Financial advisors often work against their clients' interests if it means earning more in fees, according to a recent study by the National Bureau of Economic Research.
"Advisors encourage returns-chasing behavior and push for actively managed funds that have higher fees, even if the client starts with a well-diversified, low-fee portfolio," according to the NBER, based in Cambridge, Mass.
NBER reached that conclusion after its auditors, pretending to be clients, made 284 visits to financial advisors in the Boston and Cambridge areas.
The advisors "tended to move shoppers away from existing strategy, regardless of the initial portfolio, that is, even when they looked at a low-fee, diversified portfolio," the study said. "So they were willing to make the client effectively worse off."
The study, The Market for Financial Advice: An Audit Study, was written by Sendhil Mullainathan of the Department of Economics at Harvard University; Antoinette Schoar of MIT's Sloan School of Management; and Markus Noeth at the University of Hamburg in Germany.
The study's premise was that individual investors are bad at choosing portfolios on their own, but many factors can influence their behavior, including input from financial advisors. The advisors audited in the study were those an average citizen would have access to through a bank, independent brokerage or investment advisory firm. The advisors were usually paid through fees they generated themselves for products rather than fees for assets under management or portfolio performance. The auditors claimed to have investments between $45,000 and $55,000 or between $95,000 and $105,000.
The auditors presented the advisors with various portfolios and asked for advice for future investments. The advisor praised the investor's portfolio choices, but then proceeded to change them.
"Overall, advisors had a significant bias towards active management," the study found. In nearly 50% of the visits by auditors, the advisor encouraged investing in an actively managed fund, while only 7.5% of the advisors encouraged investing in an index fund.
When the advisors mentioned fees, they did so in a way that downplayed their importance. If an auditor was older, the advisor was more likely to mention fees without being asked, suggesting that advisors may believe an older person is more astute and knows more about fees, the authors said.
"These results suggest that the market for financial advice ... exaggerates biases that are in the advisor's financial interest while leaning against those that do not generate fees," the authors said.