Kramer explained that with this new backing for her research she will continue to work on questions of how individual investors make decisions, how financial market professionals make decisions, and how human nature aggregates up into the way financial markets behave. She cites the common example of overconfidence bias. It’s been well demonstrated that humans tend to believe themselves to be above average at most things. When asked to rate their driving ability, for example, most people will claim to be above average.
Kramer says that this overconfidence can be seen in investor behaviour, even among investment professionals. Investors’ belief in their ability to time the market often results in underperformance. Even if their instincts and decisions are right, that overconfidence tends to result in more frequent trading, which tends to erode any brief advantage. The trouble is, even people aware of these human faults still tend to make them.
“In the early days, we hoped that maybe education would be the antidote to behavioural biases. And I think that reality hasn’t lived up to that expectation,” Kramer says. “Learning more is a good starting point but it doesn’t necessarily eliminate the propensity to exhibit these kinds of behaviours. I think that’s where the contribution of Cass Sunstein and Richard Thaler comes in. They developed this notion of choice architecture and nudges and the possibility for us to design decision environments in a way that steers people to better outcomes.”
Even as researchers and scientists have worked on finding new frameworks to control for human bias in decision making, Kramer notes that actually implementing these frameworks in the practice of wealth management can be incredibly difficult. There is no quick panacea, she explains, for managing these potential pitfalls. That’s, in part, because so many of these human biases are built into the structure of this industry.
Kramer cites the example of fee structures in the industry. Advisors might be well aware of their biases, but if the fee structure at their firm favours directing clients towards a specific set of products, they will tend to still prefer those products, which can lead to different outcomes.
