Human beings are predisposed to make bad investment decisions. Our natural reactions will lead us to buy near the peaks and sell near the lows, which is not a good recipe for building wealth.

Sure, some people can be dispassionate about investing, but most of us succumb to an emotional response at some point and we inevitably zig when we should zag. Just look at mutual fund money flows compared to mutual fund performance. Cash flows in near the top and out near the bottom.

Economists and psychologists have been studying irrational decision-making for years, and a couple have even won Noble Prizes for their work. But unfortunately, while the field of behavioral economics has gained some acceptance in academia, it still is not being embraced by the financial industry. Instead of gaining from the lessons behavioral economics has to offer, many financial companies have treated this field as a parlor game.

Greg Davies, however, is making real inroads at Barclays Wealth to change that. He has built a career by helping people and companies manage the unfortunate quirks of human nature that often dictate bad decisions.

He was the right guy at the right time for Barclays Wealth, which is a unit of Barclays plc, and now he’s making concrete suggestions from a field often considered too soft to be of any real benefit.

As head of behavioral finance at the London-based firm, he has implemented one of the most rigorous applications of behavioral finance in the industry. And far from being treated as a fad at Barclays, it is deeply imbedded into the recommendations that advisors make regarding asset allocations and specific products. And it’s different for each client as it is tailored to suit the individual.

Somewhere between his college studies of economics and philosophy, Davies became interested in decision theory. After college he worked at Oliver Wyman managing projects for banks in Europe and Asia, before earnings a PhD in decision theory and behavioral finance. He then became a director at London-based startup Decision Technology, which focused on consumer behavior. But he said that he wanted to focus on financial decisions more than decisions that shoppers make at a grocery store.

Now, Davies runs a small team of specialists at Barclays, most of whom also have advanced degrees in psychology or decision science, that does detailed psychometric testing on clients to measure their “financial personality.”

It’s not just about drawing a detailed profile, though, or even showing them the differences between their true risk tolerance and own self-perceptions (that would be the parlor game). For Davies, the final stop in this process is making a real connection to their portfolio.

Davies said that he feels confident in the surveys that clients take. It took his team more than a year to write the surveys, which are constantly being honed.

The team has conducted more than 5,000 lab tests worldwide in the process. And then they got the biggest lab experiment of a lifetime for financial decisions being made under duress: the financial crisis and recession.

The success of their recommendations through that time just bolstered Davies’ confidence of his team’s work.

What separates Barclays from most other financial firms that talk about behavioral finance, he said, is its focus on a client’s entire investment journey.

“One things that is missing from classical finance is that it focuses on an end goal, but not the journey,” he said.

Say you know a client’s ultimate risk threshold, but a few months down the road, the market dips and the client gets spooked and pulls out his money. Davies said that the advisor in that case has not really helped the client. Having a long-term measurement is good, but his team also measures a short-term gauge they call “composure.”

Indeed, a client can really be a risk taker in the long term, but “emotionally involved” in his investment in the short term. Entrepreneurs are often in that category, Davies said. And there are very specific ways to construct that portfolio to offset that, Davies said.

“We all know that smoking isn’t rational. But if you are a smoker, in times of calm when you’re not smoking, there are steps you can take [to offset the effects of your irrational tendencies,]” he said.

Davies suggests that the best lesson is to resist grouping clients in your mind in terms of behavior. He said that advisors need to remember that individual differences outweigh any such group norms.

“People ask me all the time if there are [behavioral] differences between men and women or between cultures,” Davies said. “And the answer is, yes, there are, but those differences aren’t as important as individual differences.”

Check out more "Product Guru" here or click here for some of our other columns.

Register or login for access to this item and much more

All Financial Planning content is archived after seven days.

Community members receive:
  • All recent and archived articles
  • Conference offers and updates
  • A full menu of enewsletter options
  • Web seminars, white papers, ebooks

Don't have an account? Register for Free Unlimited Access