The average investor could retire two and a half years sooner if they want a moderate standard of living in retirement, by avoiding holding too much in cash and not making investment decisions based on ‘emotional comfort’, a study has found.
Oxford Risk estimates investors on average lose 1.5% each year from holding too much in cash, and 3% overall when this is combined with making emotionally based mistakes with their invested assets.
Its analysis shows that for the average investor, this level of emotional comfort equates to a loss of around £1,600 a year, or up to £76,000 over 30 years, highlighting the enormous cost to them of focusing on emotional comfort at the expense of returns.
According to the Pensions and Lifetime Savings Association (PLSA), the average person needs £14,400 a year for a minimum standard of living in retirement – defined as covering all of your needs, with some money left over for fun. If the average investor could increase their retirement savings by £76,000 overall, they could potentially retire over five years earlier if they were happy with this level of living standard.
To have a moderate standard of living in retirement, the PLSA says people need an annual income of £31,300, and by increasing your retirement savings by £76,000 you could potentially retire around 29 months sooner. For a comfortable retirement, the PLSA estimates you need £43,100 a year, and with an extra £76,000 saved you could retire up to 19 months sooner.
Seeking emotional comfort with investment leads to errors such as focusing on familiar and domestic assets from well-known companies, chasing current and popular investment themes, following star fund managers, focusing on past performance, trading too much, not rebalancing enough to effectively diversify, and seeking income or yield over total returns.
Oxford Risk says wealth managers need to focus on behavioural alpha to help investors avoid the losses they make from poor and emotionally driven financial decisions.
Understanding and guiding the emotions that drive investing decisions can help wealth managers boost returns for clients and deliver behavioural alpha, but the industry needs technology to deliver personalised behavioural engagement at scale, Oxford Risk argues in a newly published white paper.
Its white paper, Behavioural Engagement Technology: Using technology to understand, map, and improve engagement in personal finance outlines how using AI and machine learning to engage investors can improve financial outcomes and grow assets under management for advisers by 10% or more.
Dr Greg Davies, Head of Behavioural Finance, Oxford Risk said: “Investors are human and regularly make expensive mistakes, such as leaving too much cash uninvested, and behaving badly with what they do have invested. Changing investing behaviour can help people retire earlier.
“People sit on cash because it feels secure at the time. They take more risk when times are good, and reduce risk when markets drop; buying high and selling low, and systematically underperforming buy and hold returns.
“That emotional comfort costs an average 3% each year which based on typical holdings of £53,000 in savings and investments which is what regular investors have, adds up to substantial losses each year and over a lifetime’s investing.
“Behavioural alpha doesn’t require beating the market but just engaging with it better and overcoming some of the emotional and behavioural barriers investors have when it comes to managing their portfolios.”
Oxford Risk says technology can help support wealth managers in hyper-personalising client engagement to support better financial decision-making.
Effective investor engagement helps investors to feel emotionally comfortable with the financially optimal decision and can dramatically mitigate the estimated 3% per year cost to investors. Furthermore, these greenfield assets are ripe for wealth managers and advisers to bring under their management to increase client portfolio value.
Well-designed personalised digital client engagement systems can target better behaviour. They can help investors and financial institutions by encouraging greater cash deployment in the markets, guiding and prompting better rebalancing and cash withdrawal strategies, effective tax location, and using better, more diversified portfolio monitoring.
Behavioural Engagement Technology uses rich data about both an investor’s financial situation and their financial personality to weight possible message prescriptions. With the use of AI and machine learning, messages are delivered to those investors who are most likely to act upon them.
Guides available on Oxford Risk’s website for financial advisers and wealth managers outline how using technology and behavioural science enables firms to tailor services more efficiently whilst communicating with clients more effectively.
The company, which builds software to help wealth managers and other financial services companies assist their clients in making the best financial decisions in the face of complexity, uncertainty, and behavioural biases, has developed proprietary algorithms which rank products, communications, and interventions for their suitability for each client at a particular time.
