Consumers may struggle to evaluate complex financial products for a number of reasons. In a survey of retail investors we find they significantly and systematically overestimate the returns from structured deposits, a type of complex investment product. This overestimation leads them to prefer structured deposits over alternatives such as cash savings. New targeted disclosure somewhat improves how consumers make these comparisons.
There are a number of reasons why investors may struggle to understand and assess complex products, including product features and marketing strategies that exploit behavioural biases. We used a survey of 384 investors, most of whom had previously bought structured deposits or other structured products, to investigate how well retail investors understand and value structured deposits, a type of complex product. The survey assessed the extent to which investors understand how structured deposits work, whether there are systematic biases in investors’ evaluation of their expected performance, and whether giving targeted information improves this evaluation.
We compared investors’ expectations about FTSE100 returns with the returns they expected from different FTSE100-linked structured products. This enabled us to calculate bias in how respondents evaluate structured deposits relative to the FTSE. While investors’ expectations of the FTSE growth were on average well aligned with the assumptions we used in our model, investors significantly overestimated the expected returns of all structured deposits, including the most simple. This overestimation cannot be easily explained by standard theory.
Although all structured deposits in the survey would have been unlikely to return more than fixed-term cash deposits, most investors did not recognise this and preferred the structured deposits. Disclosure of likely product returns and risk led investors who had initially overestimated returns or underestimated risk of return to change their preferences. Presenting likely product returns based on our quantitative model was somewhat more effective than showing returns under various hypothetical scenarios.
Understanding which combinations of product features and behavioural biases drive the misperceptions documented in this paper is an important topic for future research. Product features, that can exploit behavioural biases, may lead investors to have unrealistically high expectations of product returns and impede their ability to evaluate and compare structured products.
We outline several issues related to our findings that need to be considered by policymakers.
Stefan Hunt, Neil Stewart, Redis Zaliauskas
Stefan Hunt and Redis Zaliauskas work in the Chief Economist’s Department of the Financial Conduct Authority. Neil Stewart is Professor at the Department of Psychology of the University of Warwick.