Financial Planning

Fryer Financial Services?

By: Paul Nixon, CFP® MBA, Head of Technical Marketing and Behavioural Finance, Momentum Investments

There’s a lot to love about iconic global brands like McDonalds and Starbucks

It’s certainly not the best burger or cup of coffee you’ll ever taste, but it doesn’t need to be. Humans don’t like surprises and in general far prefer knowing what to expect.

In the past predictability was in fact a key to survival. Collaborating with fellow hunters to flush prey into a known area where assailants lay in wait saved time and energy. It is this innate need for predictability that has led to modern-day corporations providing collaborative structures to predict inputs required to deliver certain outputs. In fact, even making a promise is essentially a way of “assembling” the future thereby making the unknown known.

It may surprise you to learn that your brain is constantly trying to predict the future and is actually pretty good at it. Our eyes move faster than the brain is able to comprehend and so to give a stable video-like feed of the world the brain needs to predict what’s coming next and sometimes even fill in a few microsecond blanks. In a fascinating experiment at the University of Glasgow using a functional magnetic resonance imaging (fMRI) machine, respondents were “tricked” into viewing two flashing squares as moving while they were actually stationary.

Participants were asked to move their eyes when observing the image, which was enough to deceive feedback from the visual cortex creating an illusion that one of the squares was in motion. In essence they reported seeing a moving square from an image that was perfectly stationary.

The world of financial services however has failed miserably at delivering the predictability of the famous golden arches. A number of years ago, I was employed by one of South Africa’s major banks in the wealth and investment management cluster. In a revealing exercise we pulled random client files of financial advisers and observed a marked difference in the investment solutions and advice given to what appeared to be very similar client needs.

By contrast the world of traditional banking has been very successful at limiting the amount of judgement involved in any number of banking services. I distinctly recall my father coming back from a meeting with his bank manager during the 1980’s. He was understandably edgy before the engagement as it was at this person’s sole discretion whether to grant any additional leeway to us for missing a bond payment or two. These days any amount of pleading falls on the deaf ears of some algorithm that provides lending only on the basis of set criteria.

The bottom line is humans are poor at consistent judgement. Nobel laureate Daniel Kahneman refers to this as “noise”. Our decisions can be influenced by something as arbitrary as when we had our last meal. A study in 2011 found that the proportion of paroles that judges granted during a day decreased from around 65% to nearly zero just before breaks and then rebounded to the 65% level after teatime and lunch. Factors that have little to do with the law therefore clearly influence rulings. The Harvard Business Review refers to a study of pathologists who made a paired assessment of the severity of biopsy results; the correlation between their ratings was only 61%, indicating that they made inconsistent diagnoses quite frequently.

Flawed decision-making stems from two particular roots; bias and so- called “noise”. A well-known error such as overconfidence in our abilities is a bias that leads to fairly clustered errors like overtrading for example. “Noise” is far more random and can also be trickier to measure. The Harvard Business Review provides an elegant explanation of the difference. Think of the scale in your bathroom. A biased scale would generally give you a reading that is too heavy or (preferably) too light.

A different reading depending on where you place your feet is noisy and more random. Cognitive errors or thinking errors result in more predictable biases while errors stemming from emotional responses are far more random and noisy by nature. If we want to provide deeper insights into consistency in a financial planning context, it would clearly be useful to understand both of these aspects.

Momentum Investments will be working with global thought leaders in the months to come on scrutinising bias and noise in financial planning in South Africa. Over the past year we’ve build strong connections with the prestigious Oxford Risk in the UK and the Danish iNudgeYou Institute in Copenhagen and in 2020 we’re looking forward to publishing some revealing results when it comes to consistency and financial planning outcomes.

Like the iconic “Big Mac” built global trust by delivering consistency in 90 gram servings, South Africans will trust and save more if the industry can offer the same investment experience to investors with the same investment goals.

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