Wealth management is a demanding industry. Cutting-edge technology is creating efficient approaches to serving clients and managing money, while it’s also challenging the old ways of doing business. Clients want more personalized experience, and to meet their fiduciary responsibility financial advisors need to look beyond generalized stereotypes to understand the clients they’re working with. Men and women, young and old- investors are different. But they also may have more in common than you think.
Think about the risk tolerance questionnaires financial advisors have been utilizing for years. The industry has relied on subjective questions to assess client risk. But risk aversion and loss aversion aren’t the same thing, and subjective questionnaires don’t account for this difference. Risk aversion is an investor’s willingness to make investments with uncertain outcomes, while loss aversion measures the extent to which downside scenarios are felt more severely in the evaluation of uncertainty. Questions asking investors about their emotions regarding losses or about investment decisions after losses occur will probe loss aversion alone, giving a limited understanding for advisors to work with. Likewise, the usual questionnaires also do not account for investors gaming the system, intentionally or not, as they respond in ways they think they should to get the returns they think they should have.
Look at how the gender divide plays out with investments. We did a study having men and women assess their perceived and actual knowledge of personal finance. The former is what comes across in standard financial advisor questionnaires. We found that men are very confident in their perceived financial knowledge, while women are much less confident. This may not come as much of a surprise to financial advisors, who often see men as more risk-taking investors. But the surprising part of our study was that the “actual” knowledge of men fell short of their “perceived” expectations, while women saw the opposite effect. In other words, men have a lower actual knowledge score than anticipated and women have a higher actual knowledge score. Understanding this gap should change financial advisors’ conversations with clients.
Advisors recommendations need to understand how investors understand and approach risk, and separately losses. Investors won’t only be steered in the direction of investments they’re comfortable with, but advisors can also coach investors and build their confidence.
The study we performed looked at men and women, but regardless of gender and age, increased wealth also corresponded with increased risk appetite and a reduced loss aversion. In other words, don’t just rely on demographic stereotypes alone. If advisors want to better meet client needs, as well as convert new clients, they need to dig deeper into behavioral patterns. The easiest way to do this is to tap the technology available to highlight behaviors and fine-tune client conversations. Taking advisor relationships beyond the generalized demographics is what will differentiate a client’s experience.
The addition of technology like behavioral questionnaires in client relationships shouldn’t be looked at as an additional expense or a way to cut down on human wealth managers. Quite the opposite in both cases! Products that can save financial advisors time guiding clients toward investments that both make sense for them and keep them comfortable are revenue generating for wealth management firms. Today’s clients want personalized experiences, and its financial advisors’ duty to give that to them. Technology is merely a way to get that done.
About the Author
Andrew Rudd founded Advisor Software in 1995 to deliver world class analytics to the retail financial services market. He is an expert in asset allocation, modern portfolio theory, risk management, and performance measurement. Dr. Rudd is also a co-founder and former chairman and CEO of Barra, Inc., where he served as CEO from 1984 to 1999. He is the co-author of two industry-leading books on institutional investing: "Modern Portfolio Theory: The Principles of Investment Management" and "Option Pricing." Dr. Rudd was also Professor of Finance and Operations Research at Cornell University in Ithaca, New York. In addition, he has written numerous journal articles and research papers on a wide range of domestic and international investment practices and theories. Dr. Rudd received his Bachelor of Science degree with honors in Mathematics and Physics from Sussex University in England, and earned a M.Sc. in Operations Research, an M.B.A in Finance and International Business, and a Ph.D. in Finance and Operations Research from the University of California, Berkeley.