The Misguided Beliefs of Financial Advisors

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AlohaJoe
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The Misguided Beliefs of Financial Advisors

Post by AlohaJoe » Tue Feb 13, 2018 8:17 pm

That's the title of a new paper on SSRN: https://papers.ssrn.com/sol3/papers.cfm ... id=3101426

Their claim isn't that advisors give bad advice because of conflicts of interest or bad incentives. But because the advisors "have misguided beliefs".
Advisors are willing to hold the investments they recommend—indeed, they invest very similarly to clients—but they have misguided beliefs.
If true, this means that efforts to make advisors "fiduciaries" and disclose fees and remove conflicts of interest may only have limited impact on actually helping individual investors. It also would seem to provide more support for the common claim on Bogleheads that by the time you know enough to tell whether your advisor is any good, you could be managing your portfolio yourself.

The full abstract:
A common view of retail finance is that conflicts of interest contribute to the high cost of advice. Using detailed data on financial advisors and their clients, however, we show that most advisors invest personally just as they advise their clients. Advisors trade frequently, chase returns, prefer expensive, actively managed funds, and underdiversify. Advisors’ net returns of −3% per year are similar to their clients’ net returns. Advisors do not strategically hold expensive portfolios only to convince clients to do the same; they continue to do so after they leave the industry

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willthrill81
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Re: The Misguided Beliefs of Financial Advisors

Post by willthrill81 » Tue Feb 13, 2018 8:25 pm

I wonder how their results compare to those of the Vanguard study that found that advisors add several percent to clients' realized returns, mainly from behavioral coaching.

I think that part of the issue at work here may be that advisors are usually little more than lightly trained salespeople. They use the methods that they are taught because they truly believe they will work, even though these methods are often sub-optimal. Simple investing is often what investors need, but that doesn't cater well to an advisor who has to demonstrate that s/he is worth giving 1% or more of your invested assets to every year. The more they can move clients' money around (often generating additional fees in the process) into lots of investment vehicles, the more it looks like they're doing something worthwhile.
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staythecourse
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Re: The Misguided Beliefs of Financial Advisors

Post by staythecourse » Tue Feb 13, 2018 9:03 pm

Great so advisers are not greedy and unethical, but just incompetent. I would think the latter is even more dangerous.

Good luck.
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Re: The Misguided Beliefs of Financial Advisors

Post by nisiprius » Tue Feb 13, 2018 9:13 pm

Winthrop: Can you lead a band?
"Professor" Harold Hill: No.
Winthrop: Are you a big liar?
Harold: Yes.
Winthrop: Are you a dirty rotten crook?
Harold: Yes.
Winthrop: Leave me go, you big liar!
Harold: What's the matter? You wanted the truth, didn't you? Now I'm bigger'n you and you're going to stand here and get it all so you might as well quit wiggling. There's two things you're entitled to know. One, you're a wonderful kid. I thought so from the first. That's why I wanted you in the band, just so you'd quit mopin' around feeling sorry for yourself.
Winthrop: What band?
Harold: I always think there's a band, kid.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

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Pajamas
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Re: The Misguided Beliefs of Financial Advisors

Post by Pajamas » Tue Feb 13, 2018 9:17 pm

staythecourse wrote:
Tue Feb 13, 2018 9:03 pm
Great so advisers are not greedy and unethical, but just incompetent. I would think the latter is even more dangerous.
Why not greedy, unethical and incompetent? Works in many fields and makes for interesting newspaper headlines.

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Re: The Misguided Beliefs of Financial Advisors

Post by z3r0c00l » Tue Feb 13, 2018 9:47 pm

This was indeed my brief experience with a Chase bank FA. He sold me an overpriced mutual fund with (A|B) that did okay for a while. As I learned about Vanguard and other things, and returned to him, he was shocked to see that one fund could have $50 billion in assets. He had never heard of I-bonds and so in the end, I taught him a few things before declining further services. He was then laid off along with other staff in the recession. My impression was that these are folks who are in the retail business but it doesn't much matter what they are selling because they don't really put too much time into learning about it.

petulant
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Re: The Misguided Beliefs of Financial Advisors

Post by petulant » Tue Feb 13, 2018 10:43 pm

The study has limited applicability for a couple of reasons. One is listed in its own conclusion, which is that megafirms may retain the people who believe bad advice precisely because they believe bad advice. The article doesn't get into it, but part of the reason these advisors have bad advice is specifically because the megafirms tell them what to think, and they believe it. Another item the article doesn't consider is that advisors who are willing to agree to fiduciary standards, and who study what those standards require, may themselves be better educated and have fewer misguided beliefs than the average advisor in a non-regulated environment, even if there are no professional licensing requirements. In other words, just by raising the issue of fiduciary, things like unnecessary fund fees and the need for diversification come up, possibly improving outcomes. So while the study is interesting, there are a lot of limitations to it.

venkman
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Re: The Misguided Beliefs of Financial Advisors

Post by venkman » Tue Feb 13, 2018 10:51 pm

I took the Series 65 (Investment adviser) exam last year. I passed easily by studying maybe an hour a day for two months. Most of the questions relate to the legal/regulatory issues around being an adviser, and choosing what investment types are most appropriate for different clients. Nothing about indexing, or how to choose the best funds for a client.

The minimum amount of knowledge you need to become an investment adviser is a VERY low bar.

afan
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Re: The Misguided Beliefs of Financial Advisors

Post by afan » Wed Feb 14, 2018 6:15 am

willthrill81 wrote:
Tue Feb 13, 2018 8:25 pm
I wonder how their results compare to those of the Vanguard study that found that advisors add several percent to clients' realized returns, mainly from behavioral coaching.

I don't recall a Vanguard study like that. I know of something Vanguard published that simply assumed or asserted this advisor alpha, with no data to back it up. If you know of a study could you provide the title?
We don't know how to beat the market on a risk-adjusted basis, and we don't know anyone that does know either | --Swedroe | We assume that markets are efficient, that prices are right | --Fama

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nisiprius
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Re: The Misguided Beliefs of Financial Advisors

Post by nisiprius » Wed Feb 14, 2018 6:54 am

afan wrote:
Wed Feb 14, 2018 6:15 am
willthrill81 wrote:
Tue Feb 13, 2018 8:25 pm
I wonder how their results compare to those of the Vanguard study that found that advisors add several percent to clients' realized returns, mainly from behavioral coaching.
I don't recall a Vanguard study like that. I know of something Vanguard published that simply assumed or asserted this advisor alpha, with no data to back it up. If you know of a study could you provide the title?
I don't know about a real study, but I think this is the Vanguard study:Putting a value on your value: Vanguard Advisor's Alpha®, September 2016, "Vanguard research." It includes this table:
Image
Suitable asset allocation using broadly diversified funds/ETFs >0 bps
Cost-effective implementation (expense ratios) 40 bps
Rebalancing 35 bps
Behavioral coaching 150 bps
Asset location 0 to 75 bps
Spending strategy (withdrawal order) 0 to 110 bps
Total-return versus income investing > 0 bps

Total potential value added About 3% in total returns
I think "assumed or asserted" about right. There is weird stuff. For example, they credit rebalancing with adding 35 bps in total returns although the section on rebalancing says--in boldface!--"Note that the goal of a rebalancing strategy is to minimize risk, rather than maximize return. The chief graph they present in that section does not show a rebalancing bonus, but, merely, that asset allocation actually will drift if not rebalanced. If anything the graph outlines just how slowly that happens. If the objective is, let's say, to keep 60% stocks within the range of 50%-70% stocks, you did not need to rebalance annually or even close to annual. Rebalancing twice within 55 years is enough!

It is not a pure assertion, but the basis of their claim that their advisors as 35 bps through rebalancing is "we searched over the same time period for a rebalanced portfolio that exhibited similar risk as the non-rebalanced portfolio..." I don't want to go down that rabbit hole except to say that they lost me at "we searched for..."
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nisiprius
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Re: The Misguided Beliefs of Financial Advisors

Post by nisiprius » Wed Feb 14, 2018 7:38 am

The claim that "behavioral coaching" adds 150 bps of return is particularly interesting. For purposes of discussion let's say that the canonical behavioral issue is, in their words,
Persuading investors not to abandon the markets when performance has been poor or dissuading them from chasing the next “hot” investment—this is where you need to remind your clients of the plan you created before emotions were involved.
Their headline description of what their study actually shows is (my boldfacing)
Based on a Vanguard study of actual client behavior, we found that investors who deviated from their initial retirement fund investment trailed the target-date fund benchmark by 150 bps. This suggests that the discipline and guidance that an advisor might provide through behavioral coaching could be the largest potential value-add of the tools available to advisors.
In other words, taking it at face value, the 150 bps lag was "found," but the value of behavioral coaching to avoid it is only "suggested."

Here's the problem.

1) If the investor is not willing to stick to the advisor's plan, then the advisor must have put them in a plan that was difficult to follow.

2) Just because there is evidence that failing to follow the plan resulted in underperforming the plan by 150 bps does not show that behavioral coaching can recover that 150 bps.

3) The evidence for that 150 bps is based on only five years of data, 2008-2012, admittedly a varied period in terms of variety of market behavior, but still only five years.

4) The behavioral coaching advice is almost surely "stay the course and don't sell into a downturn." This isn't automatically good advice for everybody under all situations. It can be bad advice when dealing with a client with an asset allocation that far exceeds their risk tolerance. During the downturn, the advisor does not know how bad it will ultimately be and does not know whether it will exceed the client's risk tolerance before it is over. Certainly, it is better not to break at all, but the best way to achieve that is to design in a margin of safety to make sure that extreme loads do not create too much stress in the structure in the first place. Among the population of investors who ultimately did sell, there must have been some who disregarded their "coach" and sold at the blue arrow... and others who were coached into hanging in for a while, only to sell ultimately at one of the red arrows. (If you don't remember, even if you hung on at the first red arrow, hitting the second one was mighty sickening). Hypothetically, then, behavioral coaching might have made things worse for some clients.

Image

6) Even if you could show that behavioral coaching improved the average performance of jittery clients during a downturn, it might have increased the dispersion of results. Behavioral coaching can't have succeeded 100% of the time, an any analysis has to include an assessment of the frequency severity of the failures. One mustn't credit the advisor for successes while blaming the client for failures.

7) A piece of anecdotal evidence that behavioral coaching does not have a 100% success rate is provided by Cass Sunstein, the co-author of a book on behavioral economics! Very, very few people who sell in downturns are willing to talk about it, but he did. He sold, not during 2008-2009, but during the -19% correction in 2011. In retrospect that correction seems so small that many have forgotten it. According to his account, he actually called his coauthor, Richard Thaler, for advice, and Thaler told him "reread our book." Nevertheless, he sold anyway. My other example, sorry to keep trotting out the same too, but it's hard to find them, is Daniel Solin, who has acknowledged that he sold during 2008-2009 at the same time he was telling his clients not to. Unfortunately he didn't say what his clients actually did.

Note: in their introduction, they do go on to say
In addition, Vanguard research and other academic studies have concluded that behavioral coaching can add 1% to 2% in net return,
but they do not present or cite that research.
Last edited by nisiprius on Wed Feb 14, 2018 8:10 am, edited 2 times in total.
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bighatnohorse
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Re: The Misguided Beliefs of Financial Advisors

Post by bighatnohorse » Wed Feb 14, 2018 8:01 am

Fees can easily be determined AFTER the investment is made through the adviser due FINRA rule changes in the last couple of years regarding NAV shown on the statement. (For BDC's and alternative investments)

Previously, NAV did not reflect the actual real amount invested AFTER fees!
Instead, the statement would only show the initial amount invested. Very deceptive.

FINRA corrected that and now requires the actual real NAV be shown on statements.
Personal experience shows that the adviser takes about 3 percent commission.

Investors that participate in these type of investments need more cajones and have to ask direct questions as to how much the adviser fees are so that they will understand why their first statement will not reflect the amount that they invested.

garlandwhizzer
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Re: The Misguided Beliefs of Financial Advisors

Post by garlandwhizzer » Wed Feb 14, 2018 1:50 pm

The following are the sources of the 3% advisor alpha in the Vanguard paper.
Cost-effective implementation (expense ratios) 40 bps
Rebalancing 35 bps
Behavioral coaching 150 bps
Asset location 0 to 75 bps
Spending strategy (withdrawal order) 0 to 110 bps
Total-return versus income investing > 0 bps

Total potential value added About 3% in total returns
Knowledgeable investors can do their own rebalancing, and don't need behavioral coach to hold their hands during market declines, and know where to locate their assets in a tax efficient manner, and also don't need coaching with the spending strategy. This implied 3% alpha applies to those investors who know little or nothing about investing and financial planning and, importantly, choose not to learn about it and take responsibility for decisions. Investing and financial planning are not difficult and overly complex subjects. The basics intellectually are quite simple. Reading a few good books on these subjects and participating in things like The Forum are excellent ways to get this knowledge background. The big problem is emotions. If you can't control yours adequately an advisor might be a good idea. For others, self-education works fine and can be fun. I much enjoy managing my own portfolio and taking personal control and responsibility for its outcome.

Garland Whizzer

Random Walker
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Re: The Misguided Beliefs of Financial Advisors

Post by Random Walker » Wed Feb 14, 2018 2:51 pm

Another potential benefit of an advisor is getting the initial asset allocation right to begin with, and then making adjustments over time as well. I have found Monte Carlo Simulation highly valuable and have been surprised by the results.

Dave

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Taylor Larimore
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Re: The Misguided Beliefs of Financial Advisors

Post by Taylor Larimore » Wed Feb 14, 2018 3:21 pm

AlohaJoe wrote:
Tue Feb 13, 2018 8:17 pm
That's the title of a new paper on SSRN: https://papers.ssrn.com/sol3/papers.cfm ... id=3101426

Their claim isn't that advisors give bad advice because of conflicts of interest or bad incentives. But because the advisors "have misguided beliefs".
Advisors are willing to hold the investments they recommend—indeed, they invest very similarly to clients—but they have misguided beliefs.
If true, this means that efforts to make advisors "fiduciaries" and disclose fees and remove conflicts of interest may only have limited impact on actually helping individual investors. It also would seem to provide more support for the common claim on Bogleheads that by the time you know enough to tell whether your advisor is any good, you could be managing your portfolio yourself.

The full abstract:
A common view of retail finance is that conflicts of interest contribute to the high cost of advice. Using detailed data on financial advisors and their clients, however, we show that most advisors invest personally just as they advise their clients. Advisors trade frequently, chase returns, prefer expensive, actively managed funds, and underdiversify. Advisors’ net returns of −3% per year are similar to their clients’ net returns. Advisors do not strategically hold expensive portfolios only to convince clients to do the same; they continue to do so after they leave the industry
AlohaJoe:

Thank you for sharing this very interesting 64-page study of more than 4,000 investment advisers.

My takeaway: It is very important to select your (low-cost) investment advisor carefully or own a simple total market index fund portfolio that can be self-managed.

The Three-Fund Portfolio.

Best wishes
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

Scooter57
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Re: The Misguided Beliefs of Financial Advisors

Post by Scooter57 » Wed Feb 14, 2018 5:13 pm

Real world dialogue:
Person is an educated person with a college degree who inherited a good chunk of money.

Person: My financial advisor does great for me. (Pause for preening.)
Me: What is their training?
Person: I don't know. A friend recommended her.
Me: Does she have any certifications?
Person: Huh? What certifications?
Me: What is her approach to investing?
Person: She asked me what my risk tolerance was. I don't want to risk my money, which is what I told her.
Me: Hmmmm.
Person: She's really good. My portfolio is up 20% this past year and I didn't have to pay any taxes on the gain.

Another true conversation:
Person2 is a retired professor in a scientific discipline.

Person2: My retirement money is all in a fund and a stock my father gave me.
Me: What kind of fund?
Person2: I'm not sure, something from TIAA-CREF
Me: Is it stocks or bonds?
Person2: I'm not sure.
Me: If you have a lot of long bonds in your fund, you know that they will take a hit if rates go up.
Person2: Really. I didn't know that, but I just trust that TIAA-CREF knows what they are doing.
Me: What about that stock.
Person2: It's a small company that makes some product or other that the military buys. I'd never sell it because my father gave it to me.

With the public so ignorant about investing, it isn't surprising that advisors can be incredibly stupid and still flourish.

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