Financial Advisers’ Preferences Determine Client Allocations

Rather than tailoring the advice for a given client’s demographic profile, advisers suggest allocations based on the strategy they use for themselves.

Financial advisers’ investment preferences influence the allocations they recommend for their clients. Rather than tailoring the advice for a given client’s demographic profile, advisers suggest allocations based on the strategy they use for themselves. This lack of customization occurs even though fees associated with the advice result in worst returns relative to lifecycle funds (e.g., target date funds).

Individual investors’ observable characteristics (e.g., demographics) only explained 13% of the differences of how much of their portfolios are allocated to equities. In contrast, an adviser’s recommendations account for one and half times as much variations in equity allocations among individual investor’s allocations. An additional 10 percentage points of risk in an adviser’s portfolio corresponds to a 2.5 percentage point increase in their client’s allocations to equities. The age of the adviser also plays a role. Advisers aged 60 or older allocate an additional 10 percentage points of their clients’ portfolios to stocks.

A benefit of the more aggressive allocations is higher long-term returns. The study’s authors estimate the preference for greater exposure to equities to produce a 1.8% higher return. This benefit is more than offset by costs, however. The average advised investor pays 2.7% annually in fees. These fees include mutual fund expense ratios and front-end loads. This compares to an annual management expense ratio of 1.02% for the largest target-date fund offered in Canada at the time of the analysis.

These findings were based on an analysis of Canadian financial advisers and Canadian households. Two unique characteristics about Canada make it preferable for this type of research. First, mutual fund dealers and their agents, including financial advisers, operating outside the province of Quebec were required to register with the Mutual Fund Dealers Association of Canada as of February 2001. This allowed researchers to compare financial advisers outside of Quebec against those within the province. Secondly, a monthly survey of approximately 1,000 Canadian households gives 14 years of demographic and financial information. The study’s authors were also able to access transaction data and detailed information for both advisers and clients from three financial advisory firms.

Source: “Retail Financial Advice: Does One Size Fit All?,” Stephen Foerster, Juhani Linnainmaa, Brian Melzer and Alessandro Previtero, National Bureau of Economic Research, November 2014.