The sorry truth about what your financial advisor doesn’t know

Steve Merrell |

One of the most pervasive problems in the financial services industry is that many people have no idea what to expect from a financial advisor. Some people expect their financial advisor to be able to pick a hot stock or know which way the market will go. Some advisors even claim such superpowers. However, the sorry truth is that your advisor can do none of these things. Mortals, including financial advisors, have a very hard time seeing the future.

Instead of expecting your financial advisor to do the impossible, you will get much more value from your relationship with your advisor if you focus on areas where she can consistently add value. For example, your advisor can help you:

  • develop a comprehensive financial plan, incorporating specific targets for your spending and savings as well as reasonable returns on your invested assets.
  • provide discipline to your investment process.
  • track your progress toward your goals.
  • think through the ramification of various financial decisions.
  • learn how to adapt when real life deviates from your expectations.

All of these activities are sure-fire ways your advisor can help you secure your financial future.

It probably goes without saying, but some advisors are better than others. The National Bureau of Economic Research (NBER) published an interesting study in 2012 called “The Market for Financial Advice: An Audit Study.” The purpose of the study was to better understand how advisors behave and the quality of advice they provide their clients. The study looked specifically at how well brokers and other transaction-based advisors helped their clients develop sound financial strategies and how often the broker’s advice resulted in higher costs for the client.

The study was conducted using a group of mystery shoppers, called auditors, who posed as investors in 284 meetings with different brokers. Auditors provided the advisors with copies of their most recent statements and asked them for recommendations. The recommendations were then evaluated by the researchers and scored on various metrics. 

In general, the study found that transaction-based advisors were much more likely to push their clients toward more-expensive actively-managed mutual funds instead of lower-cost index funds, even when the client already held index funds. In fact, clients who held index funds in their initial portfolio were more likely to get a recommendation to restructure their overall portfolio than clients with actively-managed funds.

In addition, advisor recommendations tended to chase stocks and sectors that had recently been strong performers without regard to portfolio diversification. Advisor recommendations also tended to go along with clients when they expressed a particular preference even when client preferences were contrary to sound financial practice. In other words, the advisors tended to reinforce the clients’ poor biases and instincts rather than correct them.

In short, the advisors in the study did not cover themselves with glory. Their advice appears to be more about making a sale and boosting their payout than helping their clients develop and implement sound financial strategies.

As you reflect on these results, you need to keep in mind a few particular aspects of this study. First, it was concentrated in the Boston/Cambridge area, so there could be some regional bias. Second, the advisors targeted for this study were focused at the lower end of the wealth spectrum—those primarily dealing with clients with investable assets between $45,000 and $105,000. The study specifically excluded advisors that cater to a wealthier clientele, including private wealth managers, fee-only advisors and hedge funds. According to the study’s authors, “The modal adviser in our study is working either for a bank, retail investment firm, or their own independent operation, focusing on the lower end of the retail segment. Most of them are paid on commission, based on the fees and volumes that they generate.”

If you want to read the study, you can find a copy at NBER.org.

 

 

Steven C. Merrell  MBA, CFP®, AIF® is a Partner at Monterey Private Wealth, Inc., a Wealth Management Firm in Monterey.   He welcomes questions that you may have concerning investments, taxes, retirement, or estate planning.  Send your questions to: Steve Merrell, 2340 Garden Road Suite 202, Monterey, CA  93940 or email them to smerrell@montereypw.com.