Designing Products for Reluctant Investors: Applications of Behavioral Finance

Behavioral finance is often held out as offering an explanation why financial markets are inefficient and holding the prospect that an understanding of it can help active fund managers ‘beat the market’. This chapter1 argues that a more important use of behavioral finance is in understanding and meeting the needs and wants of your clients. The chapter focuses particularly on the case of defined contribution (DC) pension plans, which represent a growing part of the asset pool in many countries. It argues that most DC plan members can be characterized as ‘reluctant investors’ who do not want to make detailed investment choices and would prefer investment decisions to be made by experts on their behalf. Trends within pension plan provision mean these members typically have to operate without guidance from expert advisers and need to navigate the investment decisions on their own. Reluctant investors have limited interest in investment matters, are easily confused or put off by investment choice, and exhibit inertia that prevents them following through with decisions and actions. An understanding of the behavior of DC pension plan members can allow an investment manager to offer better products to these clients and drive business growth. Typically, this means offering simple, transparent products, avoiding excessive choice and communicating clearly what the product is intended to do for the client rather than the intricacies of its manufacture.