Understanding the Decision-making of Retail Investors

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Financial planning and investment by retail investors is fraught with many and increasing difficulties. There is much evidence that the choices they make are often inappropriate, partly due to their poor knowledge of financial products and the specific terminologies. In the UK, many retail investors obtain independent financial advice to assist their decision-making but the process of eliciting their degree of risk appetite leading to investment recommendations has been criticised by regulators and in academic research; there are dangers it may not deliver clients the most appropriate financial products. The proposed project aims to undertake a comprehensive and wide-ranging investigation of the financial decision-making process of retail investors which will not only contribute to the academic literature on the understanding of how and why investment choices are made, but will also provide practical policy recommendations for risk profiling and the presentation of financial information.We will have access to two unique databases of the responses of more than 100,000 retail investors to psychometric risk profiling questionnaires with the chosen investments and their demographic/lifestyle data which will be analysed from a number of perspectives with the aim of determining how coherent the process is and the extent to which questionnaire responses already incorporate clients' capacities for loss. We will evaluate, within the financial advisory process, the impacts of differing methods of data presentation and different terminologies on the investments chosen. For instance, it is now common for IFAs to explain risk via volatility and value-at-risk, which shows, based on historical data, how much the customer is likely to lose with a given probability over a given horizon. However, whether information is presented in a gain or loss scenario has been shown to impact decision-making and in particular risk-seeking and risk-avoidance strategies by individuals. Collectively, we anticipate that these factors may impact the decision-making process of individuals, in particular under conditions of more/less financially knowledgeable retail investors, different levels of excitement or anxiety and across demographic factors such as wealth, gender, education, and age. This aspect of the research will enable us to shed light on the likely impact of determining appropriate investment products via a consideration of the client's lifestyle aspirations (i.e., what do they want to achieve and in what way should they invest in order to expect to meet these goals?) rather than based on their willingness to bear risk.More broadly, we will step back from the psychometric questionnaire approach and visual presentation of information to consider the impact of the wider circumstances surrounding the financial decision-making process on its outcomes. This will include an examination of the effects of incidental and integral emotions on the decision-making process and outcomes. In the context of financial decision-making, integral emotions that are likely to be felt by retail investors relate to excitement and/or anxiety caused by the decision itself. For example, it has been demonstrated that fearful individuals are more risk-averse, while angry individuals are more risk-seeking. Incidental emotions, on the other hand, are emotions that are unrelated to the decision specifically, but are carried over from previous situations. For example, if a retail investor had a frustrating drive to their appointment with the advisor, or an argument at home, they can be brought to the decision-making scenario and are experienced as the decision is made. There is preliminary evidence that both incidental and integral emotions can influence investment decisions, but a systematic investigation of the impact of both these types of emotions and their interaction with cognitive biases on the decision-making process of retail investors has not been conducted.