Written by Charles Burton, LV= Wealth Investment Proposition Manager
As greater regulatory focus lands on tailoring advice to the needs and characteristics of the individual client, understanding behavioural finance can provide a roadmap for your conversations, and offer clients a more composed path towards their investment objectives.
Behavioural finance is the study of human behaviour in an economic and financial context. It seeks to understand and describe why people might make certain choices, especially when they would not be deemed rational.
Understanding how and when people deviate from these rational expectations could support your advice process and help you to strengthen your relationship with your clients while keeping them on track to achieve their objectives in the lead up to, and in, retirement.
What’s getting in the way?
While behavioural finance is a complex and nuanced field worthy of considerable time, there are four key tendencies that can describe client behaviour. It’s likely most advisers have seen one or more of these play out in their offices.
- Loss aversion – when clients are more focussed on avoiding losses than making investment gains. Clients experiencing this could remain invested in a falling asset for too long, fearing the loss becoming ‘real’ and waiting for it to recover, or avoid taking investment risk on their accumulated capital to the detriment of their long-term goals.
- Experiential bias – the concept that a client’s memory of an event (like the financial crises of 2008 or 2020) makes them believe it’s more likely to happen again, even if this is not statistically likely. This bias may also lead them to believe that because something has performed positively in the past that it will do so again.
- Familiarity bias – the tendency towards investments that a client has a history or familiarity with. As a result, clients may not be adequately diversified across multiple sectors and types of investments, which we know can reduce risk.
- Activity bias – this becomes clear in times of stress (or when facing a loss) as humans are inclined to take action to feel safer. This is not always the rational thing to do and can be detrimental to reaching their ultimate objective even if they feel temporarily ‘safer’.
There are a multitude of available options for investment and retirement propositions. For clients particularly prone to exhibiting some of these biases, and looking for a calmer investing experience, incorporating a smoothed fund could have a positive impact on their composure and, in the long term, help them to meet their objectives.
What can a smoothed fund do?
Smoothed funds seek to create an investment journey that evens out the extremes of the stock market.
At LV= we average the daily underlying unit prices of our fully diversified, multi-asset funds over a six-month period*. Short instances of volatility are ironed out by the averaging mechanism, but it won’t stop a client from seeing losses in a long-term market downturn. This is equally the case in an upward market, or short-term peak.
Over time we can see that our smoothed fund value ends in a similar position to an unsmoothed fund, but through 13 years of investment, the client probably was more likely to hold their composure. The blue line paints a much more emotionally testing journey than the smoothed, green one.
Smoothed investments could help to mitigate these innate behavioural biases and could prove a valuable tool in guiding your clients to achieve their financial objectives.
LV’s smoothed funds can be chosen as a standalone vehicle for some of your clients’ capital, combined with an annuity for retirement clients, and blended with a host of Model Portfolio Services via LV= Platform Services.
They are designed and managed to deliver a calmer investment journey that targets long-term growth, meets the clients’ risk composure, and supports them to take a considered approach to investment decisions by using a six-month average of real underlying unit prices.
Behavioural science teaches us that humans are anything but rational, but with the right adviser who understands them, and a vehicle designed for composure, they can stay the course and reach their goals.
*Smoothing in the first six months of investment varies across our products. Visit our website to learn more.
The LV= FGB Managed Growth fund has the same asset mix, and is managed in the same way, as the LV= Smoothed Managed Growth fund which is available today. Capital at risk. Past performance is not a reliable indicator of future returns. Smoothing can be suspended at our discretion. This may be in exceptional conditions or if the underlying price was typically 80% or less of the averaged price. If smoothing was suspended the funds may need to be valued using the underlying price. The LV= ISA will always be valued on the underlying price at this time. We also have discretion to use a daily gradual averaged price with an appropriate smoothing period of up to 26 weeks.
