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Damon Riscalla:
Hi, I’m Damon Riscalla, and I’m here to bring you the Betashares Practice Management Series. Interestingly, well we know that markets go up and markets go down, and what we’ve seen over the last few months is clearly a deterioration in markets. How can advisors help their clients get through those periods of underperformance and market volatility?
Simon Russell:
Yeah. I mean, again, it’s a key one for the client. If the client ends up switching to cash when the market goes down and misses the rebound, obviously it’s not so good for the client, and it’s a key one for the advisor. Cause obviously you don’t want… well, you could potentially lose clients during that period. Gosh, how come you’ve lost me all this money? This isn’t what I signed up for. So critical for both.
Now, what could you do? Well, one answer is I’m just going to recommend a lower risk profile investment for all of my clients. Fine, I’ve dampened the risk of decline, but I’ve also dampened the upside and it might not allow them to meet their goals. So that you could do that but that is an expensive way of dampening the impact of this volatility.
So what else can you do that’s less expensive, less expensive for the client I guess, in terms of their returns? And this is where you can come and say, well, I’m going to give them the same amount of volatility because that’s what they need to reach their goals, and that’s what actually suits their risk profile setting aside these risk perception changes in the market, but what I’m going to do is I’m going to try and communicate it in a way that will dampen the psychological impact on the client.
And so there’s a few examples of this, which are I think relatively simple things often, but they’re around how things are framed, for example. So a loss is only a loss compared with something else. So I don’t know, you can tell me the market’s down, what is it down over the last three months? Okay, fine, make it up, it’s gone down 7% the last three months. All right, down, that’s a loss. All right, is it down over year to date? Maybe it is. Is it down over three year? Okay, three years, no, it’s up a lot. Oh, I don’t know, I’ve just made that up. However, the point here is changing the reference point can change what seems to be a loss into a gain. Maybe it’s up versus as a benchmark, maybe it’s up compared with an alternative investment strategy. So part of it I think is changing the reference point.
And then part of it I think is then changing the way people respond or clients potentially respond to the same information. And my favorite example which I tested with a whole bunch of individual investors some time ago, was about changing the order in which returns are shown. So the archetypal example is you have a table of returns and you show them the six months, the one year, the three years, the five years, and it goes across the page left to right. And I guess that’s sort of standard industry practice, often you see returns. But the problem is that we see that first number is the shortest period, which is probably the most volatile, which is the most likely to be a loss, and that’s the thing that I might overreact to.
So if I’m the advisor and I’m saying what you should be doing is focusing on the long term, I can say those words, but to help reinforce it what I should do is take that long term return from the right-hand side of the table where you’ve had to skim your eyes all the way across before you’ve seen it, and I should take that and I should put it at the start of the table where it’s the thing you see first and you’re most likely to respond to.
And in that research that we did when we gave people different investment options, and we split them into two groups, gave them the same investment options with the same sets of returns, but the people who saw the long-term returns put on the left-hand side of the table, well, they’re more likely to make a long-term decision about which investment option has the best long-term returns. And the people who saw the short-term returns on the left, well, they’re more influenced by the short term.
So if I’m an advisor, I need to be thinking about not just what I say, but how is it presented in those tables, how is it presented in charts? So there’s a whole bunch of communication in there that can reinforce, I guess, the message that the advisor is explicitly saying to the client with some of the sort of psychological tricks as well.
Damon Riscalla:
So that’s a great tip. Just something as simple as rearranging the way that information’s presented can have a real impact on a client. Now on that note, one of the things that for advisors sometimes is difficult, we do know there’s a lot of paperwork that’s involved in presenting a financial plan, that can lead to a great deal of information overload and complexity for clients to get their heads across. What is some of the ways that an advisor can help their clients deal with that complexity of information? I know in your book you refer to layering and chunking. I was very interested in those as concepts and I think they’d be quite useful. Could you expand on that a little bit for us?
Simon Russell:
Yeah. So the problem here I guess is not necessarily that a client is misunderstanding what their advisor is saying or misinterpreting it, which all those things are possible, but this is even a step before that and saying, what if they don’t even look at it at all? What if they don’t even read it? And how many SOAs are read cover to cover by the clients? Very few I would imagine. How many emails go unopened? I mean, I work with super funds and they’ll tell you the vast majority of them. How many letters… So a lot of it is just getting people to pay attention to the information before they even get to the point of understanding it.
So I guess that’s what we’re trying to do with some of these strategies. And layering is a good example I think because it’s saying, all right, sometimes I just have to give you a lot of information. Sometimes it’s my legal obligation as your advisor, I’m legally obliged to give you this 50 page statement of advice, maybe not 50, but anyway, this lengthy document that you may not want to receive. Maybe I have to communicate to you because there’s some changes coming up. Maybe the things I’m communicating to you about are actually fairly complicated and so I can’t simplify them down into a nice pithy one point sentence or bullet point. Sometimes I have to communicate complex, difficult material and a lot of it.
So the idea of layering was to say, well we know if you give people a lot of information, they can easily become overwhelmed and just not read it. And when they don’t read it often they will do nothing or they’ll stick to the default or they’ll do what they always did. And if those things are in the client’s best interests, if everything’s fine, if their investments are doing all right, if they’re matching their target asset allocations in their risk profile, they’ve got right amount insurance, if everything’s fine, maybe it’s no problem. However, if you’re an advisor who actually wants to get your clients to do something, become a client to start with, implement some advice, I don’t know, do some stuff, then you’re going to have to worry about this.
And so the idea of layering’s to say giving them a whole load of information’s a risk of them doing nothing, so how can I break the information into bite size pieces and give them one piece at a time? So I’m just going to give them one little piece, wait for them to consume that, digest it, then give them another piece, and then give them another piece, then another piece.
And you see this all over the place, this is how Google search works. You put your Google search in, you get a headline or maybe a link and a one line sentence from the website and if you want you can click on that and you’ll get the website and then there’ll be stuff and you click sort of lay. News is the same. If they gave you a massive article, you’re not going to read the whole thing, you get the little picture, you get the headline, maybe you get a half a sentence or whatever it is, you can click on it, you get half a page, then click for more, you get more. So you sort of see it as quite an effective strategy.
Now, in the context of advice, what does that mean? It means, what is the main thing I want to get across to my client? What is the thing I want them to do or to think or to feel? I want that right up front. So if it’s an email, the header of the email, I want the message in the email. So instead of it saying market update, for example, yeah okay, fine, that’s a market update, but I have to read the email, then work out what’s happened. It could say market’s up strongly over the last three months. I just made that one up, maybe it’s a bad example, market’s down. Anyway, you get the point is that the point is to put the main point easily, accessibly upfront. Then the next layer might be a bit of content in the email, which shouldn’t be too lengthy. And then there might be another layer which is, And here’s a link for more information, or here’s a video. So I’ve got layers.
Same with my SOA. Here’s the main points in the executive summary, then here’s the body, then here’s all the analysis and appendices and reports and other things at the back if you want it. Same with the PowerPoint slide. Header tells me what the main message is, then maybe there’s some subpoints and then maybe there’s some bullet points with the detail. So in each of these cases it’s just about, it’s not about the content itself, it’s just about how it’s presented and trying to put it into small pieces that can be consumed.
And chunking, the other one you mentioned, is a similar idea. So I’m trying there to reduce the burden on people’s short-term memory. So the problem is that people, you’ve probably heard people can hold between five and seven chunks of information. I find this quite amusing, I often give people a little memory test and they really struggle and they get a seven. But the trick here is they’re chunks, so if you can find a way of getting all of that information and putting into one sort of chunk that organizes that, one sort of aggregation of that information, then instead of it being five small pieces that I struggle with, now it’s one bigger piece. And actually I can have five of those bigger pieces.
So this one is saying… Well, this is the archetypal example. You see a PowerPoint slide and it’s got 15 bullet points on it. The problem is by the time I get to bullet point eight, I’ve forgotten bullet point one. So if you are my advisor and you want me to think about all this sort of stuff, you have to realize that I can’t keep all that in my short term memory, therefore I can’t process it together.
So what you need to do is you need to chunk it into groups, so maybe take those 10 or 15 items, group them into three or four subheadings. Three or four, that’s fine, I can cope with three or four. Then if I want more information about those three or four, then I can see the bullet points in there.
So again, I think when I look at my clients and how I help them, often it’s not about the content itself, it’s just about packaging it in a way that’s less sort of cognitively demanding for the client. It just seems easier and therefore when it seems easier, they’re more likely to engage, more likely to read it, more likely to understand it, more likely to act on it.
Damon Riscalla:
Yes. Good tips. Very good tips. Onto something a little bit different, and the reason that I raised this as a question is that, as a country that our demographics are becoming older, it means that advisors are typically starting to deal with older and older clientele, and we know that cognitive decline is part of that. So it’s something I think advisors need to be aware of.
Do you have any tips or thoughts around how people can potentially deal with clients that perhaps maybe that cognitive decline has started to kick in a little bit? How do we deal with that as an advisor fraternity?
Simon Russell:
Yeah, huge topic, and I don’t have a silver bullet, but I think at least we can glean some insights from what the research around what that cognitive decline looks like. So what does that research tell us? Well for a start, cognitive client isn’t uniform, so it doesn’t just mean I become less and less intelligent. So you can break intelligence into a couple of pieces and we can break it into many pieces, but a way it’s often broken is between what’s called crystallized intelligence, which is about my experience and the buildup of my knowledge over time and how I apply that. And that’s actually not that… there’s not much detrimental impact on that. That can go quite sometime into my… through my retirement, and I can still function quite reasonably well on that basis.
But what tends to decline more so is my fluid intelligence, which is my problem solving, my ability to take sort of unique, dynamic environments and work through them and work out what the problems are and the solutions. And with that comes numeracy and some of the
risk perceptions aspects. And unfortunately, some of those things are quite central to investment decision making, some aspects of advice. So it’s that piece I guess that’s important.
But also it’s not just that intelligence doesn’t decline uniformly, it’s that sometimes it’s early onset, sometimes it’s late onset, sometimes it’s rapid, sometimes it’s delayed. And advisors aren’t geriatricians or psychologists, you might be able to see things and go, I think that person’s probably not quite as sharp as they used to be, but it could be because they had a bad night’s sleep or who knows, a range of things could be going on. Maybe they’re unwell, who knows?
So I think it’s very difficult for a start. What can you do? I think one of the things you can do is you can try as much as possible to prepare early because it’s very difficult in the moment for, well, not just for your advisor to recognize, but for the individual themselves, gosh, that’s a hard thing for me to say, you know what? I’m struggling a bit here to think about what’s going on. Gosh, it has implications for my independence and my whole sense of self. So can you A, start this before these signs become evident? So then we’re having a theoretical conversation, you go, Simon, I think you’re okay now, but what we should be doing is planning a bit for the future, just in case this may happen, I’m not saying it does, but actually this may happen to you in the future, can we plan? So I’d say we can do that, and I know that advisors get a lot of resistance from clients when they do say that, so it’s not going to work for everybody.
But secondly, how can we maybe frame it in less confrontational terms? So suggesting that I’m going to lose my faculties is a bit confronting, but you could potentially frame it in terms of a range of other changes that might happen as I go through retirement. So there’s a thing called the end of history illusion, which in a nutshell basically means that we underestimate how much our preferences and priorities and things will change over time. So you could say to me, well look, Simon, I think that maybe through retirement you might find that how you want to spend your time might change and I know that you love choosing your own individual shares at this point and getting really heavily involved in how this portfolio works, but over time you might decide that you don’t really want to do that anymore. Maybe we should set up a plan for if you don’t want to do that, how are we going to function with your SMSF? Maybe we can get to a more managed approach, sort of outsourcing blah, blah, blah, blah, blah. All that sort of stuff.
So these are definitely not silver bullets because it’s a very difficult issue, but it’s I guess trying to dampen the psychological impact of confronting someone in the moment with their own cognitive decline.
Damon Riscalla:
Good points, good points. Now lastly, my very last question for you today, a hot topic, FASEA Code of Ethics. How do you see that linking up with what you do, behavioral finance?
Simon Russell:
I think in a fairly big way, to be honest. And somewhat explicitly, I mean there’s an obligation for advisors to understand their clients and some of those behavioral issues that we’ve talked about, like the risk profiling piece we talked about and the projecting. So advisor has to understand the client, client has to understand the advisor or the advisor has to have a reasonable basis to assume that, which is about all the communication, the layering, and the questioning technique, so there’s a chunk in that. The advisor has to consider their own biases and their client’s.
So those things by themselves, but I think perhaps the killer is that it says something along the lines of, the advisor needs to provide advice that they think will put the client or has a reasonable basis to think that the client will be in a better position or something like that, which to me says, not only do I have to deliver good advice that actually if they implement, would put them in a better position, but if I deliver advice that they ignore because I’ve delivered it in this massive document that nobody reads or because I haven’t positioned it in a very good way and the client’s not going to actually implement it and do it, that’s not going to make the client better off. So I think there’s a heap in that.
And then you’ve got things like ESG as well, which is I think not explicitly recognized in there, but some people have suggested the broader client circumstances should factor some of that sort of stuff in there as well. And again, there’s a raft of issues around how do you understand the client’s priorities, how do you pass them into the bits that are most important, the trade-offs they’re willing to make in those respects as well.
So I think that the Code of Ethics is big in itself, there’s broad ranging obligations in there, but there’s quite a behavioral flavor to some parts of it.
Damon Riscalla:
Now for advisors that want to dig deeper into some of the things that we’ve spoken about today, where can they get help?
Simon Russell:
Well, I mean if they want to see some of the stuff that I’m doing, I think they can connect with me on LinkedIn as long, as they’re not an Nigerian prince, so I’m happy to connect with an advisor. So on LinkedIn, I do have a mailing list, I maybe once a month or something send out a podcast or a new book or something that I’m running that’s related to behavioral finance. I think there are probably a couple of easy things that, my website’s, if they search for Behavioral Finance Australia, they’ll find it.
If they want to dig a little bit deeper, they can check out that book, which is on the website. It’s available through Amazon’s. It’s Behavioural Finance: A guide for financial advisers. And if they’re not into reading the book on the text version, like there’s online courses on the website as well, so they can effectively get the video and sort of interactive discussion, Q and A questions. And if there’s something else, feel free to reach out to me on LinkedIn or via the website, I’m sure I’m happy to have a chat.
Damon Riscalla:
Great. Simon, thank you very much for joining us today, it’s been a pleasure. And thank you for your time.
Simon Russell:
Thanks very much.
