This action might not be possible to undo. Are you sure you want to continue?
November 2010 Overall co-ordination Decision Technology Ltd Academic Participants Nick Chater Professor of Behavioural Science, Warwick Business School and cofounder, Decision Technology Steffen Huck Professor of Economics and Head of Department, University College London Roman Inderst Professor of Finance and Economics, Johann Wolfgang Goethe Universität Frankfurt
Online Interactive Research Ltd
The inability to benefit fully from this market is in part due to limited financial literacy or asymmetric information. 3. According to the fourth Consumer Markets Scoreboard. fourth worst in experiencing problems. retail financial services are one of the sectors characterised by substantial market malfunctioning. The purpose of this project was to study the decision-making processes of consumers in the market for Retail Investment Services (RIS). Introduction The EU Consumer Policy Strategy 2007-2013 underlines the importance of empowering consumers. Consumers are not always selfish. pensions and securities” ranks worst out of fifty consumer markets for overall market performance. This evidence reflects one of the main tenets of Behavioural Economics (BE): the homo economicus of classical economic theory is an over-simplified description of human behaviour. as a key driver of innovation. the 2010 Scoreboard shows that the market for “investments. The financial environment has evolved so much that consumers are often ill-prepared to make sound decisions about increasingly complex retail financial products. Recent evidence shows that consumers often have limited time to fully understand complex retail financial products.Consumer Decision-Making in Retail Investment Services: A Behavioural Economics Perspective EXECUTIVE SUMMARY 1 1. The objectives of the study were twofold: to obtain survey and experimental evidence regarding both the individual behavioural traits and the external factors most influencing consumers' decision-making 1 SEC(2010)1257 “The Consumer Markets Scoreboard” 4th Edition – October 2010 November 2010 2 . there is evidence that consumers often fail to make optimal choices and not only because of asymmetric information. "Herding" instincts and over-reliance on experts' advice may also limit rational reflection. but it may also be directly related to instincts driving consumers towards choices which are inconsistent with their longterm preferences. worst in trust that suppliers will respect consumer protection rules. competition and productivity. rational and independent agents but instead they exhibit a strong interdependency and limited or "bounded" rationality. 2. However. and worst for overall satisfaction. Even well-informed and numerate consumers may exhibit systematic departures from welfare-maximising behaviour. worst for ease of comparing products and services sold by different suppliers.1 In particular.
and an assessment of policy options. a review of the retail investment market.000 consumers in eight EU Member States.000 subjects in eight EU Member States. Chapter V: summarises the available evidence on consumer decision-making in the retail investment market. Chapter III: describes the structure of the retail investment market in twelve different EU Member States and briefly analyses a small sample of retail investment marketing material from across the EU.Consumer Decision-Making in Retail Investment Services: A Behavioural Economics Perspective in RIS. 2 4. a consumer survey of the retail investment purchase process. Chapter VI: reports the findings of an online experiment with 6. and to explore the effectiveness of different policy remedies in helping consumers make better decisions. exploring people’s decision-making capabilities in November 2010 3 . corresponding to the two phases of research involved in the project: review (first phase) and experiments (second phase). to review the available evidence on consumer decision-making in retail finance and to highlight the “behavioural biases” most likely to lead to consumer detriment in these markets. choosing and purchasing a retail investment product. Chapter II: surveys the literature from fields such as BE and Psychology. describes the current regulatory regime and the range of available policy options. Chapter IV: reports the findings of an online survey of 6. Each chapter reports the findings and conclusions of the following component of the research: Chapter I: provides an overview of the project and a summary of the main findings and conclusions. Structure of Report This report is divided into two main parts. and prioritises decision-making biases and potential remedies for experimental testing. The second phase consisted of three experiments that investigated specific aspects of retail investors’ decision-making processes and the impact of potential policy interventions. concerning the process of researching. The first phase had four components: a review of the BE literature.
The formation of beliefs is based on the perception of circumstances. and the role of trust. we place considerable emphasis on processes of persuasion. Chapter VIII: reports the findings of a laboratory experiment with 480 subjects in three EU Member States. exploring the impact of direct communication between advisor and advisee upon the efficacy of disclosing conflicts of interest and upon the trust people place in advice. For example.000 subjects in eight EU Member States. 3 5. the importance of personal interaction. Preferences may be reference-dependent and inter-temporal preferences can be subject to biases such as short-sightedness or procrastination. so it can be context-dependent and subject to framing effects or biases such as overconfidence. a distinctive feature of this review is that it identifies the importance of a range of cognitive and social biases that play a role in consumer investment decisions when assisted by an advisor or salesperson. Summary of Review Findings Our review of the existing literature on BE focuses particularly on issues relevant to the European (as distinct from the US) investment market. Some of the key findings of the review are: • A growing body of evidence shows that the “standard” model of a rational self-interested economic agent does not adequately describe human decision-making. exploring people’s response to the disclosure of conflicts of interest in stylised advised investment choices and their willingness to pay up-front fees for information and advice. In addition to the familiar behavioural biases that we identify as potentially relevant in the retail investment market.Consumer Decision-Making in Retail Investment Services: A Behavioural Economics Perspective simple unadvised investment choices and the impact of a range of policy interventions on decision quality. Chapter VII: reports the findings of a second online experiment with 6. Cognitive limitations November 2010 4 . Chapter IX: summarises the experimental findings and assesses the implications for policy makers. as well as suggesting future directions for further empirical experimental research to support policy decisions.
for example by inducing positive emotions. A small sample of retail investment marketing materials from eight countries was analysed in terms of its content. and some consumers may be particularly compliant in the presence of perceived expertise.such as pension wealth forming a large part of households’ total wealth or the relatively low share of wealth held in risky equity investments . Disclosing conflicts of interest may undermine trust in advice and give advisors “moral licence” to act only in their own self-interest. • Features of the retail investment market may make consumer decisions particularly prone to biases and errors. where data is available. Our review of the retail investment market in the EU draws together publicallyavailable data and existing comparative studies in order to provide an overview of retail investors’ behaviour across twelve EU Member States. and people are often averse to ambiguity as well as uncertainty. Generalised trust. and through which retail channels those investments are typically purchased. Evidence suggests that many people . trust in advice and trust in consumer rights can all influence people’s willingness to hold risky assets. Retail investment products are inherently risky and often involve long time horizons. Consumers do little searching and instead typically rely on the advice of a professional advisor or salesperson.especially the younger and less educated . The market is characterised by a wide array of products with complex pricing structures. as well as in the composition of households’ financial portfolios.Consumer Decision-Making in Retail Investment Services: A Behavioural Economics Perspective can lead to a reliance on heuristics. we describe for each country what kind of assets investors choose to allocate their savings to. In particular.do not possess a sufficient level of financial knowledge and understanding. • Consumers’ reliance on advice makes issues of trust and persuasion of key importance in the retail investment market. While there are some commonalities across the countries we survey . while evidence on the success of financial literacy programmes is limited. Personal interactions may enable an advisor to persuade or influence an advisee.there are also large differences between countries in overall saving and borrowing rates. 6. suggesting that such November 2010 5 .
000 consumers in eight EU Member States describes the decision-making process followed by recent purchasers of retail investments. Only around 33% of investors compare investments from more than one provider or consider more than one product from a single provider. The majority of investors mostly or completely trust the advice they receive. and do not perceive their advisor to be biased. investors. and most investors disregard the information or do not think about it. especially purchasers of pensions and structured products. returns and costs. In particular. • Advice is ubiquitous in the retail investment market. Just 27% of investors shop around to get the best deal. Our online survey of 6. information search is very limited. Some of the key findings of the survey are: • Consumers are often confused about the true nature of their investment. • Trust in advisors is high. November 2010 6 .Consumer Decision-Making in Retail Investment Services: A Behavioural Economics Perspective material primarily reminds consumers of the need to invest and attempts to convey expertise. while the advisor initiated the purchase on a quarter of occasions. 58% of investors say their final choice of product was influenced by an advisor. We find no strong evidence for a prevalence of misleading claims or use of framing effects relative to other product markets. 7. Conflicts of interest are often only verbally disclosed. Nearly 40% of investors in stocks and shares (wrongly) believe their initial investment is protected. usually with an employee of the investment provider or a professional advisor. if at all. • Although investments are usually triggered by a change of life circumstances and not marketing. Nearly 80% of investments are made in a face-to-face setting. but consumers are often unaware of potential conflicts of interest. are often uncertain whether or not they are exposed to the risks of stocks and shares. as well as exploring the main differences between purchasers and non-purchasers of retail investment products. rather than communicating specific detailed information about risks.
November 2010 7 . It addressed questions related to cognitive and behavioural factors in nonadvised retail investment decisions. and they were disproportionately averse to uncertainty (risky investments). Older.Consumer Decision-Making in Retail Investment Services: A Behavioural Economics Perspective 8. even in very simplified investment tasks. How capable are consumers of making appropriate choices between investment products in the absence of advice? To what degree are their choices influenced by “behavioural biases”? To what extent can policy interventions improve the quality of retail investment decisions? 2. female. • Investment decisions are prone to biases and framing effects.000 subjects in eight EU Member States. ambiguity (incomplete information) and product complexity (structured products). with 25% of investment decisions being completely optimal and only 1. Some of the key findings are: • People struggle to make optimal investment choices. and after considering the current EU regulatory regime as well as options for policy interventions.4% of subjects making all five investment choices optimally. In light of all the above findings. Our first experiment was conducted online with 6. less educated and less numerate subjects made worse decisions. Do consumers respond appropriately to the disclosure of conflicts of interest? Does the format of disclosure matter and which is most effective? Does disclosure of conflicts of interest undermine trust in advice? Would consumers be willing to pay an up-front fee for advice? 3. How does direct interaction between advisors and advisees influence investors’ decision-making? Can free communication enable advisors to persuade or pressure advisees to make certain choices? 4 Summary of Experiment Findings 9. annual returns not compounded over the duration of the investment). Only 56% of funds were invested optimally. Subjects made worse investment decisions when the optimal choice was harder to understand (fees framed as percentages. the following issues were chosen as priorities to be addressed in the experimental phase of the research: 1.
• Full and transparent disclosure or a “health warning” may be necessary for people to understand the implications of a conflict of interest. This led to better decisions when the advisor’s and advisee’s interests were adversely aligned but worse decisions when their interests were aligned. laboratory subjects exhibited a strong reaction to the disclosure of biased incentives. Only those subjects who took more time over the decision reacted appropriately and even then only when the disclosure was flagged in a bold red font.000 subjects in eight EU Member States. Online subjects. Some of the key findings are: • The impact of disclosing conflicts of interest is context-dependent. in different formats and in different settings. who were only told that their advisor was paid a commission. and addressed questions related to social and behavioural factors in advised retail investment decisions. Standardising and reducing the amount of information provided helped subjects identify the optimal choice between similar investments. Laboratory subjects who were told the exact details of their advisor’s remuneration structure responded to disclosure without such a warning. Providing comparable pre-calculated information on the net expected value of each investment helped subjects identify the optimal choice between dissimilar investments. It addressed questions related to cognitive and behavioural factors in advised retail investment decisions. for the simplest of decisions. showing evident mistrust of advice. In contrast. 10.Consumer Decision-Making in Retail Investment Services: A Behavioural Economics Perspective • Simplifying and standardising product information can significantly improve investment decisions. Online subjects hardly responded at all to disclosure. Subjects exhibited “contrarian” behaviour in their investment choices when biased incentives were disclosed. Our third and final experiment was conducted in the laboratory with 480 subjects in three EU Member states. did not react to this disclosure unless it was accompanied by a “health warning”. Both experiments addressed the issue of disclosing conflicts of interest. • Disclosing conflicts of interest elicits a “knee-jerk” reaction that can be harmful as well as helpful. Our second experiment was also conducted online with 6. November 2010 8 .
Consumer Decision-Making in Retail Investment Services: A Behavioural Economics Perspective Subjects lost trust even when an advisor with misaligned incentives was not actually able to deceive them. Arguably. Providing pre-calculated and directly comparable relevant information about investments enables better choices between dissimilar options. showing that their reaction is reflexive. 5 11. experimental evidence alone cannot justify regulatory interventions in a market. as well as the relative impact of some of the policy remedies available. as a clear market failure must be identified with empirical real-world evidence. across product classes. Simplification and standardisation of product information enables consumers to make better quality investment decisions. at least in our simple choice tasks. • Direct interaction enables advisors to exert (limited) additional influence on advisees. Greater use of such testing would improve the design of policy initiatives. These principles and ideas November 2010 9 .g. given that the research shows that small practical details can have a significant effect on consumers. Between twenty and thirty percent of the online subjects displayed evidence of “narrow framing” and loss aversion making them excessively averse to an up-front fee. Conclusions and Recommendations The findings of our experimental research shed light on retail investment decisionmaking and provide a detailed insight into the factors influencing consumer behaviour in this market. our findings do point towards certain future directions for policy making and for policy research: 1. Nonetheless. There was no strong socio-demographic or attitudinal signature for this group of people. There is evidence that free communication enables advisors to exploit advisees’ existing biases but not to “de-bias” them. any proposed policy action to correct a market failure should ideally undergo further testing in more realistic (although less controlled) settings in order to assess the likely real-world impact and to determine the best way in which to implement the details of the policy. e. • A significant minority of people may be disproportionately averse to paying an up-front fee for advice. Furthermore. Free communication between advisor and advisee tended to mitigate the “knee-jerk” loss of trust resulting from disclosure of a conflict of interest.
November 2010 10 . especially given their limited capacity to make good decisions without the help of an advisor.Consumer Decision-Making in Retail Investment Services: A Behavioural Economics Perspective could be applied to current and future work on information disclosure. such as the Key Investor Information (KII) document. Our findings point to the need for either full disclosure or an accompanying health warning to ensure the implications of disclosure are understood. 2. Policy makers must also be careful not to simply elicit a “knee-jerk” loss of trust in advice that may not be in consumers’ best interest. such as commission payments to advisors. is mandated then further testing should be conducted to determine the best form and format for disclosure. If disclosure of conflicts of interest.