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, they save, they invest, they live in retirement, and they pass on their wealth to their heirs.
The finance industry provides tools and services to help people accomplish these things. When these products work well, financial services enhance the well-being of society. When they don’t, they lead to not-so-good outcomes like over- or mis-selling in some markets or segments and underpenetration in others. In extreme cases, they lead to financial crises.
Products are designed — well and badly.
Financial products have evolved over time to meet consumer needs. For example, payment systems developed from barter to currency to checking and electronic bank transfers. Credit has progressed from simple IOUs to securitization of collateralized and uncollateralized (personal) loans. The concepts of insurance and the joint stock company 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 functionality and form, they also have signifiers that tell users how to use them.
Over the centuries, we have tinkered with the designs of these financial tools. Sometimes we’ve improved them. At other times we’ve sabotaged them. The trust structure is a step forward, offering fiduciary supervision where asset owners and managers are separate. Hence, mutual funds and exchange-traded funds (ETFs) are examples of effective evolution.
On the other hand, some products purport to combine two very different benefits, say, insurance and investments. By fusing two very distinct services in the same “wrapper,” they make things more complicated. So much so that providers claim such offerings “are not bought but need to be sold” through expensive distribution channels. The product signifiers are so bad that even after extensive training, the salespeople barely understand what they are selling. Of course, the wrapper hides many sins, including poor investment performance.
Providers compare these new products to mobile phones. After all, if you can call, text, email, record, film, and consume all types of media on one pocket-sized device, shouldn’t a financial product offer similarly broad functionality? But would you cook with them? Similarly, managing downside risks (insurance) and upside wealth growth (investments) are too different. Unbundling the two will not only make more efficient — with insurers sticking to insurance and outsourcing the investment management to asset management companies — but also simpler to purchase.
The insurance and investment product landscape across the globe has grown so complicated that a whole industry — wealth management — now sits between providers and consumers. These intermediaries are called distributors, agents, broker-dealers, or financial advisers, depending on who is paying them. Their job is simple: to sell products or match consumers with the right ones. Either way, their existence shows that most consumers don’t know how to select among the products by themselves.
The Role of Financial Content
There are other players that sit between products and consumers. They offer more generic guidance through media, education, and research — what we collectively call financial content. Each segment of financial content serves a different purpose: The media report on the news, education gives investors a basic understanding of the state of the sector and its offerings, and research analyzes various products and recommends which to select.
But the financial media seem to think content is content and ignore how intricate the landscape has become and the increasingly high skill level needed 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 brains work. For example, we now know how chunking helps us grasp information, how visuals are more effective than text alone, how multi-tasking has its drawbacks. Google makes it easier to find factual 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 insight into how financial markets work, what factors predict future performance, and sound judgment about human nature, among other skills. Research on credit differs from that on equities. So credit and mutual fund ratings are quite distinct; one is science, the other art. Stock research is different again. Good research is incredibly hard to find. Yet it’s key to the smooth functioning of capitalism.
It’s worth looking at the economics of the content industry too. Media are mostly funded by advertising. Adviser and investor education is also funded either directly or indirectly through advertising, although not-for-profit organizations and government agencies also contribute. So is research.
Many academic studies demonstrate how ineffective financial education and research are. But without analyzing the economic incentives or whether basic educational and research principles are applied, that’s hardly a surprise. We don’t need a study to tell us that.
Is systems thinking or market design the answer?
Questions about whether providers should design better products and sell them responsibly — the “seller beware” model — or consumers should take responsibility for their own purchases through financial education — “buyer beware” — miss the point. So too do those questions about the role and utility of financial advisers — this industry exists because both buyer and seller beware concepts don’t work in isolation. Such questions address only part of the problem and the solution may solve one problem and create others.
A “systems thinking” approach — one that looks at the causes and effects of all the moving parts over time — might be a more appropriate solution. We need to analyze the whole market and each player’s role within it. We need to balance product design vs. financial education. And we need to balance the seller beware model vs. the buyer beware equation. We also need to look at the role of regulators and other intermediaries: Are they reducing or increasing the friction? We certainly need to look at the role of incentives.
We need to design complete markets, not just products and content separately.
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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 CFA Institute or the author’s employer.
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