Close

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:

  • 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.”

Second, most advisers asked for demographic data and gave portfolio advice that was broadly consistent with accepted portfolio theory. In other words, they suggested an acceptable level of equity allocations. There were some biases, however, with women being asked to hold a more conservative allocation. Furthermore, advisers were more likely to mention fees when meeting with an older auditor.

Finally, advisers were initially supportive of the auditor’s current allocation, but showed no hesitation in encouraging the auditors to start following a different investment strategy. The paper’s authors believe this contradiction is related to the sales process.

This study shows why it is critical to ask questions and consider whether the advice given is in your best interest. This suggestion applies to all financial advice, whatever the source.

Source: “The Market for Financial Advice: An Audit Study,” Sendhil Mullainathan, Markus Noeth and Antoinette Schoar, National Bureau of Economic Research


Discussion

Bernice from NY posted over 2 years ago:

Does any investor really think that many (all)
"advisers" do NOT act in their own self interest?


Jerry Durham from TN posted 11 months ago:

I too use to think that actively managed mutual funds was the way to go. It was easy to feel this way during the 1990's when actively managed funds led the way during the great Bull Market. Since then, it has been hard to beat index funds and this is due to their ultra low fees. However most advisors still like active funds, even though the majority do not beat low cost index funds. In the past I have owned both load and no load funds, and although several load funds are consistently good, I feel that most investors are better off with index funds.


You need to log in as a registered AAII user before commenting.
Create an account

Log In