The decisions we make with our money – whether to pay for holidays, cars, home improvements; stuff it under the bed or save for a pension – are inherently bound up with our our personal psychologies. It’s more than about who is a risk taker and who isn’t. It’s our approach to gratification, how sentimental we are, how afraid of the future… our attitude towards death (“you can’t take it with you”, etc), our relationships with our parents. You name it – it affects what we do with cash.
There’s a whole field of study around how our minds affect our money called behavioural finance. It’s really fascinating – banks are all over it in how they communicate with customers, their branding choices, even their product design… but if you want to stay one step ahead, you should be all over the interplay between your own mind and your money, too.
That’s why good-with-money.com is creating a new series of posts called MIND AND MONEY. Because we genuinely think that understanding how your mind works better can empower you financially – maybe make you wealthier.
To kick off the series, we spoke to uber-brain Greg Davies, head of behavioural finance at Barclays and a man who knows a thing or too about mixing your personal values with your money decisions.
Why have you done so much work around impact investing?
“It has long been a personal interest – it’s in my background. And from a behavioural perspective I’m deeply interested in the full range of factors that motivate investors’ decisions.
“The opportunity to look at impact investing came from wanting to weave social value much more into the heart of how we do things as a bank.
The ideal is that we should be trying to build social good into the way we do business. Rather than employees just taking one day off a year to go and volunteer and paint fences, our expertise could be more valuable if applied to generating social value from what banks do day to day. A lot of what I do in the wealth management space is connecting investors with investments, so we have to look at impact investing if we want to make this activity more socially focussed.
“The pushback with impact investing is often that ‘others have tried it and it’s not going anywhere; there’s no demand; they’ve put some green products on their shelves and no one is interested’. But because of our behavioural focus, we thought well, maybe they are just approaching it the wrong way. Maybe we need to focus on the needs of the investor, rather than just finding investments and trying to push them onto people.
Hand-holding
“Our approach to impact investing is an evolution of the way we think about investments more generally. We shouldn’t spend so much time optimising solutions for people, because there is always a trade-off between the ‘right’ thing to do and the comfortable thing to do. If we push people too far towards the ‘optimal’ action, it can make them feel uncomfortable; they can panic. So when offering financial solutions, we have to consider people’s needs for emotional comfort alongside their need for financial satisfaction.
“It’s about satisficing rather than optimising. If we can get people sufficiently close to a good financial solution, in a way that makes them sufficiently comfortable to enact it and stick with it, we’ve done a lot more than if we try to sell people the perfect financial solution, but in the process make them feel so uncomfortable they don’t want to go anywhere near it. So we thought: let’s take that approach and build it into the impact investing side.
“Finance talks about this trade off between risk and return. In our paper Overcoming the cost of being human, we introduced the term anxiety adjusted returns rather than risk adjusted returns. Everyone deviates from the right financial decision in a particular direction, and it’s in the direction of what makes them comfortable.
“The particular source people get comfort from can be different from person to person: some are made comfortable by familiarity; some from doing nothing; some from sitting in cash; or by following recommendations from friends or family. Whatever it is, people are sacrificing some of what is ‘best’ for their narrow financial needs, for emotional comfort. The question we try to answer is: how do we help people get the comfort with the least cost to what’s optimal? In contrast to the position of classical finance which says ‘ignore your need for comfort, just do what’s optimal’.
Can we not manage ethical and financial considerations at the same time?
“We have to look at our human response to complexity. Psychologists talk about mental accounting. When faced with complex decisions, we compartmentalise. We don’t think about decisions in the context of the complete big picture, but approach them one at a time. It’s called narrow framing and means that in isolation, we can make a bunch of seemingly good decisions about where to put our money, but these do not lead to a good portfolio in aggregate.
“With ethics and finance, you’ve got a complex mix of apples and oranges. People feel very uncomfortable because they don’t know how to compare the two, so they say ‘we’ll keep the apples over here and the oranges over there’. And it’s a way of isolating decisions in a way that helps people to make them, so they feel the decision is more approachable. That’s an innate hardwired psychological thing – to simplify and compartmentalise decisions so that they are more approachable. We naturally feel more comfortable separating financial decisions, from our desire to do social good.
“However, I think that once that separation starts happening we then start to build cultural, social and institutional commercial structures around it, which starts to turn it into something more deeply embedded. So if the first people to look at ethics and money found it difficult to integrate them, they designed solutions separately. This then starts to have a snowball effect, making it increasingly difficult to tie them back together.
The problem for those who might wish to get involved in impact investing is not knowing where to start, or how to gather information on what to do, because the relevant information is in two different camps. There is nothing that helps you to think of how to combine your social and financial objectives in one decision. But what if we can give you a way of stepping through the process which helps you to do this?
Is impact investing always financially beneficial?
It is yet to be proved that sustainability definitively outperforms over the long term. There are lots of claims about better performance from the impact investing industry. This is what we know: we know that people are prepared to make a trade off because they are clearly prepared to donate to charity; so a trade-off between financial v social is often acceptable.
“Yet the impact investment industry has spent a lot of time trying to pretend that there is no trade off. If you stick to the fairly vanilla ESG screened stuff it may well be true that you can do less harm or even a little bit of incremental good without affecting your risk return trade off. In fact possibly even in the long term earn a little bit of outperformance. But there’s a whole bunch of stuff for which that is not true, for example, venture social enterprises in Africa, where to get something off the ground, you are going to have to give up liquidity, and possibly significant returns, for a long time. We want to be open to the fact that there is a whole spectrum of possible returns in social investing; and to understand that people are prepared to make this trade-off once they’ve got a framework in which to do this. Equipped with such a framework, like the one we’ve developed, it might well then be true that most people would be prepared to take a cut in returns to do some social good.
“I worry that unsubstantiated claims from the impact industry that impact investments are always going to outperform, make the sector potentially quite fragile. When times are good, competitive performance may be quite achievable, but as the saying goes, you don’t know who is swimming naked until the tide goes out. The danger is that we encourage people to pile into impact under a marketing pitch that it’s not going to cost them anything, and then it turns out that something happens and the investments that get hit hardest are the impact investments. Then we’d have undermined the industry henceforth. So I am a bit sceptical about those claims and, more to the point, I don’t think we have to make them to support and encourage impact investing.
To what degree are we able to unlock people’s interest in ethics in finance?
“People are interested. People engage in stuff they believe in in a whole bunch of ways whether that’s merely liking things on Facebook, or buying free range. People do give to charity and they do volunteer, so that interest is certainly there. The question is: can we get that interest over that gap between social and finance? And I honestly don’t see why not. But it requires us – the industry – the IFAs, the providers, the product designers, the journalists – it’s up to us to do the hard work to design the systems that enable people to express that interest.
“Now, IFAs have the problem: ‘my client isn’t interested because they haven’t thought about it before, and they don’t know it is out there. If they do know it is out there, there are too many questions to ask, so it is daunting… meaning they don’t bother’. The IFAs themselves are in a similar position. They find it daunting; they don’t know what is out there; and it is not in their core expertise to develop a framework that they can take to a client to say: ‘here’s how we think you should approach this’. So they don’t broach the question, everyone is out of their comfort zone and everyone just puts it out of their tunnel of vision.”
“We aren’t going to solve the demand problem by expecting advisors to do it on their own. There is a core set of IFAs with conviction in this space who will do the work. But for most there is a barrier we need to pass through if they’re to act. Even if something is an area we are actively interested in, we often won’t engage if it seems too hard.
For example, for most people, once you start banking online, it’s much easier, it’s much faster. But the first few times you do it, it’s new and it’s daunting, so most people just don’t even try. So we have to provide the catalysts to get people over these initial blocks. Make this area less daunting; design decision processes that will walk people through it step by step. An important aspect of that is personalisation. That’s why we have built a profiling approach – 24 questions that enable us to understand each investor’s social preferences uniquely, and offer them a set of guidelines of what they should do…personalised for them – that way we are saying: “We will do all the work and come back to you with a solution.”
Is being ethical with money a luxury of the very wealthy?
“Ethical finance is, in a way, income dependent – something of a luxury good. But a bigger barrier to entry than income is current priorities. If impact is far down my list of priorities, I am not going to devote time and energy to thinking about it.
“The flip side of that is that many people don’t engage with all sorts of aspects of finance as much as they should, and for the same reason that it’s way down their list of priorities. “It’s not today’s problem so I am not going to think about it today”. If you can couple impact investing with something else that people are interested in but fail to engage with, then even though neither is today’s problem, bringing the two of them together may bump them up the list. So if you can think about social good and solve a financial problem at the same time, and you harness them together in people’s minds, then you might bump them both up the priority list…killing two birds with one stone.
“People frequently sit on cash once they’ve got it, often for long periods of time, because they are too nervous to invest. What gets people out of cash and into investments is very seldom a good risk return trade-off. People don’t buy efficient combinations of risk and return, they buy stories.”
One of those stories can be doing social good at the same time as managing your money.
So yes, it is income dependent now, but it doesn’t have to be.
Two birds with one stone
The prospect of solving two problems at the same time – doing more good and earning more money – might make people get over the threshold of doing something rather nothing. A thematic investment with a social angle, such as a climate change ETF, could be a good example that simultaneously engages investors’ social and financial needs.
With this, you may have someone saying they aren’t massively interested in investing, and they don’t have enough to just give money away to charity, but here you have a way of investing easily and doing some social good so there’s a stronger impetus to look at it.
Are investments just more ethical than they used to be anyway?
“A whole lot of consumer products, food, haircare… are much more environmentally compliant than you might think, but one reason providers might not be promoting this aspect is because it can lead to an assumption that the ethical product is inferior. People think if you are making a big deal about it then it is designed to appeal to the kaftan and sandals lot, but not normal people, who just want their hair shiny. There’s a potential parallel set of perceptions here with the investment world.
I suspect some companies are already over-complying with ESG and just not marketing it, yet.
But this just perpetuates the separation between ethical and financial. There are increasing numbers of people who want to know about the impact their investments are having and funds are preparing for this behind the scenes, so at the time they are ready to market it as such, they can put an ESG stamp on it with some track record.”
