Behavioral finance theories are interesting in many respects, but they are also very useful for understanding how investors position themselves. What is their relationship to risk? What types of products do they want to invest in? To sell more, financial institutions need to know exactly what investors want. In this sense, behavioral finance proves to be a formidable tool to make recommendations adapted to investors’ preferences, and thus sell more. Here are some explanations.
What is behavioral finance?
At the frontier between psychology, neuroscience, and social sciences, behavioral finance is a field of research that has flourished since the 1970s, crowned by a Nobel Prize in Economics in 2002 and 2017.
What are we talking about? Behavioral finance aims to model the psychology of the investor. It is opposed to the predominant classical financial theory which considers that investors systematically operate according to rational behavior. Loss aversion, mental anchoring, ratio bias, confirmation bias, herding effect… Behavioral finance has highlighted the role of cognitive and emotional biases in investor decision-making. For example, a sunny Friday has a positive impact on the market, whereas a rainy Monday is synonymous with a bear market: this is called the weather effect. Another example is overconfidence, which leads investors to believe that they know the market well enough to anticipate the most extreme fluctuations, when in fact they do not. All of these irrational behaviors explain excessive volatility, stock market crashes, and other speculative bubbles in the financial markets.
Behavioral finance: what opportunities for the banking and financial sector
Behavioral finance allows us to better understand the behavior of investors, to understand why in a given situation they will make a particular decision. This is precisely what the Markets in Financial Instruments Directive (MiFID) seeks to assess. Since 2007, this European directive provides for the measurement of the profile of individual investors. However, as the regulations left a lot of room for maneuver in this area, most banking and financial institutions were content to create relatively basic questionnaires, without exploiting the potential offered by behavioral finance.
Financial situation, family situation, age, performance objectives… MiF 2 questionnaires require the collection of easily measurable information, but also the evaluation of much more subjective elements, such as the investor’s financial skills or tolerance for risk and loss.
Behavioral finance: the ideal solution for assessing investor profiles
Behavioral finance theories have proven to be a good way to describe the risk attitudes of individual investors. In their report “Evaluation of MiFID questionnaires in France”, researchers André de Palma and Nathalie Picard stressed the need to move towards a more subjective approach to measuring financial knowledge, which led the AMF and the ACPR to issue recommendations in this regard in 2013. Financial institutions are therefore strongly encouraged to use behavioral finance theories to understand their clients’ risk tolerance. However, these theories remain complex to understand and apply, which is why some companies have developed tailor-made solutions for banks and financial institutions.
Behavioral finance: what tools should you use?
Based on behavioral finance theories and gamification principles, the start-up Neuroprofiler has designed a series of fun applications to understand clients’ investment preferences and improve their financial knowledge.
RISKprofiler: Understand your clients’ relationship to risk
“Would you rather have a 50/50 chance of winning $100 or nothing; or a 50/50 chance of losing $100 or winning $300? An immersive and dynamic questionnaire, RISKprofiler allows you to evaluate your clients’ risk preferences and predict their behavior, thanks to behavioral finance. Thanks to an adaptive and fun course, this application allows you to increase your sales while meeting MiFID II obligations on the use of behavioral finance.
EDUprofiler: improve your clients’ financial knowledge
80% of individual investors say they lack financial knowledge. In 50% of the cases, this lack of knowledge leads them to invest in products with low returns. By not acting in favor of better financial education, financial institutions are sitting on an opportunity. Individuals only want to better understand the financial mechanisms to invest more! This is why Neuroprofiler has developed EDUprofiler, a fun e-learning application that makes the world of investing more accessible to savers.
ESGprofiler: sell more ESG products to your investors
Sustainable finance is an underlying trend, driven by investor expectations and encouraged by regulation. Understanding investors’ preferences in this area are not only a regulatory requirement but also a great opportunity to sell them more ESG products. By using the ESGprofiler investment game, you can assess your clients’ appetite for sustainable finance and understand the impacts they are seeking in their investments. The associated behavioral finance algorithm then identifies the ESG product that best matches the client’s values.
Behavioral finance is a strong asset for financial institutions because it allows them to accurately identify investors’ expectations and behavior. If you want to boost your clients’ investments, don’t hesitate! Ask for a demonstration of Neuroprofiler’s expertise.