Personal finance decisions involve lots of jargon. They are confusing and complicated, and the stakes are high. To make things worse, many investors suffer from odd biases that can end up costing them dearly. No wonder many of us turn to an expert for financial advice.
But we have to recognise an unpleasant possibility: that the typical investment advisor does not give good advice. The fact that we are so easily bemused by finance makes this all the more probable. So it was with interest that I read the recent research of three economists who have been exploring this issue with the help of a field experiment, and good sprinkling of tabloid investigative journalism mixed in.
Sendhil Mullainathan, Markus Noeth and Antoinette Schoar recruited a team of mystery shoppers, each armed with one of four different portfolios designed to unearth different possible failings in financial advice. They were let loose in Boston, Massachusetts. The first portfolio was stuffed with last year's hot stocks, and the mystery shopper was told to ask for help finding the next big thing. Such returns-chasers tend to buy high and sell low and pay excessive trading costs into the bargain. But a financial advisor motivated by commission would be tempted to recommend more of the same.
Thirty per cent of the second portfolio value was invested in the bogus investor's employer, which is common but too risky. The clever thing about this is that it tempts the commission-hunting financial advisor to do a little good, advising the investor to sell the employer's shares and buy a wider range of investments.
The third portfolio was an economist's dream, well diversified and packed full of low-cost tracker funds. A saintly financial advisor might well suggest leaving well alone. The final portfolio was a blank slate, invested fully in super-safe cash accounts (far too conservative for most sensible investors) and inviting an advisor to suggest — well, almost anything.
The results of the experiment? Advisors were full of flattery but then suggested changes likely to generate commissions for themselves. Rarely did advisors mention the fees charged by investment funds — and when they did they downplayed them.
Confronted with the low-cost, diversified portfolio, advisors were likely to lavish it with praise (perhaps knowing that such portfolios are widely regarded as wise investments) but then more than 85 per cent of them tried to talk their clients into doing something that would generate more commissions.
Many advisors refused to give any advice at all unless clients handed over control of their portfolio. Curiously, they were most likely to try such pressure tactics when the mystery shopper was a woman.
The lesson is that we should all be careful whose interests our financial advisors are serving. And, if you're an advisor, beware economists and their mystery shoppers.
Tim Harford is a Financial Times columnist and author of Adapt: Why Success Always Starts With Failure (Abacus, £8.99).
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