The performance of human investment decisions
Figure 1: Investor Portfolios vs. Indices
Source: Dalbar & Lipper (2010)
Graphics: AllianceBernstein
Figure 2: Performance of Premium 5-star
Managers
Morey (2005)
The change in advisory model and reduction in human advisers risks creating an “advice
gap”.6 While individuals may welcome more engagement with their financial decisions, they
have a distaste for the cognitive burden and emotional strain it brings with it. While the new
electronic systems and product offerings may eliminate many of the detailed decision
problems such as those pertaining to optimal portfolio construction and management, to lay
investors many of the higher level decisions such as ‘Which risk profile?’ or ‘What time
horizon?’ are not immediately straightforward. Moreover, despite consolidation of individual
securities in funds, the number of options offered on various investment platforms is still
overwhelming and obscure, which makes it difficult for a potential investor to make an
informed decision.
Overcoming these difficulties, we argue, requires human interaction. In particular a human
adviser can offer three things that investors value and are willing to pay for—1) personalised
advice; 2) better informed decisions that improve investor confidence; and 3) ongoing
consultation to help clients cope with their changing personal circumstances and market
conditions. In the next sections, we will outline a framework that describes how advice
interacts with the psychology of decision making and identify the areas in which advisers will
continue to add value and areas where technology is become increasingly prevalent.
The gateway to better client-engagement
Understanding the interaction of advisory functions with clientdecision making can shed light on how to emphasise client services
appropriately.
In his recent book, Thinking Fast and Slow,7 Nobel Laureate Daniel Kahneman outlines that
our mind employs two systems of cognitive reasoning that underpin decision making: an
automatic subconscious process (System 1) and a controlled, conscious process (System
2). For example, a hasty decision to short a stock that is losing value is a reaction led by
System 1; whereas taking a decision after performing a thorough analysis on why a stock is
losing value is a decision led by System 2. Usually, we engage System 1 first when making
7