Are Financial Advisers Encouraging Bad Behavior?
Not only do many financial advisers fail to discourage behavioral finance errors by investors, but many advisers also reinforce behaviors that are in their own best interest, according to a new working paper published by the National Bureau of Economic Research. Researchers at Harvard University, MIT and the University of Hamburg found that advisers “may exaggerate existing biases or, in some cases, even make the clients worse off.”
The study sent auditors on 284 client visits to gather information from advisers. The auditors described their current investment strategy to the advisers as one of the following:
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- Chasing returns, a scenario where they attempted to beat the market by identifying those industries that performed the best in the recent past;
- Investing 30% of their portfolio into their employer’s stock;
- Owning a well-diversified portfolio comprised of low-fee U.S. index stock and bond funds; or
- Holding all investable money held in certificates of deposit and expressing no preconceived investment biases.
After reviewing the data, the paper’s authors reached three main conclusions.
First, advisers showed a significant bias toward actively managed funds, with this type of fund recommended in 50% of the auditor visits. Advisers also encouraged trend-chasing, but discouraged investing in index funds. Researchers bluntly described the results as exaggerating “biases that are in the adviser’s financial interest while leaning against those that do not generate fees.”
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