Noise – the title of Nobel economics prize winner Daniel Kahneman’s latest book – refers to the situation where expert judgments differ when they should be identical, such as when different judges give different sentences to criminals who committed the same crime.
Kahneman's research shows noise is a big problem in many areas. Does this include investment advice? Yes, says Oxford Risk founder and behavioural finance exert Dr Greg Davies.
In research conducted earlier this year, Davies presented 200 financial advisers with profiles of six different hypothetical clients. The advice given was all over the place.
Evenly split
For four of the six clients, there was at least one adviser who recommended a very low level of risk, yet another proposed a very high risk level. For one client, advisers were almost evenly split between recommending a lower, medium, or higher level of risk.
Even when advisers agreed on how much risk to take, they disagreed as to what kind of portfolio to recommend.
Advisers’ own circumstances also informed their recommendations. Single advisers recommended more risk than married advisers, while salaried advisers recommended more risk than those on commission.
One solution, suggests Davies, is for advisers to use algorithms to guide decisions. Solutions aside, investors should know it’s “entirely possible” for advisers to be unbiased “but nonetheless to give very inconsistent answers to different clients, or to the same client at different times”.
