Can advisers ‘nudge’ clients into making better financial decisions?
Industry experts discuss whether behavioural economics have a place in finance.
The Government has been using nudge theory to try and get us to insulate our homes, give up smoking and pay our taxes. But does behavioural economics have a role in the advice space and is it necessarily a force for good? Money Marketing invited a panel of industry experts to a roundtable debate to discuss how advisers might employ “nudge” tactics to help their clients make better financial decisions about their future.
This type of behavioural science was popularised under David Cameron’s government, which established a department known as the “nudge unit” or, more properly, the behavioural insights team. Its stated aim is to “use insights from behavioural science to encourage people to make better choices for themselves and society”. The principle is the public Industry experts discuss whether behavioural economics have a place in finance. Leah Milner reports are prompted to make socially beneficial decisions, but not compelled into doing so or penalised for failing to fall in line.
One example of the theory put into practice was where a police force wanted to encourage residents to park their cars in their garages due to a spate of thefts. They realised the main reason residents with garages were not making use of them was because they tended to be piled high with junk. So the council put out free skips on every street to “nudge” residents into clearing out their garages and enable them to lock their cars away safely. It was effective, skips were filled, cars were locked away and thefts decreased. The DVLA tried using more direct language to target motorists who did not pay their road tax, with letters stating “pay your tax or lose your car”. This reportedly doubled payment and when the agency tried including a photo of the vehicle in question, payments trebled.
But is “nudge” necessarily a good thing and if so, how can it be used to improve the financial wellbeing of the nation? “Government nudge behaviour falls into two categories,” according to Cicero Group executive director John Rowland. “On the one hand you have outcomes that the Government is trying to improve for itself, for example how do we get this tax bill paid more quickly, how do we get people to respond to this letter saying they are going to be fined or can we get people enrolled into organ donations?”
Such goals, he believes, are relatively uncontroversial as they are in the public interest. On the other hand, there are goals such as influencing individuals to make better financial decisions, where the desirable outcome is more subjective and it is much harder to have a one-size-fits-all approach. One example of “nudge” in terms of the Government influencing financial behaviour are the incentives in the tax system to encourage saving, said Rowland. “Nudge is a cuddly phrase - you are almost better off looking at it as soft paternalism. It is about taking a whole unit of people and saying ‘these are the sorts of behaviours we want to encourage and we will create a choice architecture that pushes in that direction.’”
Nudging whole groups of consumers down a particular financial path is not without its pitfalls, some of the panelists pointed out. EValue strategy director Bruce Moss said: “It is quite dangerous. You are effectively taking away choice and making decisions on behalf of consumers about what is the right thing they should be doing. It’s a very delicate balance.” He argued only the Government would have dared to do something like automatic enrolment. “Essentially people are, without realising or signing up to it, putting their money into a pension fund. You have to opt out in order to get out of it and you are not taking any account of whether or not they have credit card debts that they should be paying off. It is effective but it is also quite a dangerous tool.”
He believes it is a strategy firms need to treat with the utmost sensitivity and awareness. “Certainly in direct-toconsumer applications you have to be extremely careful about using behavioural finance and relying on people’s heuristics – the natural things they will tend to do. You are effectively saying ‘we know best’ or assuming what it is they should be doing.”
For Rowland however, auto-enrolment does not fall into the nudge category. “That’s not nudge, that’s shove. I would call that soft compulsion.” But he did agree with Moss on the difficulty of reaching a consensus about what is necessarily a desirable outcome for consumers. “It does entail risk because upfront you are making a call about what is in somebody’s individual interest. The Government is on much safer ground when it is tweaking its own procedures and processes to get a public policy outcome which benefits the Exchequer. When you are talking about individual behaviours, you are potentially storing up problems for the future if a product doesn’t perform or doesn’t deliver the desired outcome 20 or 30 years down the line. The other problem with financial products is the time horizons are way longer so you don’t immediately know where it is going to end up.”
"Auto-enrolment is not nudge, that’s shove. I would call that soft compulsion"
"Nudge is a cuddly phrase,you are almost better off looking at is as soft paternalism"
The role of the adviser goes far beyond nudge, although there are still powerful insights the profession can take from research into behavioural finance, claimed Sesame Bankhall Group executive chairman John Cowan. “I don’t think ‘nudge’ is the role of the adviser. The role of the adviser is to absolutely advise the client and say ‘this is the direction you should go’. But at the centre of it is the question of how they communicate with the client. If there are any lessons from the world of economic behaviouralism these seem to be in how they advise the client and how they transmit that information to them. There is a lot of testing going on about how customers react to the different signals and the different languages.”
Cowan cited research showing mortgage brokers who failed to signpost the fact that life insurance and other types of protection were part of their advice process tended to have a low rate of sales on these products. However, when a mortgage adviser explained the whole process to the client at the outset and flagged up the fact that his or her role would be to handle communication with solicitors, surveyors, lenders, etc, as well as arranging cover, sales went “through the roof”.
EA Financial Solutions managing director Minesh Patel also believes communication is the key to encouraging people to make better financial decisions. He said: “At the moment it is way too jargonistic. Aviva, for example, has done a lot of work on introducing a less jargonistic approach. Fund management groups are notorious for being jargon-heavy. We need to be less jargon-focused. It’s like a finance club that we create.” Finance & Technology Research Centre director Ian McKenna strongly agreed. “Consumers resent jargon. To get their trust we have got to talk their language and explain things in ways they can easily understand but without being patronising,” he said. “But this is the sector that brought us ‘trivial commutation,’” Rowland quipped.
For McKenna, frequency of adviser contact with clients is important in countering harmful consumer reactions to market events as well as further cementing the trust relationship between an advice business and its customers. He said: “Research in the US has identified the optimal frequency for giving people updates on their portfolio to mitigate against overreaction to events is actually fortnightly. If you are giving them a summary that just appears on their phone once a fortnight showing where their investments have moved to, they get used to seeing things go up and down. When something does happen, they are far less likely to panic because they are used to seeing those movements take place on a regular basis. That’s an example of a very simple nudge.”
Patel said his firm had successfully implemented this tactic. “Avoiding market timing strategies is another common theme that comes up with clients. Investment returns come from time and not timing.” Patel’s company recently had cause to increase the frequency of communications in order to calm jumpy investors following the EU referendum vote. “We did react after Brexit by doing fortnightly reporting. Many people would have sought to exit their portfolios to avoid market turbulence and indeed for some we did rebalance somewhat, but to hold the course is critical when it comes to making investment decisions and nudge is crucial. The feedback from our clients was they really valued the fact we had bothered to communicate as opposed to letting them read things in the newspapers because it was coming from someone they trusted which is important. You are more likely to absorb information from someone you value or respect rather than ad hoc information from any other source that is available.”