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Decision Prosthetics: the best of both worlds

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Ahead of his speaking slots at FundForum International 2019, Greg Davies, Head of Behavioural Science, Oxford Risk, discusses if decision prosthetics are the best of both worlds and how can behavioral science be applied to finance?

Behavioural finance makes finance more relevant to real-life. It bridges the gap between the mathematically optimal model village of the textbook and the more practicable, but more psychologically complex world where humans live, in all their haphazard glory.

Where did behavioural science's influence on finance come from?

The awareness of behavioural concepts within financial advice has come a long way since I founded the banking world’s first behavioural finance team at Barclays in 2006. Conferences are dedicated to its discussion. Kahneman and Thaler inhabit adviser bookshelves. The FCA has a Behavioural Economics and Data Science Unit.

"Tech can turn outputs of a creative process into algorithms, and save human energy for appreciating the ambiguity inherent in their interpretation."

However, despite these advancements, I’m still often asked questions along the lines of: ‘This is all interesting and insightful, but how do I, as an adviser/investor, apply these ideas to help my clients? What does behavioural finance actually look like in real life?’

Where is behavioural finance heading?

It’s an important question. The answer isn’t a bigger list-of-biases infographic.

It isn’t even asking better questions. Better questions alone can as easily excuse productive application of the answers as it can ensure them. It also isn’t reactively throwing out the tools of the traditional-finance approach, executing a hypercorrective jump from nothing but number-crunching classical finance to nothing but hand-holding counselling.

It is about moving behavioural finance from the fringe to the core of decision-making systems. About blending the best of both worlds. It’s about using ‘decision prosthetics’: tools that help guide humans towards a better, engaged, decision, not make it for them.

Wise use of decision prosthetics in finance is about providing tools to make both advisers and clients more consistently the best versions of themselves. And of making these tools as integral to the investment process as an artificial limb to its host: better built-in than bolted on.

When you’re running in a long bull market, a new discipline like behavioural finance can coast along as a nice-to-have niche, rather than a core piece of the suitability puzzle. However, when the market tide turns, it will pay to have been prepared; no one wants to find they’ve been swimming naked, without the ability to cope with more emotionally challenging circumstances.

Comfort that comes from the core is more stable than that produced from stroking the surface. Behavioural insights are better baked in than sprinkled on top, when it’s often too late and panic has already set in.

Are your communications now working with your clients’ idiosyncrasies to prepare them for handling hotter states, or encouraging behaviours that will trigger alarms when pressure builds? When you’re required to send a MiFiD-mandated 10% drop letter, will previous client communications have paved the way to cool indifference or screaming panic? How do you know which insights to use, when, and for whom?

Humans and tech: the future?

Humans are great. But they make systematic mistakes. Advisers are skilled technicians, but they are also human. And in every field, from chefs following recipes and using scales, to writers using editors, to sportspeople using coaches, to doctors following checklists, even the most skilled technicians use tools to ensure consistency.

The coach or the checklist rarely tells the pro anything they don’t already know. But regardless of ability, no one relies on their A game turning up every time. Delegate some of the decision-making over the structure within which the performance is played out, and the performer can concentrate on the performance alone.

Tech is also great. Well-designed digital platforms can deliver information to clients that is automatically personalised, easy to use, and shaped by its users’ behaviours. Tech can turn outputs of a creative process into algorithms, and save human energy for appreciating the ambiguity inherent in their interpretation.

The combination can lead clients through decisions in a tailored fashion, with the tool learning and refining as it goes, like a limb that isn’t just strapped on, but wired in to neural networks. Investor-investment interactions are as constant as the changes that surround them. If the investor is changing, their prosthetics tech needs to be wired in such a way it not only stays attached, but learns and adapts along the way.

This in many ways simply reflects how human advisers’ subjective understanding of their clients’ needs already deepens over time. But with advanced data analytics, gamification, and, potentially, machine learning, we are coming to the point where we can blur the distinction between formal profiling and an adviser’s client understanding, creating a digital profiling process that complements and enhances the essential human side of investing.

"When you’re running in a long bull market, a new discipline like behavioural finance can coast along as a nice-to-have niche, rather than a core piece of the suitability puzzle."

Systems that combine human and non-human elements can be greater than the sum of their parts. In complex environments that involve human values, ambiguity, and changing rules of the game, the human-machine hybrids tend to win out against the independently human or machine competition.

Robust, reliable and repeatable insights are hard to scale. Creating recipes is an art, but sticking to them consistently (and enabling others to do so too) is a science. Gut instincts should be trusted, but verified, and guided to where they can be most helpful. It’s time to give financial decisions a helping prosthetic hand.

Greg Davies PhD will be speaking on open banking and API's at FundForum International 2019, June 26, 2019.

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