The Horrible Truths about Financial Advisers

There might be a few bad financial advisers, but on average they must give helpful advice, right? (Nope). Even if they give bad advice, most people wouldn’t listen, right? (Also nope).


Earlier this year, with the passage of a law requiring financial advisers to act in their customers’ interests (imagine that, I know), there was a lot of discussion about whether this was necessary. Sure, there are great movies about selling junk bonds, but most advisers aren’t like that, and investors would be too clever to be duped systematically anyways. We even delved into the topic, largely to disagree with the former point.

There’s new evidence that both claims are wrong. A new article forthcoming in the Journal of Finance (the top journal in Finance) analyzes an amazing dataset from Canada and shows that financial advisers do not give sound financial advice, and people listen. The results are pretty overwhelming.

There’s one statistic that says it all -- Whom your financial adviser is matters more for what your portfolio looks like than how far you are from retirement, your preference for risk, and your financial literacy, combined. Let’s break that down. How far you are from retirement should be the best (maybe only) predictor of your portfolio. As you go from entering the workforce as a plucky 20-something to exiting as a weathered veteran, your retirement portfolio should go from more high-return, risky assets to a more low-return riskless assets (like bonds). That this doesn’t predict your portfolio well means two things. First, it means that your financial adviser is not tailoring her advice to your circumstances in a meaningful way. That’s nuts. Second, it means that you are listening to her bad advice. She is selling you assets she is incentivized to sell, neglecting the best advice she could give you… oh, and charging you 2.6% for the privilege.

Maybe we don’t expect much from financial advisers, but to see Canadians acting like this… Come on!

Are the advisers bad people, intentionally misleading their investors? We’ll look at this in more detail next week, but the data shockingly say no. The advisers trick themselves into thinking the advice is correct (something behavioral economists call “motivated reasoning”). This allows them to give the advice that pays them well while maintaining the belief they are a good person.

So if you find yourself thinking, “but my adviser is a good person”, you might be right… but that might not have any bearing on the value of what they’re saying.

Lucas Coffman, Frank

Lucas is a professor of behavioral economics at Harvard University and the Chief Behavioral Officer at Frank.

www.HiFrank.com

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