much a client actually trusts their advisor and how much the advisor thinks the client trusts them, what can they do? Well, there’s a heap of things. And I go into some of these things in one of my books but, for example, a client might trust their advisor because they trust their expertise. You’re my advisor, I trust you because you know what you’re talking about. This is your space. And what we know from the research around expertise is it is very hard to judge. So there are some things that can help. Education helps, experience helps, but sometimes they don’t. So it’s a bit murky and what we know is that when we are given difficult decisions to make, not just on an advice and not just on trust, but just generally, what do we do? We look for simple decision making shortcuts.
And so what am I going to look for if I’m a client? I don’t really know if you’re an expert at this. I can’t really judge. I’m not an expert in it. How do I know? Well, I’m going to look for some of those things, like your qualifications and how many gray hairs you’ve got as a guide to your experience. Which of course I’m sure advisors of how professional you look and how well bound your documents are. And so I’m sure advisors know this and they’ve got their qualifications on the wall and they’ve got their documents neatly bound and they look professional. So there’s probably a few ticks there. However, there’s also other things, like if you tell me something and I disagree, now I’m the client, you’re the advisor, so you probably know better than I do.
However, there’s a risk that I’m going to go, “This advisor doesn’t know what he’s talking about does he? Clearly, look at this. This is rubbish this stuff he’s telling me about the markets.” So if that’s the risk you’ve got talking to me as a client, it pays for you to try and tell me something that I know or something I agree with to build that trust before you then go in and challenge me with something that maybe I don’t agree with. So I’m not saying you shouldn’t just tell me what I want to hear, but maybe starting with what I agree with to build that trust and rapport before then going on to the thing that I might disagree with might help you get that message across in a way that doesn’t diminish my trust.
Damon Riscalla:
Sound advice and a very good tip. You mentioned the word earlier, perceptions, how do you see a client’s perceptions of risk changing over time across different markets? And I guess a newer market out there at the moment is cryptocurrency and it’s been in the press. How have you seen that translate across to that?
Simon Russell:
Yeah, so a critical question. I mean, risk profiles obviously are a legal requirement for advisors to take into consideration and align their investment advice with, so critical underpinning of much advice. However, as you say, there can be changes in risk profiles across cycles, and the danger then is that markets go up, we’re all feeling good, I don’t perceive risks as being nearly so significant. I think everything’s great. My risk profile looks like I’m going to coming more aggressive, and as it goes down I end up being the opposite and I end up being conservative. So if there’s an advice industry, we have a risk profile that follows this curve, effectively we are baking in this pro cyclicality. We’re baking in the very thing we are trying to tell people not to do, which is to buy a whole lot of stuff at the top and then set it all at the bottom. So we’ve got this potential problem.
Now, I think your question was around perception, risk perceptions, which I think is a nice distinction, because you can look at a risk profile and break it into pieces. And one piece could be someone’s risk capacity, so objectively how my life circumstances impacted by risks of me losing a job or market declining or my tenant moves out of my property. How does that actually impact me, my risk capacity? Then you can look at my risk tolerance, which you could say is like a personality profile, which should be relatively stable throughout my adult life. Yeah, it changes when I’m a kid, and yeah, it changes in later adulthood, but in that middle ground it’s pretty stable. Am I inherently risk averse? Okay, fine. But then you’ve got the risk perception piece, which is that bit that can really change across cycles.
So that’s a crucial piece for, I guess, advisors to think about is how can, in my risk profiling approach, I break some of these pieces apart? And that’s what I’ll look for sometimes when I’m helping a client, my client being an advisor [inaudible 00:11:09] vice practice looking at their risk profiling, because sometimes those things can be compounded. So if you are my advisor and you ask in your risk profiling question, “Simon, would you be happy, comfortable investing in Australian shares?” And I say, “No.” Is that because I’m a conservative low risk, risk-adverse investor? Or is that because I just read the thing about inflation rising interest rates going through the roof and the iron ore prices through the floor and I just think now is a bad time? So I think that’s part of what we need to do from risk profiling to try and break those out so we can really get a better gauge.
But your question about crypto is interesting because… Was it ASIC just released a report back in… This was early August 2022, which surveyed a whole lot of retail investors. And they actually did the survey in late 2021 about November. And November, if you recall, was right when things like Bitcoin was peaking, I think it’s 60,000 bucks of Bitcoin or… I don’t know. Anyway, it was just before the crash and all this stuff happened. Anyway, when they surveyed people back then and they released the results just recently, the results were… Well, they asked questions like, for example, do you perceive our cryptocurrencies as being high risk? Or how do you perceive the risk? And about half said high risk. So about half were saying medium or low risk at that point. That’s in November.
If you ask people now, given that what we know about risk perceptions following that cycle, given that the price is what a third of what it was at that stage, given that we’ve had other risks like frozen accounts and frauds and that sort of thing, my suspicion is if you did that survey now, you’d end up with quite a different answer. So yeah, I think your question is pertinent because it’s something that advisors need to think about. How does those cycles impacts different asset classes? But then how can we break a risk profile into bits and break the bit that really is cyclical from a personality profile from their individual characteristics.
Damon Riscalla:
You mentioned personality profiles and that’s one of the things that I did pick up from your book, and it’s a wonderful read by the way, but the impact that a person’s personality type or traits can have on their risk taking behaviors really can have a strong influence. And I do recall the acronym OCEAN being thrown into that as well. Perhaps you could just give us an oversight of that, what OCEAN actually means and how those personality traits feed into risk behaving… Or risk taking behaviors.
Simon Russell:
Yeah. So perhaps take a step back, because OCEAN is a strata… Or a way of characterizing personality. It’s not my acronym I should say, by the way. But if you look at personality, I’m sure many advisors would’ve come across, as many people have already done, you end up with a whole lot of personality profiles. Some people have done Myers-Briggs and you might be an ENTJ or something and some people have done DISC and you get a different profile. Anyway, there’s a heap of these different personality profiling tools out there. So how should an advisor think about personality when you’ve got so many of these different things?
Well, academic researchers have said, “Well, yeah, we’ve got all these personality profile tools and approaches, but are they really getting at some core underlying issues? Is there a thing called extroversion in Myers-Briggs? And does that align with something in DISC that’s measuring the same thing?”
So they’ve looked at these personality profiles, tried to pull out the main things, and they’ve got these five, what they call big five characteristics, and that’s… The OCEAN acronym stands for what those big five things are. So to run through them, so you got the O stands for openness. So how open am I to new information and ways of thinking, compared with being more traditional and set in my ways. So O. C, conscientiousness. Do I have more self-discipline? Do I follow a process versus am impulsive, for example? E, extroversion. So the extrovert, introvert. Do I get energy and excitement externally versus be a bit more inward looking? A, agreeableness. Am I trusting and warm? Or am I more cynical and individualistic? And N, neuroticism, which sounds like there’s something seriously wrong with me, but it’s basically how emotionally responsive am I to things like market cycles in the case of investing?
So if we’ve got these five factors, then academics and researchers have said, “Well, how do those things then align with people’s behaviors around and then tolerance for risk?” And I shouldn’t overstate it because it’s somewhat predictive. It doesn’t give you a full answer, obviously lots of things go into it. However, it does give you some guide. So the O, the OCEAN… Sorry, the openness part of the OCEAN acronym, that tends to be people who are more open to information and new ways of thinking. It Tends to have higher tolerance for risk, which makes intuitive sense. And extroversion, similarly. I like excitement seeking. Yeah, I like risk as well. But those two things give you quite different distinct outcomes, because if I’m open to new information that tends to be more correlated with intelligence and better problem solving. So if I’m taking more risks now, that’s actually probably not such a bad thing.
Those open people tend to take good risks, not always of course, but on average, versus the extrovert who might just be gambling because they love the excitement of being at a casino. I mean, it’s a bit of a stereotype, but that’s… So I want to think about those two things differently. And then on the flip side, so I’ve got conscientiousness. Do I have self-discipline and control of process? It tends to be lower risk profile, which sort of again really makes sense. And the neurotic, for people high on neuroticism, if I really feel the emotions of this big rollercoaster that investments is, I’m not going to really have a great time on the depths of that cycle. So again, they’re going to have lower risk tolerance. So there’s a few things going on there and people aren’t just one of those things. So they’re going to be combinations.
And some of the combinations might be okay. If I’m that high neuroticism person, I really feel the cycles, but I’m also quite conscientious. Well, maybe as an advisor you can go, “Well, actually you know what? What we really need to do is help you get the process. I know you like processes because you’re high on conscientiousness.” And I should say, by the way, I’m not suggesting the advisor gets the client and sits them down does a personality profile, but they can probably see some of this stuff in their conversations. So if they see a client who’s both on that rollercoaster but quite focused on process, well that gives you a clue, I guess, as to how then you use some of the personality traits to tailor an approach that links into those personality profiles.
Damon Riscalla:
One of the other things that did strike me in your book was one thing that we can look at from the other side of the coin, there are a lot of inherent bias misses that people carry with them. If I look at that from the advisor’s perspective, what bias are advisors suffering from, I guess? And what can influence an advisor’s decision making processes?
Simon Russell:
Yeah. Again, a good question because it’s easy to overlook. It’s easy to overlook your own biases and think that biases apply just to somebody else. And I should say advisors are definitely not the same as their clients. And I’ve tested this when I give various different investment related or advice related problems to advisors versus non-ad advisors. Sometimes the advisors swim through it no problem. Sometimes they’re affected but to a lesser degree. Sometimes people are people are people and I can do the test with non-ad advisors, advisors, and I get the same results.
But I think some of these things are particularly critical, because they’re now in the code of ethics. The code of ethics says you have to think about… Advisors have to think about their client’s biases and also their own. And in the book that we talked about earlier, there’s a couple of examples, I guess, of some key advisor ones. So one of them, and I refer to a study out of Canada and they had a heap of data in Canada. It was fantastic study. So you’ve got all these clients, I forget how many, but I think it was tens or even hundreds of thousands of clients, and a wealth of advisors. And you’ve got all this investment data, not just the advisor… Not just the clients, but the advisors as well. And you’ve got their risk profiles and you’ve got their… You’ve all this data. So they looked at all this data and said, “What does it tell us about the risks that people are taking?”
And what it showed was that people with higher assessed risk profiles had more growth assets. And you go, “Well, that makes sense.” And it showed that younger clients tended to have more growth assets and you go, “Well, that should make sense too. Okay, fine.” However, the problem was that those relationships were actually quite weak. They were weaker than you’d expect or that you might expect. So a lot of other stuff was going on to determine people’s propensity to invest in equities, for example. And so the researcher said, “Well, what other things seem to be more important than the things that make a lot of sense?” And one was, if I’m a client, so you’re my advisor… Sorry. Sorry to keep putting you in the deep end here. If you’re my advisor and I’m your client and you recommend I’m, I don’t know, 70% equities, well, what’s a good predictor of my 70% equity allocation?
Well, if I looked at all of your other clients, well they tend to be around that mark as well. So your other clients are a good predictor of my outcome, which looks like maybe you are giving us all advice that maybe is towards that range. Well, why would you recommend 70%? And then they looked at the advisors investments, and your investments are around 70% as well. So it actually turns out, I mean, and they’ve simplified a bit because they’ve done a whole bunch of other tests to see what happens when clients move from advisor to advisor and all that sort of stuff. So it’s not quite as simple as what I’ve just described. However, the broad conclusion is that advisors are projecting their risk profile onto the clients.
So it looks like if you are quite tolerant of risk, you’ve made a similar assumption about me and therefore recommended something similar to me. So I think that’s one case. I mean, that’s a critical one given where risk profiling sits. And it’s part of a broader category of what are the ways that biases can impact not the advisor per se, but the advisor in that communications piece with their client.
So that projecting the risk profile, there’s a thing called the illusion of transparency, where the advisor feels like they know more about what the client is thinking and feeling than they actually do, which has implications because you don’t feel like you really need to ask clarifying questions if you think what they’re talking about. There’s another one called the curse of knowledge, which makes it hard to empathize when someone doesn’t know what you know. So there’s a few of those things. So I think advisors have to recognize that they’re subject to biases as well, but thinking about some of them actually are in that interface in the client interaction piece, which can I think sometimes go overlooked.
