Investor Characteristics and Long-Term Financial Decision Making

Project Start:01/2018
Researchers:Konstantin Bräuer, Andreas Hackethal, Christine Laudenbach, Steffen Meyer, Thomas Pauls, Annika Weber
Area: Household Finance
Funded by:LOEWE

This project is being continued by the project "Finanzforum - Panel Rounds 2,3 and 4 and Corresponding Projects".

Topic and Objectives

There is no shortage in theories on what drives household financial decisions. However, two major challenges make it difficult to empirically test many hypotheses. First, finding exogenous variation in the variables of interest is hard, if not impossible. Second, many of the determinants of households’ financial decisions such as expectations, risk attitudes, financial literacy, or perceptions of financial products and services, are inevitably unobserved in standard financial datasets.

As one way out, randomized controlled trials (RCTs) artificially induce exogenous variation in the variables of interest. This ultimately allows to study their causal effects on individuals’ financial behaviors. As a second approach, in cases where RCTs are not possible, correlational evidence from matching survey measures of behavioral factors to administrative data on individuals’ financial choices may provide novel insights into what governs households’ financial decisions.

In our project, we launched an online survey and experimental platform (named "Finanzforum") together with a large European retail bank in November 2017. We approached more than 80,000 of their clients to attain a stratified panel of some 4,000 bank clients willing to participate in the panel. We run 3-4 rounds of surveys and RCTs on the platform each year are also in a position to conduct ad-hoc questionnaires after exogenous shocks like market downturns or inflation hikes. Importantly, the survey data is linked to broad and deep historical (up to ten years) and concurrent administrative data on clients’ financial activities with the bank. This allows to observe any response in financial behaviors of surveyed and treated clients and several control groups before and after our interventions. Nonetheless, the anonymity of participants is guaranteed at every point in time and very high data protection standards are applied in the administration of the panel. In accordance with the bank, the platform shall be in place for several years. The platform shall be accessible for researchers outside the core project team in the future.

To date, three survey waves have been run. The initial questionnaire run in August 2018 elicited key behavioral and demographic attributes missing in the administrative bank data such as risk preferences, financial literacy scores, and attitudes towards financial decision-making. The second survey wave focused on households’ demand for financial advice. The third wave did contained a random information treatment aiming at spurring respondents’ participation in equity investments through educational videos. In November 2019, the fourth wave of the survey will be dedicated to the elicitation of standard risk measures from the experimental literature. The goal is to empirically validate, which of the experimental measures best explains respondents’ real-world behavior.  

Key Findings 

  • German Households are on average quite financially literate, when financial literacy is measured using standard questions taken from the literature. Questions regarding the costs of investing or the relative risks of different financial products are less often an-swered correctly. When linked to the administrative data, we find financial literacy to be strongly related to financial outcomes such as, for example, stock market participation, risk taking, or advice seeking.
  • When it comes to old age provision, most households cannot assess how much money they will have or need in their retirement. Investments in real estate are considered the best option for old age provision, followed by employer-funded pensions and securities. Less than half of the households consider statutory pension schemes to be suitable.
  • The demand for the bank’s costly in-person financial advice is found to be driven by needs other than the quest for superior investment outcomes. Rather, households seeking advice with the bank do so due to a preference for personal contact and handholding. These cli-ents perceive it as less risky to take financial decisions together with their advisor rather than on their own. Inversely, clients renouncing the assistance of an advisor show a strong preference for independent decision-making. Motives for not taking advice suggested by the principal agent literature, such as a better awareness of advisor conflicts of interest, on-ly rank second.
  • Clients who depend more strongly on their bank financial advisor end up paying significantly higher fees on their investments. This is mostly due to the bank’s advisors heavily distrib-uting the bank’s own asset-management funds, which carry high annual fees.
  • To cater clients, bank financial advisors customize their strategies to the individual client: Advisors confronted with acquiescent clients stick to standards and recommend expensive but well-diversified mutual fund portfolios. Confronted with clients who voice their own ideas, financial advisors deviate markedly from their standards, resulting in poorer portfolio diversification and lower Sharpe ratios.
  • Financial education videos seem successful in familiarizing clients with the financial markets and in waking their interest. In particular, we are able to show that clients, who were not participating in the financial markets and who were exposed to short financial education videos, showed an increased financial knowledge, an increased motivation in searching in-formation on financial market on their own, and an increased willingness to consider an in-vestment in the capital markets. 

Policy Implications 

  • So far, recent regulatory steps aiming at improving consumer financial protection have focused on the disclosure of ever more ex-ante information.
  • Generally, little is done to validate the effects of and re-design newly established regulations.
  • However, care has to be applied when enacting such measures. Scaring individuals away from investing or consulting with an advisor may reduce client benefits rather than increasing utility.
  • RCTs and survey studies such as those run in the Finanzforum help to understand how individuals perceive themselves to be making financial decisions and whether and how they incorporate any information provided in their financial decisions.
  • Preliminary results from the Finanzforum, in particular with respect to clients’ patterns of financial literacy, their demand for financial advice, as well as the results from the financial education experiment suggest that more needs to be done to enable consumers to make sense of the vast information provided. Illustrative examples are the information on product fees and the transparency of financial advisor conflicts of interest which most bank clients still appear to be little aware of. 

Related Working Papers

219Andreas Hackethal, Christine Laudenbach, Steffen Meyer, Annika WeberClient Involvement in Expert Advice: Antibiotics in Finance?2018 Household Finance Financial Advice, Individual Investors, Client Involvement