Consumers need a range of financial products to help them manage cash flows and risks throughout their lives. They use money to exchange goods and services. They borrow, save, invest, live in retirement, and pass on their wealth to their heirs.
The financial industry provides tools and services to help people achieve these things. When these products work well, financial services improve the well-being of society. When they don’t, they result in not-so-good results such as overselling or under-selling in some markets or segments and insufficient penetration in others. In extreme cases, they lead to financial crises.
Products are designed, right and wrong.
Financial products have evolved over time to meet the needs of consumers. For example, payment systems developed from barter to currency to checking account and electronic bank transfers. Credit has progressed from simple promissory notes to securitization of secured and unsecured (personal) loans. The concepts of insurance and corporation revolutionized the world by transferring risk and reward from one to many. Each of these concepts is an example of beautiful product design. Well-designed products are not only elegant in function and form, but they also have signifiers that tell users how to use them.
Over the centuries, we have tweaked the designs of these financial tools. Sometimes we have improved them. On other occasions we have sabotaged them. The trust structure is a step up, offering fiduciary oversight where asset owners and managers are separated. Therefore, mutual funds and exchange-traded funds (ETFs) are examples of effective evolution.
On the other hand, some products claim to combine two very different benefits, for example, insurance and investments. By merging two very different services in the same “wrapper”, they complicate things. So much so that suppliers claim that such offers “are not bought but must be sold” through costly distribution channels. Product signifiers are so bad that, even after extensive training, sellers hardly understand what they are selling. Of course, the wrapper hides many sins, including a poor return on investment.
Vendors compare these new products to mobile phones. After all, if you can call, text, email, record, film, and consume all kinds of media in one pocket device, shouldn’t a financial product offer equally extensive functionality? But would you cook with them? Similarly, the management of downside risks (insurance) and upward wealth growth (investments) are too different. Separating the two will not only make it more efficient, with insurers sticking to insurance and outsourcing investment management to asset management companies, it will also be easier to buy.
The landscape of insurance and investment products around the world has become so complicated that an entire industry, wealth management, is now between providers and consumers. These intermediaries are called distributors, agents, stockbrokers, or financial advisers, depending on who pays them. Your job is simple: sell products or connect consumers with the right ones. Either way, its existence shows that most consumers do not know how to select between the products themselves.
The role of financial content
There are other actors who are located between the products and the consumers. They offer more generic guidance through media, education, and research, what we collectively call financial content. Each financial content segment serves a different purpose: the media reports the news, education gives investors a basic understanding of the state of the sector and its offerings, and research looks at various products and recommends which one to select.
But the financial media seem to think that content is content and ignore how intricate the landscape has become and the ever-increasing skill level it takes to navigate it.
Financial education requires an understanding of both finance and education. There is enough academic research on how education can be more effective based on how our brain works. For example, we now know how fragmentation helps us capture information, how images are more effective than text alone, how multitasking has its drawbacks. Google makes it easy to find objective information, so we don’t need to retain trivial knowledge and can free up capacity for analysis and decision making.
Similarly, research requires an investment philosophy and knowledge of how financial markets work, what factors predict future performance, and sound judgment on human nature, among other skills. Research on credit differs from research on equities. So mutual fund and credit ratings are quite different; one is science, the other art. Stock research is different again. Good research is incredibly hard to find. However, it is key to the proper functioning of capitalism..
The economics of the content industry are also worth looking at. The media are mainly financed by advertising. Adviser and investor education is also funded directly or indirectly through advertising, although non-profit organizations and government agencies also contribute. So is research.
Many academic studies show how ineffective financial education and research are. But without looking at the economic incentives or whether the basic principles of education and research are applied, that’s not a surprise. We don’t need a study to tell us that.
Is systems thinking or market design the answer?
Questions about whether suppliers should design better products and sell them responsibly – the “beware the seller” model – or consumers should take responsibility for their own purchases through financial education – “beware the buyer” – lose consciousness. So do those questions about the role and usefulness of financial advisers – this industry exists because both buyer and seller need to be wary of concepts that don’t work in isolation. Such questions address only part of the problem and the solution can solve one problem and create others.
A “systems thinking” approach, one that looks at the causes and effects of all moving parts over time, might be a more appropriate solution. We need to analyze the entire market and the role of each actor within it. We need to balance product design with financial education. And we must balance the seller-care model against the buyer-care equation. We also need to look at the role of regulators and other intermediaries: are they reducing or increasing friction? Without a doubt, we must analyze the role of incentives.
We need to design entire markets, not just separate products and content.
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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of the CFA Institute or the author’s employer.
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