Paul Moran
Investors are making irrational asset allocation decisions based on inaccurate recollections of past performance, reinforcing the value of professional advice, according to new research by Dr Paul Moran, Founder of iFactFind and Principal of Moran Partners Financial Planning.
Presenting at the Financial Planning Association Congress in Sydney on Wednesday, Dr Moran revealed the findings of his doctoral research on the relationship between investor beliefs and financial decision-making.
“The most important factor in investment decision-making is people’s perception of past performance and most of the time that perception is poor or just plain wrong,” Mr Moran said.
“When asked to choose the best past performer out of superannuation, Australian shares and residential real estate, more than 60% of people got it wrong yet they indicated that past performance was a significant factor in their asset allocation decisions.”
The research also found significant differences in investment preferences, depending on how questions were framed.
When asked to select their preferred asset class out of superannuation, Australian shares and residential real estate based on past performance, 38% of respondents chose Australian shares, 33% chose real estate and 26% chose superannuation.
When asked to select their preferred asset class based on their expectations of future performance, almost 48% of respondents chose Australian shares, 18% chose residential real estate and 33% chose superannuation.
“People can give very different responses to the same question, depending on how the question is framed, therefore, relying on a one dimensional, mean variance approach to assessing risk tolerance without consideration for investor beliefs and perceptions about risk is dangerous,” Mr Moran said. The research poses challenges for proponents of digital advice as the key solution to the advice affordability and accessibility dilemma.
“If clients don’t know what they don’t know, and digital advice platforms only ask questions designed to obtain a pre-determined outcome, otherwise called an algorithm, it is questionable how much they can really help,” he said.
“Problematically, people typically use digital experiences to obtain pleasurable outcomes, like buying clothes and concert tickets, but not for things like life insurance and topping up super, which doesn’t help solve the advice access issues.”
Dr Moran’s research was based on an online quantitative study, completed by 280 randomly selected participants sourced through social media, mainstream media and an Australian financial planning body. Half of respondents had an ongoing relationship with a financial planner.
Other insights included a very poor understanding of risk and return among consumers, despite the sample being identified as financially literate.
“The research reinforces the importance of having an experienced adviser to help guide clients to make smart decisions,” he said.
“It also highlights the importance of incorporating some questions about client beliefs in the discovery process, albeit it subtly so not to reinforce these misconceptions.”
