The CFA Institute's 9 proposals for client protections amid gamification

November 28, 2022 6:26 PM

GameStop and wallstreetbets screens — The conversations on Reddit's "wallstreetbets" forum helped drive up the value of GameStop's stock to soaring heights at the beginning of 2021.

The tens of millions of new investors flocking to self-directed platforms and wealth channels need some tougher protections in an era of gamification, according to the CFA Institute.

In a Nov. 17 report, the global association for investment professionals offered nine recommendations that the study's author, Director of Capital Markets Policy Sivananth Ramachandran, proposed to harness the benefits of the growing client base while reducing the risks of conflicted or faulty information that can lead to giant losses. The term "gamification" refers to the adaption of game-like features into other areas like investing. Fintech platforms such as Robinhood often receive the most scrutiny for the way that their digital cues resemble a video game, but all wealth management firms are racing to build the best apps and dashboards.

The GameStop short squeeze of 2021 and, more recently, the downfall of cryptocurrency exchange FTX have provided ample evidence of the dangers at the intersection of wealth, investing, technology and behavioral finance. Despite discussions about new regulations from multiple agencies, few new safeguards have emerged in recent years. The CFA Institute's Ramachandran is calling for licensing requirements for social influencers, more warning labels and greater disclosures at the point of sale, among other suggestions.

Fintech

J.P. Morgan and Charles Schwab top J.D. Power ranking for best digital experience; Vanguard and Merrill at the bottom

November 22, 2022 5:41 PM

[To see a summary of the nine recommendations, scroll down to the slideshow.]

"Gamification can be a powerful tool for increasing financial literacy and attracting new and younger audiences to investing," Ramachandran said in a statement. "However, the techniques that are so adept at increasing user engagement are often leveraged to drive excessive or high-risk trading, or to encourage other harmful behaviors at the expense of investors. To maximize the benefits of gamification in the investing context, our recommendations are three-pronged, comprised of principles, conduct, and disclosures."

Losses from crypto and the current bear markets in stock and bonds come with the silver lining of lessons for younger investors, according to Josh Brown, the CEO of Ritholtz Wealth Management, a New York-based registered investment advisor with $2.7 billion in client assets. He compared their experiences with those of older investors, such as those during the last period of high inflation in the late 1970s and the dot-com bubble two decades later.

"It's my belief that every generation comes into the investing game and makes huge mistakes, and it's usually some sort of a mania that prompts it," Brown said in an interview. "This generation, I think, is lucky. Their saga is not going to take five years to play out. They just witnessed the most speculative market in history, 2020 to '21, followed immediately by the most treacherous environment since the 1780s for a stock and bond portfolio. Never before have we had a first 10 months of the year with stocks and bonds both collapsing double digits like this."

That hard-earned knowledge carries different implications, depending on the outcome, Ramachandran pointed out in the report.

"The pandemic created a new class of investors for the first time, and some of these investors had better outcomes than others," he wrote. "The lucky ones might mistake their luck for skill and increase their risk taking, and the risk-taking effects may last for a long time. In contrast, for those who lost money, their risk aversion may linger too, to their own detriment."

Wealth management

Why behavioral finance is top of mind with wealth managers

September 19, 2022 11:16 AM

Scroll down the slideshow below for a listing of the CFA Institute's nine recommendations from its report, "Fun and Games – Investment Gamification and Implications for Capital Markets." For a look at how investors grade the digital tools of some of the largest firms in the industry, click here. To see a deep dive into why questions about investor behavior are so important to financial advisors, follow this link.

App design

Homescreens, leaderboards and transaction buttons should "help traders slow down and think about consequences" on self-directed platforms, rather than focusing on short-term gains, according to the study.

"Requiring third-party authenticator apps for validating transactions in penny stocks and moving away from one-click transactions toward an order, review and confirm process are possible ways to introduce a little friction without taking away investor choice to invest," Ramachandran wrote.

Confetti and other rewards

So-called confetti regulation that cuts down on user rewards or congratulatory graphics stems from concerns "that transactions, rather than long-term outcomes, are rewarded with instant gratification," according to the report.

"Reward and feedback systems, if any, should focus on long-term investor outcomes and not on transactions or short-term outcomes," Ramachandran wrote.

Reputable research

Quality research from real experts, rather than from people who play with investments on social media, should inform investors, according to the CFA Institute.

"Research about stocks and other asset classes must be based on reputable sources, such as recognized firms and other third-party knowledge providers," Ramachandran wrote.

Disclosures in plain English

Intermediaries such as advisors or self-direct brokerages should explain a transaction to clients before they carry it out, in language that investors can understand, according to the study. That language should appear at the point of sale and discourage investors from making common mistakes, Ramachandran wrote.

"This is an area where behavioral science can be made to work beneficially for users," according to the report. "Since users are most attentive at the point of making a transaction, they are most likely to pay attention to risks involved in the transaction, including, for example, purchasing a penny stock or a stock that has high recent observed volatility."

Social influencer pay

Just like advisors, financial influencers on social media need to disclose conflicts of interest like whether they are being paid to pitch certain products, according to the CFA Institute.

"Regulators should require full transparency on the remuneration that financial institutions provide to influencers for their advertisement via social media," Ramachandran wrote. "This disclosure can help investors distinguish clear product advertisements or placements, for which influencers are paid, from pure gossip."

Warning labels

Before they use a discount brokerage, investors should know whether the company receives "payment for order flow," the controversial practice in which firms receive compensation for directing their trade orders to specific exchanges or market makers, according to the CFA Institute.

"We propose that brokerage advertisements include a message that excessive trading may be injurious to financial health," Ramachandran wrote. "Also, brokerages that derive revenues from [payment for order flow] driven by retail investor transactions must prominently mention that fact."

Licensing for influencers

Social media influencers making financial recommendations to their followers should face "a limited licensing requirement" for general commentary and a more serious one for personal advice, according to the study.

"There are risks associated with fake accounts and social media messages driven by bots," Ramachandran wrote. "While influencers who make questionable product recommendations are troubling, it is worse when they also overstate their number of followers, which is a metric that is purported to imply a greater level of credibility."