Journal of Financial Planning: January 2024
Dani Fava is group head of product innovation at Envestnet, the financial services technology company transforming the way financial advice and wellness are delivered. For more information, please visit www.envestnet.com, subscribe to https://envestnet.blog, and follow them on Twitter (@ENVintel) and LinkedIn (www.linkedin.com/company/envestnet).
In an era where technology and finance are becoming increasingly intertwined, there’s a compelling narrative emerging: the powerful convergence of fintech and behavioral finance. Finance has grown. It’s no longer simply earn, save, invest. Now, it’s: earn, save, invest, and feel.
As an industry we’re starting to understand the emotional ties to money and the impact these feelings have on our financial lives. This intersection is reshaping how investors approach the market, and there’s a compelling reason financial planners should be paying attention. An emotional connection to investments might just be the game-changer your clients need.
The Rise of the Retail Investor
The COVID-19 pandemic didn’t just change our daily routines; it catalyzed a significant shift in the investment landscape. A record 10 million new brokerage accounts were opened in 2020, The Wall Street Journal reported (McCabe 2020), signaling a new wave of retail investors eager to make their mark. What are these investors doing now? They’re still trying to navigate the markets, and they’re growing their assets.
The record number of brokerage accounts that were opened during 2020, a black-swan type of year if there ever was one, is a positive development—it suggests that, even amid extreme market volatility, everyday people remain interested in participating in the market, and using investments to earn extra money and reach their financial goals.
During this time, we saw the rise of meme stocks, like GameStop and AMC, where retail investors, fueled by chatter on Reddit, led the prices of these stocks to skyrocket in value. Driving the mania around these stocks was excessive enthusiasm from investors, which created a sense of FOMO (fear of missing out) for other retail investors and ultimately caused the prices to grow aggressively. Market volatility during the pandemic also contributed to new attitudes and increased investor interest in cryptocurrencies like bitcoin and ethereum. At the time, this activity was driven by similar investor behaviors, taking on many of the characteristics that drove meme stocks, including a sense of urgency to invest in something undervalued.
Financial advisers and planners have an opportunity to demonstrate their value to this cohort of interested investors by helping them manage their emotions, and remain on track with their financial plans, during current and future volatility.
Emotions in Investing: A Double-Edged Sword
Investing has always been influenced by emotions, but recent data from Envestnet adds a new dimension to this narrative. Investors are 10 percent less likely to sell their investments during market volatility if they’re invested in something they genuinely care about. This isn’t just about risk tolerance; it’s about personal resonance. When clients are emotionally connected to their investments, they exhibit greater discipline and commitment, even in turbulent times. The closure of this salve has been eluding financial advisers for decades.
There are several common emotional and behavioral phenomena that can influence investors’ financial decisions. These include:
- Confirmation bias: The tendency for people to look for perspectives and information that support their existing beliefs, and to ignore or discount data and other materials that contradict those opinions. Advisers and planners can help clients overcome confirmation bias by continuously emphasizing the importance of seeking out a diverse array of viewpoints related to market trends and opportunities, and considering all of the different data and perspectives you have obtained before making decisions.
- Loss aversion: A different bias, in which people are far more fearful of potential losses than gains, which can cause them to miss out on promising long-term opportunities because of fear about losing money in the short term. Advisers and planners can work with clients to cope with, and overcome, loss aversion by frequently reminding them about the importance of taking a long-term view of market performance and reassuring them that short-term market fluctuation shouldn’t distract them from the goals and tactics in their financial plans.
- Anchoring bias: When someone tends to rely too much on the first piece of information they receive about a topic or trend when it comes time to make a decision. That initial impression based on the first information they received can cause them to discount other material that becomes available later. As with confirmation bias, advisers can play a vital role by reminding clients about the importance of taking into consideration all the information and perspectives they encounter when making financial decisions.
Investors can also unintentionally stymie themselves when making decisions due to biases driven by either overconfidence in their abilities, or lack of confidence in their capabilities. Advisers can reassure investors that they shouldn’t underestimate their ability to make good decisions with the proper information, and not to let an inflated sense of accomplishment blind them to crucial data and perspectives. But they can also utilize technological innovation to curate varying points of view and research on different topics or companies and demonstrate different scenarios, in order to “coach” clients into preventing emotional or behavioral biases from clouding their judgment.
Fintech’s Role in Personalizing Investments
Ongoing fintech advancements are at the forefront of combining technology with behavioral finance for personalizing and optimizing finance. Companies like Betterment and Wealthfront are leveraging algorithms and behavioral cues to help investors make better decisions, nudging them away from common pitfalls and biases. These platforms are not just offering financial services; they’re providing a personalized investment experience that resonates on a deeper level.
Platforms like Stash allow investors to dive into thematic portfolios, aligning their investments with personal values, from clean energy to social justice. Schwab defines thematic investments as “target ideas, personal values, or trends that don’t fit squarely into existing industry classifications” (2022). But there’s not necessarily an alpha thesis to thematic investing. Rather, there’s a behavioral thesis—because the themes of the investments that people choose to align with their values appeal to emotions, passions, and goals.
Advisers and planners can harness modern fintech solutions to build thematic investing portfolios and walk clients through how different types of strategies and asset allocations can affect their net worth as well as the causes that are important to them. The next time you are scheduled to meet with a client, take a few minutes beforehand to think about your past conversations. What interests have they previously mentioned? Are there specific initiatives they are passionate about? Gather those thoughts and leverage them in your next conversation to go beyond traditional portfolio investments. It’s fair to say that at some point nearly everyone has wished they invested in Apple or Microsoft before they exploded into the giant tech companies they are today. Maybe your client wants to be invested in next-generation technology companies. Looking at the emerging energy transition, maybe they are passionate about sustainable energy investment opportunities. Keeping personalization top of mind with your clients can help keep them engaged.
Why This Matters for Financial Planners
This isn’t a fleeting trend; it’s the evolution of investment. As financial planners and financial advisers, understanding this shift is paramount. Clients are seeking more than just returns; they want their investments to reflect their values, passions, and aspirations. They want to know that their money isn’t just invested, but that they’re personally invested too. By tapping into this emotional connection, you can foster trust, commitment, and a long-term perspective, essential ingredients for investment success.
Moreover, this new paradigm offers a golden opportunity to strengthen the bond between you and your clients. By delving into these deeper, more meaningful conversations, you’re not just gathering data; you’re building an understanding. Asking profound questions about values, passions, and aspirations isn’t a futile exercise. These discussions will directly inform investment strategies and broader financial planning decisions. More than that, they’ll pave the way for a deeper, more genuine relationship with your clients—one built on mutual understanding and shared goals.
The apps and tools that you can take advantage of in today’s marketplace give you the chance to ask clients questions about what they want to accomplish in life and what impact they want to make—and walk them through the different options available to them
The Bottom Line
Investing is undergoing a transformation, driven by technology and a deeper understanding of human behavior. As financial planners, embracing this new paradigm means recognizing the power of personal resonance in investment decisions. It’s time to look beyond the numbers and delve into the stories, values, and passions that drive your clients. In doing so, you’ll unlock a new dimension of investment strategy, one that promises greater engagement, commitment, and success.
Charles Schwab. 2022, July 14. “What is Thematic Investing?” www.schwab.com/learn/story/what-is-thematic-investing.
McCabe, Caitlin. 2020, December 30. “New Army of Individual Investors Flexes Its Muscle.” The Wall Street Journal. www.wsj.com/articles/new-army-of-individual-investors-flexes-its-muscle-11609329600.
As an expert deeply immersed in the intersection of technology, finance, and behavioral finance, I bring a wealth of first-hand expertise to the table. My background involves a comprehensive understanding of the evolving landscape, particularly the integration of fintech and behavioral finance. The narrative presented in the Journal of Financial Planning's January 2024 edition resonates strongly with my knowledge base.
The article highlights the transformative convergence of fintech and behavioral finance, emphasizing the shift from a traditional approach of earning, saving, and investing to a more nuanced paradigm that includes emotional considerations. This evolution becomes particularly evident in the context of the rise of retail investors, a trend catalyzed by the COVID-19 pandemic.
In 2020, a staggering 10 million new brokerage accounts were opened, indicating a surge in retail investors navigating the markets. Notably, the article discusses the impact of meme stocks like GameStop and AMC, driven by retail investors fueled by online discussions. This phenomenon is underlined by the emotional aspects of investing, such as fear of missing out (FOMO) and excessive enthusiasm, leading to market volatility.
The article suggests that financial planners have a unique opportunity to demonstrate value by helping investors manage their emotions during market turbulence. It delves into the emotional aspects of investing, pointing out that investors are 10 percent less likely to sell their investments during market volatility if they have a genuine emotional connection to them.
Furthermore, the piece explores various emotional and behavioral phenomena affecting financial decisions, including confirmation bias, loss aversion, and anchoring bias. Financial advisors are encouraged to address these biases and leverage technological innovation to curate diverse perspectives, preventing emotional or behavioral biases from clouding judgment.
The role of fintech in personalizing investments is also emphasized, with companies like Betterment and Wealthfront using algorithms and behavioral cues to guide investors. Thematic investing, aligning investments with personal values, is highlighted, showcasing platforms like Stash that allow investors to explore portfolios reflecting causes they care about.
The article concludes by stressing the importance of financial planners understanding this shift towards personalized investments. Clients now seek investments that align with their values, passions, and aspirations, emphasizing the need for a deeper understanding of clients' emotions and goals. The evolving landscape offers financial planners an opportunity to build genuine relationships based on mutual understanding and shared objectives.
In summary, this article underscores the evolving dynamics in the financial landscape, where technology, behavioral finance, and personalization intersect, reshaping how investors approach the market. Financial planners, armed with an understanding of these shifts, can navigate this landscape effectively, fostering trust and success for their clients.