What are the sub-conscious behaviours that drive our financial decisions?

My guest on the show today is Neil Bage.

Neil is the Founder of multi-award winning Be-IQ. Working with leading Academics, Be-IQ is an entirely new model and approach to understanding a client’s risk personality, their financial capability, and their financial decision making.

Neil works closely with some of the most influential financial brands in the world, and regularly features as a keynote speaker, focussing on the sub-conscious behaviours that drive our financial decisions. He is an expert at bridging complex theory with real-world understanding.

Listen to this conversation if you want a better understanding of the factors that contribute towards your attitude, capacity and need for investment risk.

Here’s my conversation with Neil Bage, founder of Be-IQ, in episode 306 of Informed Choice Radio.

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Interview transcript

Martin:    Well, welcome back to Informed Choice Radio. I’m delighted today to welcome Neil Bage. Neil is from BIQ, and we’re going to have an interesting chat I’m sure about behavioural science. Neil, could you start by introducing yourself, who are you, what it is you do?

Neil:    Absolutely, Martin. My name is Neil Bage. As you already alluded to, I am the founder of a UK-based financial behaviour specialist, BIQ or Behavioural IQ. To explain a little bit more about what we do, we work with renowned academics and experts in the fields of human decision making, conducting frequent surveys, carrying out research, which helps us identify, but more importantly, quantify the relationships between the behaviours that influence a person’s risk in decision making. Through this work, we have created an entirely new model, a new approach, to understanding a person’s risk personality and how their behaviours influence their financial decisions.

Martin:    This is a hot topic at the moment. Behavioural finance, behavioural economics, behavioural science in general, seems to be the darling of the academic and business world, right now. We had Professor Richard Thaler last year winning the Nobel Prize. How did your interest in this particular field begin?

Neil:    Oh, gosh. I’ve got to do a little history lesson then, right, [inaudible 00:01:21]? It guess it started when I left school and decided at that time that I wanted to be a PE teacher, of all things, a sports teacher. As part of that, I was introduced to two things which I’ve always, since that time, had a passion for, human biology or physiology, but also sports psychology. That was the embryo, the beginning, of my love affair with psychology, I guess.

Over the years, through more study and through reading and working with people, this has developed into a more specific area of interest around the psychology of how people make decisions, and not just to do with money, but how people make decisions, full stop. Like you said at the beginning, more on the behavioural science front as opposed to the more specific behavioural finance front. I’m also interested in how our psychology affects our physiology. I guess it stems from the fact that I’m an incredibly inquisitive person. I was always that child that took apart his toys to see how they worked. So, understanding how people behave or how people work really fascinates me.

Martin:    This is now an established academic field, isn’t it? Alongside economics, we’ve got behavioural economics who’ve got a very different approaches and very different beliefs in how humans work and make decisions. What sort of research is being carried out, out there? How does that field look?

Neil:    You’re right. It’s a developing field. We’re starting to see more universities around the world dedicate courses specifically to behavioural finance, for example, and behavioural economics. Once upon a time, where it was just psychology and this was a little branch from that, it goes back to your opening gambit, Martin. It’s become such a darling that we’re starting to see, quite quickly I would say, within the academic world especially, much more focus being put on it. That can only be a good thing.

Martin:    I know part of your work looks at investment risk, and we’d like to talk about investment risk on this show. When we talk about risk, we often break it down into three distinct parts, people’s attitude towards risk, how they feel about it, their capacity for risks, how much risks they’re able to take, and then how much risk they need to take, all about their goals. Why those approaches to understanding investment risk distinct and so important to separate into those areas?

Neil:    It’s an interesting question. I would go as far as saying that I don’t think those three broad headings go deep enough when it comes to investment risk, but let’s do them one at a time. As you said, risk capacity is all about a person’s ability to absorb losses without it affecting their lifestyle. That’s a pretty standard definition. That is clearly important to understand. I would caveat that by saying, I don’t think we should be expecting people to answer that question themselves with any level of accuracy. I think we as an industry, as advisors, should be creating the answer to that question by using software and using data. A person would not understand a percentage of how much their wealth can be impacted, for example. We should be doing that for them, but there’s also a part of this element which I think is often overlooked. That is, mental capacity. “Do I have the mental strength to cope with losses or fluctuations in my investments?”, which leads to the second point, which is attitude to risk, which is much more behavioural.

There’s a crucial point about behaviour, I think, in the context of risk-taking, in that it wears many hats. Our attitudes towards risk which are domain-specific, and that means that if you are a dare devil on a ski slope, it doesn’t mean that you will be a dare devil with your money. This attitude can’t be established by simply asking a series of subjective questions, psychometric or not, because there are other objective elements at play. There are some crucial elements when it comes to risk taking. I would go as far as saying, attitude to risk taking when decisions involve ambiguity, because that’s the core statement, there. That’s true especially when you’re planning for the future, which brings me on to that third strand that you mentioned, goals. You know what, Martin, I could dedicate an entire conversation to goal planning, and how humans are pretty much terrible at it.

Martin:    Why are humans so bad at goal planning?

Neil:    One of the things that we think we are good at, because it’s a subjective view, but the reality bears out a different story, is putting ourselves into a future state and answering any questions or trying to get any proper clarity from what that future state looks like. If you say to me, “Okay, Neil, let’s talk about your money. What is it that you want to do when you are 60?” What I will do is, I will give you a whole raft of socially-conditioned responses. “I want to retire. I want to go on holiday. I want to …”, all the things that most people will say. I would argue that there’s probably 10 things that every human says to that question.

The reality is different, because as we step through life, and as we get closer to that time, things change. Life happens, and we have to make adjustments. So, asking questions of a person that involves a response to a future state is predominantly a flawed approach. That’s one of the issues I have with goal planning, but saying all of that, it’s really important to understand why people are saving and what their high-level aspirations and dreams are, and tie into that how much uncertainty they are willing to experience to realise that. This whole future self conversation really interests me, but it’s one for another day.

Martin:    Absolutely. It’s certainly one we could dive into more deep I’m sure, in the future. Thinking about those different approaches to risk in attitude, capacity, and goals, you mentioned that behavioural concepts apply mostly to attitude. Do they apply also to capacity and goals? How would you go deeper into each of those?

Neil:    Yeah, they do. I would once again go further and say that actually, within the elements, I think there are sub-elements if you like. I think, to help us understand this better, Martin, if we remind ourselves of one simple truth, the human brain and the way that it operates in particular around decision making, containing uncertainty, is hugely complex, which is where my issue with traditional subjective attitude-to-risk tools lie. I think they’re too one-dimensional in their attempt at measuring behavioural traits and asking for other skills to be called into action. If I give you an example, a question that I’ve seen in several risk questionnaires, “What would you do if your investment fell by 15%?”, or 10%. I don’t care what the figure is. That’s a stock question. Not only does this question require a person to have the ability to mathematically model in their head a 15% drop in their investments, which most people can’t do, it also asks them to put themselves into that future state, and try to imagine what they would do.

We struggle to do this. People struggle to do those two things. Of course, what if you are present-minded? What if you are highly loss-averse? What if you react to the question because of the way it’s being framed? You can see who we can quickly unpick this and how the current methods are just, being frank, inadequate. I think with attitude to risk, it’s all behavioural capacity. It needs numeracy skills and potentially can be influenced by mental accounting. Goal planning can be influenced by present bias and illusion of control. There are lists as long as my arms for all of those three areas that I’d happily go into.

Martin:    If I think back to my career as a financial planner, which is now 15, 16 years, when I first got started, measuring attitude towards risk is very simplistic. It was asking a client to tick a box. It was, “I’m cautious,” “I’m balanced,” or “I’m adventurous.” It’s improved since then, dramatically. Firstly, we had very simple risk attitude questionnaires. The ones we use these days are psychometrically-based. They’re tested with large groups of people to get consistency and things. You think that possibly, I think from what you’ve said, there needs to be another big improvement to the way we establish attitude towards investment risk.

Neil:    Yeah, that’s right. I’m not dissing every attitude-to-risk tool out there. It’s the complete opposite. I think that they have a valid place, but only if the way that they are constructed and the way that they are academically validated is there. We should not be presenting clients with questionnaires that have been produced by some marketing department, for example. That doesn’t work, but there is an abundance of evidence that shows that that is just one side of a multi-sided picture if you like of risk. There are other tests that need to be done to make sure that you absolutely understand the person and the person fully understands what they’re getting into.

Martin:    A moment ago, you mentioned present buyer. What role does that play when we’re understanding investment risk?

Neil:    When we talk about present buyers, we’re actually discussing what’s called hyperbolic discounting. It’s quite an interesting behaviour. In essence, it’s all about how strongly someone feels when presented with an immediate but small reward relative to a larger but more delayed reward, 50 pounds today or 70 pounds in a week, that sort of thing. One of the ways that present buyers manifests itself in risk-taking is linked to the question we ask individuals when they invest, which is, “How long are you planning on investing for?”

Once again, we enter the world of subjective questioning, because that’s completely subjective. Worse still, it’s a question that we often frame for people by presenting them with pre-defined time periods that we’ve created, one to three years, three to five years. These framed options can absolutely steer the response. With present buyers, there is an abundance of evidence that shows that those people who are very short-term in their thinking are more likely to react to market movements than those who are long-term in their thinking.

Let’s play a scenario out, here. If you imagine somebody who’s been through an attitude-to-risk tool and because it’s subjective, they think that they are high-risk, but behaviorally are as cautious as you can get. They have opted subjectively, based on those time frames, for a long-term, say five to seven years, but in reality, they are painfully short-term in their outlook. The market moves in a dramatic way, they see a potential short-term impact, which could be negative or positive, and they react, and that often negatively impacts their financial plans. Of course, the riskier the investment, the more probability [inaudible 00:13:23] experience these market movements.

I say this when I speak at conference or when people interested in what we do ask me these questions. I say the same thing. It’s not that individual behaviours are bad, per se, in isolation, but when you put them together, when they’re compounded, you can get to a place very quickly that can harm your entire financial plan. Of course, we want to try and avoid that at all costs, right?

Martin:    Yeah, absolutely, yep.

If somebody comes to see a financial planner like me who’s hopefully using an academically-grounded psychometric risk profile questionnaire, who’s got some understanding of these behavioural science issues, as well, that’s fine. We can help them establish their attitude to risk and their capacity for risk and their goals and things, but what about if they do it themselves? What’s the best way for investors to understand their own approach to risk?

Neil:    The best way is, without doubt, what you’ve just said, is to go through a process that is academically and scientifically rigorous, but one that tests all facets present in risk taking, and at the same time, making sure that it’s not 100% subjective or future-scenario based. Again, as always with behaviours, there’s a few caveats to this, because other behaviours can very quickly creep in. Let’s just jump back into the advice world for a second, if we can. If an investor is asked to fill in a risk questionnaire, given everything I’ve just said, they really should not be completing this questionnaire at the same time that they’re discussing investments or even when, I would go as far as saying, when they’re sat in an advisor’s office. Ideally, it should be done completely outside of this discussion, before any detailed conversations take place. Otherwise, there’s a chance that the way that they answer the questionnaire can be influenced by the very fact that they’re discussing investments, and it becomes more of a, “How should I complete this question?”, as opposed to being uninfluenced or unbiased by the situation.

I would also say to people, if they’re doing this themselves, and I’m going to reiterate this point, be very wary of subjective statements that have no substance behind them. If I give you another example, “Would your friends describe you as a risk taker?” is an example of such a statement. That question in itself can be interpreted in so many different ways, to in essence make the outcome meaningless. Which friends? Which situation? There’s a whole raft of other questions I need to know before I can answer a question like that. It’s completely subjective.

Going back to what you said, Martin, I’m a big believer that a good quality financial advisor should be using that data they gather through the risk-assessment process to inform a discussion, and not use it as a rigid immovable [inaudible 00:16:28], if you like. If it wants to be accurate, I would say it just needs to be, find a tool that is as objective as possible, and try your hardest to avoid subjective questioning.

Martin:    That brings up nicely on to the tool that you’ve developed. Tell us a bit about this. It applies the singular behavioural risk score that can be mapped to investment solutions. How does that work? How does it look?

Neil:    It does. Three and a half, four years in the making. We have taken the behavioural measures that we test through BIQ. There are numerous measures. We’ve worked with psychologists mathematicians and data scientists, and created a model that can account for these multiple inputs, including ATR, including loss-aversion, present buyers, capacity for loss and time. It uses some very clever maths and algorithms to model for consistency and reliability and correlation. Then, it outputs a single behavioural risk score, which is much more reflective of the person and the behaviours that sit behind their financial decisions.

The reason why we did this is because we have repeatable evidence that shows a significant percentage of the investor population could potentially be mismatched to investments, all because the process used to get them there in the first place was a one-dimensional subjective questionnaire. BIQ fixes this issue by insuring that those foundations are robust, that they’re valid, meaningful, relevant, and importantly, as objective as possible. At the moment, we work with large institutions where we are seeing beautifully a fundamental change in how they’re engaging with investors in relation to risk. This year will see us launching a service for advisors as well as a service for customers to use themselves, to find out more about their financial behaviours and their risk personality.

Martin:    There’s a term I spotted on your website, which I like the sound, or I don’t like the sound of, I’d like to know more about. That was behavioural self-harm. What does that mean? How does it happen from an investment perspective and what’s the best way that we can stop it from happening?

Neil:    Yes, it often gets mentioned, this phrase. I’m going to bet that people listening to this, at some point in their life, have asked themselves the question, “Why did I do that?”

Martin:    Daily.

Neil:    Daily, yeah. We do, right? I’m not just talking about money. I’m talking about life in general. We make a decision and then later on when we reflect, we say, “What was I thinking?” That statement underpins behavioural self-harm, which is when we allow our subjective views to override our objective judgement .

Let me put that into simpler words. We have a tendency, very easily, as humans, to let our personal opinions, our assumptions, our interpretations and our beliefs to get in the way of objective, measurable fact. I don’t want to get too political here, but think Brexit. There was facts in place that were indisputable fact, but opinion, assumptions, interpretations of that data, and predominately belief got in the way. The facts are pushed to one side for a step forward and making of a decision that is completely subjective now.

In order to prevent this, the first thing you have to do is, you have to pause. You know that old adage, “Sleep on it.” It couldn’t be more true in this regard. You know when somebody sends you an email and you’re quite frustrated and you type an email frantically, very quickly, and somebody, usually your wife, says to you, “I wouldn’t send that now if I was you. Send it tomorrow when you’re calmer.” The next day you look at it, and you think, “I’m so glad I didn’t send that.” It’s that type of thing, sleeping on it. You don’t want to cause ourselves upset, so we can also put measures in place, a commitment device, for example, that prevents us from doing stupid things.

Let me give you a quick example. If I know through the BIQ process, that I am naturally a short-term thinker, and I have investments, I may put measures in place that prevent me from accessing information on my investments on a daily basis. I may ask my trusted professional, such as my advisor, to put measures in place to stop me acting out these decisions that will impact on my financial well-being. I may say to my advisor, “Every time I’m saying I want to do something, I have to come to your office, I have to sit down, and explain my actions to you.” This is a silly example, but there is a whole multitude of little tweaks people can make to their lives, behaviorally, that can have significantly lasting benefits.

Martin:    It’s understanding what your weaknesses are, I guess, and then putting things in place between you and your weakness.

Neil:    That’s exactly what it is. Exactly. I would say one more point to this, I guess, Martin, is that I’m a believer that you can get other people to help you do this. It’s quite nice to have that third party validation or that third party blocker to decisions that ultimately could cause me pain.

Gosh. If you’re a smoker, do you give your packet of cigarettes to a friend or your partner, and every time you want one, you need to ask for their permission, that type of thing. You could go really far or you could just scratch the surface with it. Whoever you ask to help, and I would suggest the advisor is in a prime place to help especially an investor, not self-harm. We need to remember that people have a tendency to make inaccurate predictions and assumptions about how people will behave and then make inaccurate attributions and judgments where we see how they actually do behave. “Oh, I know Neil. I know what he’ll do. He’ll do this,” then when you see me do the opposite, you’ll say, “Ah, yeah, but that’s because, blah, blah, blah.” It’s really important that, in this process, there’s accountability, at some level, else people will never change.

Martin:    Neil, it’s a fantastic subject. It’s really interesting. I’m sure we could go a lot deeper. Hopefully, I’ll get you back in the future. We’ll dive a bit deeper into some of these particular areas. Thank you for your time. Thank you for coming on the show.

Neil:    You’re welcome. You’re very welcome.

Martin:    Where can we find out a bit more about you and about your work?

Neil:    You can follow me on Twitter if you want my normal ramblings, which is @neilbage or the BIQ Twitter address is behavioraliq, or finding the website, which is [BIQ.com 00:23:34].

Martin:    Lovely. We’ll put those links in the show notes, as well, so our listeners can find that nice and easily. Neil, thanks for your time.

Neil:    Thank you. Thank you. Cheers, Martin.