Investors sometimes hire a financial adviser to manage their money professionally if for no other reason than to escape their own irrationality. Many investors know that, in investing, their emotions can be their worst enemy ? leading them to buy high and sell low. They think that a financial adviser, detached from their emotions, will behave more rationally and act in their best interest. Unfortunately, a recent undercover academic study concluded that many financial advisers are too detached from their clients and too attached to their own financial interests to provide professional financial guidance. (“Financial Advisers Flunk Undercover Sting,” Ryan Sager, SmartMoney.com).
Economists from Harvard, MIT Sloan School of Management and the University of Hamburg hired and trained a group of actors and turned them loose to make 300 visits to Boston-area financial advisers, posing as clients and presenting various portfolios for review and analysis by the financial advisers. This occurred over a five-month period in 2008.
For some reason, the economists expected that the advisers would exhibit “catering behavior” ? complimenting their new clients on their portfolios to build rapport and advising them to stay the course. What they found was very different.
“[T]hey largely found that the advisers were willing to recommend big changes fairly quickly.” “Most strikingly, the advisers nudged people in low-cost index funds toward high-fee actively managed funds — blatantly making their clients worse off. Presented with the index-fund portfolio, the advisers recommended a change in strategy more than 85% of the time. Meanwhile, advisers largely encouraged returns-chasers to keep chasing returns.”
The economists concluded that the lesson to be learned from all of this is that it is very important for investors to understand how their financial adviser is getting paid. If they are making money from commissions and fees from selling products, they are incentivized to push those products whether they are appropriate for their client or not. Financial advisers may overcome this incentive, and recommend, say, an index fund that pays them next to nothing, but 85 percent of them in the study did not act in their clients’ best interest.
Unfortunately, the authors observed, most of us are no better at picking advisers than we are at managing our money.
Page Perry is an Atlanta-based law firm with over 170 years of collective experience maintaining integrity in the investment markets and protecting investor rights.