If you became a client of a financial advisory firm, you would probably like to think that the recommendations you would receive would not differ depending on which of the company’s advisers you spoke to.
You would definitely like to think they would not differ based on the weather, the time of day, or the tempestuousness of your adviser’s relationship with Twitter or TikTok.
Recommended investment solutions should differ because they reflect variations in individual investor circumstances, or because they come from different companies with different philosophies. They should not change when an allocated adviser within a company does, or swing with an adviser’s mood.
Investment recommendations are the culmination of a series of objective assessments and adviser judgments that paint a hopefully accurate and well-evidenced picture of a client’s financial circumstances and financial personality.
Those recommendations can be influenced by all sorts of factors, in different directions (say, more or less risk), and with differing levels of intensity (how much more or less risk), based either on differences in client inputs (for example, a client’s risk tolerance), or not (for example, an adviser’s personal proclivities).
Some of these influences are relevant. For example, an investor’s willingness to take risk should, other things being equal, correlate positively and with appropriate weight, with the risk they are advised to take.
Some of these influences are irrelevant; for example, the client’s age or sex. While an investor’s age may point to relevant factors, such as accumulation of future assets or the need for special treatment owing to vulnerability, it is not in itself relevant.
Some of these influences are predictable. When a relevant factor influences a decision in the correct way every time, everyone is happy.
Unpredictable influences
Advisory firms, clients and regulators like such consistency. Advisers can also err in the same way every time — we call such predictable, one-way errors “bias”. For example, a model that puts every client into too risky a portfolio.
Some of these influences are unpredictable. We call unpredictable variations in advice based on irrelevant factors “noise”.
Noise is unpredictable and irrelevant, but it is still influential. Noise is an under-researched problem in financial advice, and we should do more to understand it and to tackle it.
In their book Noise, Daniel Kahneman, Olivier Sibony and Cass Sunstein note that when an individual selects an investment manager, they are selecting “much more than the average level of that professional’s judgments”.
They continue: “The lottery also selects a kaleidoscopic assemblage of values, preferences, beliefs, memories, experiences and associations that are unique to this particular professional. Whenever you make a judgment, you carry your own baggage. You come with the habits of mind you formed on the job and the wisdom you gained from your mentors.
