Tips and tricks for making investment tools more transparent in these high inflation times

25 May 2023

In these times of high inflation – significantly higher than interests on savings – investing your excess money (wisely) is crucial to avoid losing purchasing power.

Hundreds of books and courses try to introduce the basic concepts of investing and almost all of them mention a few key guidelines that everyone should follow, i.e.

• Invest according to your financial goals and risk profile (risk tolerance), i.e. if you can’t sleep at night when your positions suddenly drop in value, then don’t invest in risky assets.
• Invest only excess money that you don’t need in the short term. Typically it is recommended to keep 3 to 6 times your monthly expenses available in cash (i.e. on a liquid saving account) as a kind of emergency fund.
• Try to eliminate the impact of timing on the market. This can be done by investing regularly (i.e. invest on a recurring fixed frequency, instead of looking at the market).
• Invest on the long-term and start early. Not only will you profit from compound interest, but history has shown that on the long-term a well-diversified portfolio of more risky assets like equity generally gives a positive return. When looking at the history of the S&P 500, you see significant fluctuations on a yearly basis, e.g. since its existence 27% of the years had a negative return. But if you look at any 10-year period in its history, only 6% of them had a negative return.
• Diversify your portfolio across multiple axes. First of all by investing in a mix of different assets, such as stocks, bonds, real estate, etc., but also by avoiding a too strong concentration on specific issuers, sectors, regions and/or currencies.
• Keep your investment costs (commissions & taxes) as low as possible, as they can eat away a big part of your investment return. This can be done by investing in low-cost index funds or exchange-traded funds (rather than in expensive investment funds), but also by certain tax optimizations or by choosing a broker or bank with an interesting fee policy.
• Educate yourself and stay informed about the markets and the companies you are investing in.
• Review your portfolio regularly and check if it still meets your investment goals and risk profile and is still sufficiently diversified. If not, adjust your portfolio to bring it back in line with your investment goals and constraints.

All these guidelines are aimed at reducing market risks (such as timing risk) and to force investors to set aside their emotions, as this typically leads to (bad) impulsive investment decisions.

Almost every investor knows these key lessons, but in practice very few people actually follow them. Primarily because people are inherently emotional (and greedy), but also because banks provide very little tooling to accommodate their customers with these practices. Sometimes banks even push for contradictory actions, often because these are commercially more interesting.

Regulations like MiFID2 already force banks to be more transparent and sell only investment products that are appropriate (according to their knowledge and experience) and suitable (in line with their risk profile) to the customer. Unfortunately most banks have implemented these regulations in a way that is not very appealing to the customer, meaning the imposed checks and questionnaires are considered rather as a burden than as an investment aid.

Most innovations in the investment domain in recent years have been predominantly for the customer segments of frequent traders (like Robinhood, Fidelity, Freetrade, eToro…) or investors who want to “outsource” their investments to their bank, e.g. via robo-advisory (like Betterment, Wealthfront, Vanguard, etc.). Traditional retail customers, with little to no knowledge of investing, have been neglected a bit in recent years. In the past went these customers visited their banker for advice and ended up investing excess money in a few mutual funds proposed by the bank. Not only is this in-person investment advice disappearing as branches close, also regulations around investment advice make it increasingly difficult to advise this type of customers. At the same time limited digital tooling has been put in place to replace these traditional investment services offered to this customer segment.

Market opportunity for making investment tools more transparent and intuitive

We believe an important market opportunity exists for traditional incumbent banks, that often service this type of customers, to provide intuitive services to make investing easier, while respecting as much as possible the above guidelines.

Some examples of such tooling are:

• The MiFID risk questionnaire could be presented in a much more appealing way, for example via gamification in the form of a quiz, making it more pleasant, engaging and informative for customers to complete. Additionally the questionnaire could be the starting point to help educate customers, so they increase their knowledge of financial products and associated investment risks. By visualizing how knowledge, experience, financial goals and risk profile evolve over time, the customer’s learning journey can be presented (with “rewards” as a gamification element).

Additionally the impact of choosing a specific risk profile resulting from a questionnaire can be better visualized, i.e. what is the expected average return and value-at-risk of the resulting risk profile (and compare it with other risk profiles). However instead of presenting this with bank specific terminology, it should be made visually appealing via animated graphs or infographics.

• To ensure customers only invest money they do not need in the short-term, banks can offer simulators to calculate the minimum amount to keep non-invested and add automatic rules resulting in warnings and alerts on the saving account.
  Banks can also offer new innovative products, like the Lombard² product of Capilever, which allows lending money at an attractive interest rate with your investments as collateral in a flexible and fully automated way. Such a product can reduce the burdens certain customers face with (short-term) liquidity management.
• The diversification and market risk of your portfolio can also be presented in very graphical way, e.g.
  • Show how different positions correlate by allowing the customer to increase/decrease the price of a position and see how this is expected to impact other positions.
  • Show the value-at-risk in a distribution graph, showing the probability of each possible return. This gives a very intuitive way to explain what a customer can expect of their portfolio in the future.
  • Show the impact of buying a security or selling an existing position (partially or in full) on the diversification of the portfolio. At the same time similar securities can be suggested (i.e. same asset type, risk profile, sector and/or currency), which result in a better portfolio diversification.
• When a customer decides to buy a security, the bank can propose to:
  • automatically capitalize profits of more than X% (i.e. automatically sell the position partially or in full when this profit is reached) or
  • automatically execute the buy order in parts spread over time (to reduce timing-risk). In the same way the bank can propose to execute a sell order in parts spread over time.
• The bank can also propose to apply certain hedging techniques. Again this should be initiated in a few clicks and explained in layman’s terms. Examples can be:
  • Automatic creation of a stop-loss order when buying a security to limit losses of more than Y%. The stop price could be fixed or gradually increased over time (by setting a stop price which is X% lower than the highest price the security position ever reached).
  • Proposing a specific market risk insurance product. A nice example is AvaProtect, which offers insurance against losses. This insurance automatically pays out a contribution if the insured security position ends with a loss at the end date.
  • Allow to initiate a covered call writing with a few clicks, i.e. automatically write a call option with a strike price of the acquisition price plus X%. The underlying position is automatically blocked while the option exists. This option strategy allows a limited amount of downside protection (as the option premium compensates part of the loss). Also this feature can be presented in a very simple way to the customer, by visualizing the resulting losses/profits for different market scenarios.

At Capilever, we strongly believe such digital and user-friendly tooling can help customers to invest their excess money in a safe and secure way, while respecting the above core investment guidelines as much as possible.