Choice overload and financial instruments

Financial instruments should be more carefully scrutinized before entering the market. Similarly, risk should be portrayed comprehensibly (and comprehensively) to investors.

If individuals behaved rationally, they would seek to enhance their welfare. They would invest and hold a portfolio of assets that met their allowable risk-return trade offs  and was consistent with investment horizon and needs. Unfortunately, this is rarely the case. Indeed, “behavioural economists and empirical researches have shown that in reality members are not particularly good at handling their retirement savings, either because they lack the necessary cognitive ability to solve the optimization problem, because they have insufficient will power to execute it, or even sometimes because they are overconfident.

Extrapolating from the above article, one can assume that people are making sub optimal choices in their investments. Additionally, evidence suggests that the number of choices available amplifies these facts and “induce a preference for simpler, rather than less risky, options”.

The most likely candidate to address issues around choice overload, poor comprehension and the resulting obtainment of risky assets is the pubic sector. While private sector companies, such as S&P and Fitch have attempted to create evaluative mechanisms, they have failed. Since the crisis, rating institutions have been critiqued for lack of impartiality. Seemingly, a “cosy” relationship existed between rating agencies and banks during the crisis; “many financial experts believe that overly optimistic assessments by ratings firms were a key factor in creating an overblown market for derivatives and mortgage-backed securities.”

If, however, a public sector entity were able to evaluate instruments, and relay this information to the public, a more robust financial system would result. Less risky assets would be on the market, and comprehension would be improved.

Not only would investors be making better decisions, from better choices, but they would also be happier about it. While particularly cloying, it seems that that the mere “presence of categories, irrespective of their content, positively influences the satisfaction of choosers who are unfamiliar with the choice domain.

When framed like this, it suggests that presenting choices in a better way – where options are relevant to investment goals, and are not too numerous or complex – will result in a type of self-fulfilling prophecy whereby motivation, learning and well-being are enhanced.

 

 

 

 

 

The city is bleeding bankers

Increasing regulation (perceived to reduce innovation) combined with job insecurity and stricter remuneration structures are causing a brain drain in financial services. Meaning, the best and the brightest are now choosing start-ups, technology and other sectors –the chance to innovate and build business– over banking.

What does this realistically mean for the industry? In the short term, it is unlikely to be meaningful. Banks are consistently in the news cutting jobs, and reducing costs. Simply said, an exodus is apparent. In ten or fifteen years down the road, however, a lack of people will exist to step into executive and strategic positions.

On the other side, many argue there has been too much innovation in financial services. A brain drain, whereby the “creative” use their talents in other industries, and leave more conservative individuals in finance, is welcome.

Yet, we must remember that financial services currently:

  • Account for 14.5% of UK economic output
  • Offer a combined total of 63bn GBP in tax
  • Have a 47.2bn GBP trade surplus; larger than all other net exporting UK export industries

If the industry continues to contract a lack of talent in the future will mean an even greater decline in the economy. We are currently on the cusp of our third recession in four years. If top talent continues to leave finance (or choose to not enter in the first place),  how can we drive growth?

We must consider that the movement of talent to other industries is unlikely to lead to an equivalent gain for the UK economy. Digital Shoreditch, for instance, cannot compare to Silicon Valley. Graduates are frequently choosing to move to other countries, where VC funding and government grants are easier to obtain. Additionally, if talented individuals leave the financial sector, what guarantee is there that those who will remain will act in a more conservative manner? Perhaps we will be left with a group of individuals who are unable to manage risk entirely.

Talent should remain in financial services – an industry where infrastructure is already developed and the UK is a recognized global leader. Policy makers and bank officials must begin to address issues of worker outflow now before it is too late.