In other news, water is still wet and may be for the foreseeable future. <hr/> Financial Advisers Flunk Undercover Sting Sager: A new study finds advisers often put client interests second to their own. By now, you may have realized that you aren't always the most rational manager of your money. Chasing returns. Buying into bubbles. Selling into troughs. Keeping too much in cash or company stock. Heck, even if you keep a textbook, well-diversified portfolio of low-fee index funds, you've still probably felt tempted over the last month or so to buy Apple at $600. (You may turn out to be right in retrospect; that won't make it rational.) To keep yourself in check, perhaps you've turned to a financial adviser. The majority of retail investors have. If so, a new study posted this month by the National Bureau of Economic Research has some bad news for you: Financial advisers not only fail to curb investors' worst habits, they actually tend to reinforce them -- especially when those habits generate fees for the advisers. The study, by Harvard economist Sendhil Mullainathan, Markus Noeth of the University of Hamburg and Antoinette Schoar of the MIT Sloan School of Management, looks at the behavior of typical investment advisers available to the general public through their banks, independent brokerages or investment advisory firms (focusing on the market for those with less than $500,000 to invest). These advisers are typically paid on the fees and commissions they generate by selling stocks, mutual funds, insurance products and the like. To see what kind of advice was doled out by these advisers in real-life situations, the study's authors hired and trained actors to make nearly 300 visits to Boston-area financial advisers over a five-month period in 2008. The actors were assigned to one of four fictional investment portfolios: 1) a returns-chasing portfolio, filled with holdings in sectors that had over-performed in recent years; 2) a portfolio heavily invested in company stock; 3) a diversified, low-fee stock/bond portfolio, and 4) an all-cash portfolio. So, when the actors came into these offices, what happened? Basically, the advisers advised the dummy clients to do a whole lot of things that were in the advisers' interests, while making some adjustments based on just how much they thought the clients could be persuaded to do. 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. And they tried to nudge cash-only and company-stock investors toward active management, too, though they seemed to take things a bit slower with these clients (apparently inferring that they had a lower tolerance for risk). While the researchers expected that they might find "catering" behavior -- that is, advisers telling clients to stay on their current course to avoid alienating them -- they largely found that the advisers were willing to recommend big changes fairly quickly (after giving the clients' original strategies a polite reception in their initial reaction). So, should investors ditch financial advisers entirely? "I wouldn't say that people shouldn't use financial advisers," says Ms. Schoar of MIT. Many people, without an adviser, are too timid to enter the market at all, which isn't good for their financial health. The best advice in the experiment, she said, was given to those who came in without a strategy (that is, those with the cash-only portfolio). While the advice given to these clients wasn't perfect, it was relatively conservative and well-matched to a client's income, age, marital situation and perceived risk tolerance. The most important thing, she said, was simply to understand how your financial adviser is getting paid. Some charge based on how much capital they're managing, and thus their incentives line up much better with their clients. Some even charge by the hour, which eliminates most conflicts of interest -- though it does leave the client with the vast majority of the work. In the end, the quality of advice you get from a financial adviser is likely to be tied directly to your financial literacy -- and your willingness to hear advice that doesn't conform to your preconceptions. Individuals who are bad at making financial decisions might also be bad at picking advisers," says Ms. Schoar. That certainly seems to be the case. A 2008 RAND study of investors' understanding of the roles of investment advisers and stock brokers found that investors have little understanding of how much responsibility either type of service provider has to them (advisers generally have a much greater duty to look out for their clients' interests) or of what types of fees they are paying. Nonetheless, the majority of investors were happy with their financial-service providers. Just how bad is the gap between the quality of service and people's contentment? Well, despite the abysmal advice offered by the advisers surveyed in the Harvard-MIT study, the actors were willing to go back to 70% of the advisers they visited. This time with their own money.
people who have money to invest obviously make a good amount of money to begin with. to make that money they most likely graduated from college. to graduate from college requires hard work, studying, research, and at the very least basic math skills. i'm just dumbfounded why they invest their time in making money but do so little in trying to keep it. i don't think it's hard to understand how investing works. do some reading to realize that an actively traded fund will cost you at least 5% while a low index fund will be less than 1%. if that was all you knew, it should be enough to at least make you think which is the better choice and why your financial adviser would upsell you on it. people like to say they're just bad a math and they hate it. that's just a cop out and it ends up costing you a lot of money, not just from investing but in your everyday purchases.
I follow a few simple rules when it comes to money. Pay myself first, no debts, earn a high income, keep my investments conservative and simple. So far there is no need for us to have a financial adviser.
Yep, the average person should not be using and paying large fees for a financial adviser. I could see it if you owned a private business or multiple businesses and wanted to see some short term gains on profits. But, for everyone else, all you need is this... Max out 401k up to employer contribution Max out Roth IRA if you qualify Max out 401k completely Eventually invest at least 15% of remaining income in mutual funds
because these are a bunch of assumptions and stereotypes. you think guys working at refineries know about the stock market? how much money do you think they make ask antoine walker how his investments went there are all types of people who make money.
yea, i'm assuming college graduates who SHOULD know how to read and understand percentages. and if you don't understand something you shouldn't invest in it.
I don't know a whole lot about medicine. I periodically visit a doctor to check my health, since I can not do it myself. I trust my doctor with my health. A natural extension of this type of thinking is that I should visit a money "doctor" periodically and get a checkup. Now, I know better than to trust a financial advisor with my money. Most people unfortunately do not. I see the difference between doctors and financial advisors as ethical. Medical providers are bound to a higher standard for patient treatment than financial providers. Not all financial advisors are bad. Registered Investment Advisers (RIAs) are bound to a higher ethical standards than Broker Dealers. RIAs are bound a "fiduciary" standard where the RIA must treat their client's money as if it were there own. Broker Dealers are bound to a standard where their advice must be "suitable" to their client's financial goals. The Dodd-Frank financial regulatory reform law is seeking apply the fiduciary standard to Broker Dealers, but ... Broker Dealers have powerful lobbyists who will likely prevent this from ever happening. And the beat goes on ...
i'm not talking about just trusting an advisor. i think it's dangerous overall not to have fundamental math skills. if you can't do simple algebra, you can't tell you're overpaying for something whether it's an jar of pickles or a brand new car.
Agreed, I was listing investing only. Obviously it makes no sense to not have anything in your bank account and debts (other than mortgage) paid off first before investing.
I forgot to mention that the United States Consumer Financial Protection Bureau (CFPB) might be the white knight riding in to rescue the financial advisor customers, that is if the CFPB survives past the next presidential election cycle.
Wow is this wrong. You're assuming that educated people make all of the money. You're assuming that to graduate college you need math skills. You're assuming that people with a college degree are intelligent. This isn't how the world works. Look, most people are just dumb. It's a constant. Look at how many poor republicans there are.
Most people aren't just flat out dumb. Financial illiterate and maybe ignorant, yes. But we still live in a society where credit card debt, getting a new car every 3-5 years, financing entire college educations on student loans is considered normal. People see others doing it and think it is normal/ok. Those people aren't all dumb, they're just sheep following the flock.
For brokers willing to work with $250k - $500k, this isn't necessarily true: particularly for small business owners, widows, or senior managers in retail or heavy industry. Your latter statement that it's not that heard to learn prudent investing is true, though. Also I think if you go in with a lower risk tolerance, that actually narrows the investments a bit.
Great point! I was very fortunate early on in life that my parents(deceased) were business people and they taught me the right ways to handle money. You can not get this priceless education in your school, maybe the school of hard knocks .
If I had to guess, I'd say the financial world can make the financial world as easy to access, use and understand as facebook, but it does not benefit them to simplify things to the level where people can do and understand things themselves. There is a natural conflict of interest for the industry - which is that every commercial entity in the field will attempt to maintain an information-edge over customers, and most of the time that means holding back the education of retail consumers or confusion of retail consumers. Financial advisers rely on an imaginary piece of paper and their alleged access and knowledge to the market - these advantages are dissapearing, and so the war on industry expertise is under way, since it is the easiest to control. In the financial world, retail and wholesale are totally different industries and its unfair to group them together and make comparative observations of each. Business doesn't treat peopel like it does other businesses. Just like with humans, you give a legal entity some money and erase morals, it will start preffering its own financial kind aka other wholesale businesses. When it comes to retail in highly developed economies, there is a take it or leave it approach from businesses because regulators have made requirements for retail business so stringent that compliance is almost commercially UNdesirable. This means businesses are a step ahead of regulators in that they avoid the nightmares of dealing with retail clients in a fragmented financial framework, so they reduce their time spent on it, increase the fees, and dare retail customers to figure out their best option. Small firms have no chance because requirements such as audit, governing committees, accurate records, compliance officers/teams, blackberries, etc are all too expensive and they are probably bound to breach the rules sooner or later.
Also, there is an insane variety of mutual funds, and different jurisdictions define mutual funds differently so please don't assume they are all equally or even near-equally safe. Do real research if you plan to invest real money, don't be lazy.
IIRC 60% of Americans live paycheck to paycheck. Unsurprisingly, an even higher percent do not have meaningful savings at retirement. I suspect that not all of this 60% are financially illiterate. They know that they should save more but lack the will to do so. Of course wrt the people on the lowest rungs of the economic latter, they lack the means.
True. And I would venture to guess that most of those people not saving are short term thinkers that are worried about what their next car will be or what new toy they can save for rather than worry about retirement. Some just have different philosophies, too, ie enjoy life while they are young and disregard the consequences. I just don't equate owning a new car and having nice things with enjoying life as much as some. Also, they may not be completely financially illiterate but I imagine most of them do not understand the effects of compound interest. They think they can save more money later when they increase their salary, but don't realize the gains associated with an extra 10 or 15 years of compounding.
