Benefits to the firm can be broken down into three categories: client retention and satisfaction, risk management, and data opportunity.
Client retention and satisfaction
As a measure of their own success, firms seek to increase assets under management and retain a strong client base. However, numerous traditional and upstart wealth and asset managers are available to a client at a given time, meaning firms must constantly be up-to-date with the latest innovations to retain clients.
Clients today are seeking a more personalized experience. In a study by SEI, investors and advisors listed trustworthiness as one of the most important aspects of the financial advisor relationship. And when looking at this quality further, the study revealed trustworthiness was “rooted in tailored, highly personalized service” as 63% of high-net-worth investors find high or very high value in an advisor who personalizes advice.
Behavioral finance tailors the exact risk tolerances and biases of the client to better align their portfolio. And based on these factors, firms can preemptively and reactively engage clients as the market changes in accordance with their risk profile.
Being treated as an individual with specific needs creates a foundation of trust, and earning trust through a more personalized experience will be especially important as approximately $68 trillion in wealth transfers hands to the next generation over the next 25 years.9 Lack of personalized attention stands as the main reason that millennials switch their personal advisor, according to a survey by Qualtrics.
Behavioral finance seeks to better comprehend the minds of investors, understanding their inherent biases to best align their risk tolerance to their ideal portfolio. Creating another layer of the individual, personalized experiences better positions wealth management firms to not only provide for the current generation but to build upon a top requirement of the next generation of investors.
In the event of negative market conditions resulting in losses to their portfolio, investors may look to assign blame to explain their losses. All firms have suitability obligations under FINRA Rule 2111, which “requires that a firm or associated person have a reasonable basis to believe a recommended transaction or investment strategy involving a security or securities is suitable for the customer.” Yet an average year sees investors claim $2 billion in losses as a result of their Financial Advisors, either due to malfeasance or fraud. This all plays a part of the over 5,000 annually legal cases that investors file with FINRA against their financial advisors.10
Behavioral finance acts as a means of truly understanding the risk tolerance of an investor, making investment decisions and aligning to portfolios accordingly.
Armed with more information on their clients, firms gain another data point to show why advisors make decisions on behalf of their clients, which proves especially useful in the event firms or advisors need to defend themselves in court.
Many vendors’ scoring systems allow for the comparison of the client’s risk score with the client’s current portfolio. Some even compare the score against portfolios at other firms. Contrasts in these two values allows the client to highlight potential misalignment of their portfolio with their stated tolerances and view how much more risk in a dollar amount they hold in their current portfolio versus the level of ideal risk for the client. Using this data point allows firms to demonstrate how their strategies and decisions match the risk profile of the client when facing litigation.
Next best action
Greater amounts of data allow firms to better understand their clients, which would include the numerous risk related data points obtained through behavioral finance. While the data associated with risk profiling has the main purpose of better aligning a client’s portfolio, firms may look to leverage this greater understanding of the client to create further opportunities to better the business.
Leading technology firms serve as mainstream examples of data aggregators. Each leverages knowledge of its customer base to create predictive recommendations in the form of advertisements and product suggestions. Knowing more about their customers creates future revenue opportunities and provides a more personalized service.
In the wealth management space, more data points on customers may allow for better nderstanding of clients and provide future opportunities to the firm. The benefits of data aggregation can be broken down into four categories: