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The power of nudges in financial advice
Nudging must be used to balance integrity, client best interest, and profit
11 Sep 2020 | Sara Cheng

When was the last time you felt pressed to buy something, whether it was a Christmas gift or a financial product because you felt if you did not participate, then you will miss out on a special opportunity or experience? If you think something is only available for a short period of time or limited in quantity, then you are being nudged to give it more importance and attention. This is one of many tools to influence consumer behaviour to buy something that may otherwise be ignored. Many may not realize it, but we are often swayed in our decision-making processes by our emotions, the methods by which products or services are marketed to us and the context of our current situation or surroundings. Nudges strategically and effectively make use of biases and mental shortcuts to influence behaviour and decisions while preserving the freedom of choice.

Since the publication of “Nudge” by Richard Thaler and Cass Sunstein in 2008, there has been growing interest across the world in applying behavioural science to many areas of public policy. Behavioural science examines how psychology, behavioural biases, organizational and group behaviour affect decision-making. In 2010, the UK government established a behavioural insights team, also known as Nudge Unit to improve government services and public policies in a range of areas from health, environment, transportation, energy to finance.

Many countries have since followed with the establishment of behavioural science units, applying nudge techniques in policy measures. Some strategies to guide people into better behaviour include: nudge energy-saving by delivering to households a personalized report that grades the household’s energy consumption and compares its performance to their neighbours; nudge traffic safety by putting up speed feedback signs to lower risk of accidents when driving; and nudge healthier food choices in school cafeterias by displaying healthy snacks closer and junk food farther away from cash registers.

Behavioural insights and financial regulation

Financial regulators are increasingly using behavioural science to enhance their understanding of both consumer and financial firm behaviour. By analyzing patterns of how investors perceive, interpret, and react to situations, regulators can better understand investor behaviour, biases, and financial decision-making. In a similar way, by analyzing how financial firms perceive and react to situations and policies, regulators can enhance financial supervision and better influence a firm’s culture. The intended regulatory outcomes from the application of behavioural sciences are to strengthen investor protection, improve investor education and enhance policy and regulation. Some markets that have established behavioural science units within the financial regulator include the UK, Netherlands, Canada, Australia and Singapore.

Among Asia’s financial regulators, the Monetary Authority of Singapore (MAS) is at the forefront in applying behavioural sciences. In 2019, the MAS established a behavioural science unit that applies behavioural insight techniques from social-psychology disciplines to gain an understanding of behaviour and biases of consumers and businesses. MAS managing director Ravi Menon noted that the behavioural science unit will expand capabilities and support supervisors with methodologies to better understand conduct and culture issues in financial institutions.

In view of how behavioural science can help to better understand human behavioural patterns and decision-making, more Asian financial regulators can consider a behavioural science approach in conduct risk supervision and enhancement of culture at financial institutions.

Dark side of nudges in financial advice

If the intention of nudges is to help people make better choices to improve their welfare, then outcomes are in the public interest. However, nudges become contentious if they are used with bad intentions.

Within financial advisory services, the adviser-client relationship is generally built through time and trust. Most people still value and favour human interaction when receiving financial advice even though robo-advisory services have been rapidly growing in the last decade. Good intentions of financial advisers are to use their knowledge and expertise to advise and recommend suitable financial products in the best interest of clients. However, the inherent conflict of interest in an adviser-client relationship is that the product that may be in the client’s best interest may generate a lower profit or commission for the financial adviser, compared to other available products.

Financial firms and advisers that use nudges mainly for their own profit can lead to customer exploitation. Over the years, many financial scandals have exposed how aggressive sales-driven cultures at organizations have led financial advisers awry in order to meet sales targets. In markets with commission-based advice models, an adviser can strategically use nudges to influence customers to buy more financial products that generate higher fees and sales incentives for the adviser that are not in the customer’s best interest.

Common nudges that financial advisers may use involve how information is presented, such as limiting the choice of available or alternative investment products, providing short time windows to purchase a product or cross-selling internal products and services to clients. While an adviser’s nudge can drive clients toward certain decisions, the choice ultimately belongs to the client.

When it comes to investments, even the most well-informed individuals can be influenced in their decision-making. Nudging is a powerful tool and must be used by companies and financial advisers with good intentions to balance integrity, client best interest and profit.

Sara Cheng, JD, is a senior director for capital markets policy and strategy, Asia-Pacific, at the CFA Institute.

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