Behavioural finance: what the polka dot maxi dress sensation has to do with investing
THE polka dot Zara dress sensation comes to mind when considering recent examples of “herd bias”. The hugely popular dress, which has its own Instagram page dedicated to sightings of it, was initially a sell-out, and it seems herd mentality has been at play. However, this bandwagon effect, where people gravitate towards something because “everybody else” is doing it, also has an impact on how people manage their finances.
I’ve worked with hundreds of clients as a financial adviser over the last decade, after self-investing in my early twenties led me to a career change. Now, as Personal Finance Director at investment firm Schroders, I still find the psychological aspects of money fascinating. Financial advice is both art and science. To be successful you need to ask clients the right questions to understand what behavioural biases might be driving their decision-making.
Two years ago, Schroders worked with behavioural scientists to develop a digital tool – investIQ. The test analyses investors’ behavioural biases, strengths and weaknesses to identify their “investment personality”. The idea is if investors understand more about themselves they can make more informed, well-rounded investment decisions.
Our new report reveals the most prevalent investment traits of people who have completed our behavioural biases test in the UK. The results clearly show the degree to which people are influenced by biases and how these tendencies vary by age.
For me, the most interesting revelation is the propensity of young women to display herd bias. We found younger women, aged 18-34, are 14% more likely to follow the herd than the average. Men aged 18-34 are only 4% more likely than average to have this trait.
Herd bias can be responsible for driving classic irrational investment mistakes – buying high and selling low or chasing potential investment bubbles such as cryptocurrencies. It’s why it is important to remind people to assess their situation with a clear head and remember the herd trend isn’t necessarily the right thing for them to do. But herd bias may also be a factor in the gender investment gap.
It’s said that men are roughly twice as likely to invest as women. We are routinely told that young women are not sufficiently engaged in their finances, they are less likely to invest or contribute to pensions than men and when they do, they put in less.
Historically women have been substantially poorer than men at retirement. Women in their sixties have an average of £51,100 in their private pension pots, while men have £156,500, according to retirement research body the Pensions Policy Institute. Herd mentality might not be the reason for the size of this gap, but the fact that younger women are more likely to follow the herd should be taken into account if we want to close it.
As Nick Chater, the Professor of Behavioural Science behind investIQ, told me: “We all tend to follow what other people are doing, and investing is no different.”
It’s probably true that many women keep most of their money in cash because they are less likely to hear about their peers investing. If it is, which I believe it is, then as an industry we need to think about what this means for how we engage women in their finances.
I feel strongly that we need more positive real life examples of women who are investing and saving for their pensions. Unlike with clothes fashion, women don’t tend to talk about what they do with their finances with friends as much. It’s important because, although there is no guarantee that if you take risks with your money you will be rewarded, if women do not consider investing over the long term they could continue to miss out. It’s time to talk about money.
The views are those of the author. We cannot provide investment or pension advice; please speak to an independent adviser should you be uncertain what is appropriate for you.