August 17, 2021 Thought Leadership 5 mins read

Connecting Advisors to their Clients with Behavioural Finance

Client-focused reforms boost the rationale for financial advisor practices to adopt behavioural finance tools


The ushering in of Client-Focused Reforms (CFRs) by the Canadian Securities Administrators (CSA), in conjunction with both the Investment Industry Regulatory Organization of Canada (IIROC) and the Mutual Fund Dealers Association (MFDA), is putting the spotlight on Know Your Client (KYC), Know Your Product (KYP), and product suitability requirements. Beginning in 2022, financial advisors must meet a higher standard, with the need to be able to demonstrate that clients’ interests always come first.

To comply with CFR guidelines, it is essential for advisors to better understand their clients’ willingness and capacity to take on risk. Behavioural finance, the study of how psychological traits influence investor decision-making, can help us here. Let’s start by examining what risk means to investors and the problems with the conventional approach to client risk profiling.


Risk and the Advisor-Client Disconnect


Canadian retail investors sold a net $18 billion in long-term (non-money market) mutual funds during March 2020, following the Covid-19 outbreak. Fast-forward one year later and Canadians bought a net $14 billion of such funds in March 2021, following a 12-month total return of over 44% on the S&P/TSX Composite Index. Many investors sat out one of the great bull markets of all time. Why? Investors too often sell when markets are down and buy into markets because they have done well, chasing yesterday’s winners, and suffering the negative effects of mean reversion. It’s a familiar story.

Is the problem that some clients just don’t listen to their advisor’s encouragement to think long-term and hold tight? Or is the problem that we advisors may not really be listening to our clients in a way to understand their true motivations and intentions, their dreams, their fears, and how they think about risk when making financial decisions?

What does risk mean to our clients anyway? Do clients worry about standard deviation of returns? Hardly. More likely, they are concerned about real life stuff, like running out of money in retirement or not having enough in their RESP to support their kids through university. On the other hand, our profession loves to package things up to neatly fit how advisors think, using terms like downside risk, probability, and standard deviation. The problem with this approach is that clients often don’t relate to how we think; and so, we may not know how our clients will react when markets change direction. They may resist rebalancing their portfolios (or worse), even if it is the perfectly logical way to proceed.


A Behavioural Finance Approach to Understanding and Communicating with Clients


A behavioural finance approach to KYCs and client engagement allows advisors to gain a deeper understanding of client motivations and behaviours; thus, providing the foundation to better match clients with suitable products.

We need to communicate with clients in a way that encourages positive investment outcomes and emotional satisfaction. When I speak with clients, I like to think of myself as part financial advisor and part psychologist. Human beings are not always logical or long-term in our thinking. We often make decisions instinctually and emotionally, influenced by common ingrained biases such as overconfidence, loss aversion, confirmation, and recency biases. We project past returns into the future, and we make decisions based on how we feel on a particular day.

One of the most important concepts in the science of behavioural finance is that investor risk appetite changes over time. A traditional KYC risk questionnaire completed during March of 2020 would likely generate a different risk profile than one taken during March 2021. Investors generally become more risk-averse in times of uncertainty and become risk-seekers when times are good. The degree of change for any investor will depend on many individual behavioural risk factors.


Make the EQ Connection with Behavioural Finance


Leveraging this approach to analyze the behaviours of clients enables advisors to discover each client’s risk range and skew (behavioural risk ranges are typically not symmetrical). This sets the stage for a clarifying conversation with the client, to build a mutual understanding of behaviours, how their risk appetite changes, and how best to incorporate that information into portfolio construction.

The first step is for advisors to ask better KYC questions than they traditionally have; questions that get to the possible range of client risk appetite and associated behaviours. If you can make that connection with your clients, they will be your clients for life! They will know that you now understand them; and that they understand themselves. That’s a basis for a true partnership.

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  • Mark Doyle

    Mark Doyle is Executive Vice President, Client Experience at Pascal WealthTech and is the head of Pascal’s behavioural finance product InvestorEQ. A recognized leader in the financial services industry, he has more than 30 years of experience building strong client relationships and winning investment management mandates. Mark also serves as President of Marksman Asset Management, a portfolio manager focused on creating custom taxable and tax-exempt portfolios for individuals and families. Prior to joining Pascal, Mark held senior investment roles with several of the world’s leading financial institutions. Mark holds the CFA designation and is a registered portfolio manager.