Business

Why financial advice isn't worth the fees

By By Dee Gill     
February 25, 2015

From: Magazine

Photo by Shutterstock.

The next seven years are on track to be good ones for the financial advice industry. By 2022, the number of financial adviser positions in the United States will grow by 27 percent, according to the Bureau of Labor Statistics, compared to 11 percent growth for all other occupations. Baby boomers seeking retirement guidance will drive the increase.

For average investors, hiring a professional financial adviser may raise their investment portfolio returns, but the additional gains are more likely to go into the adviser’s pockets than the investors’.

Those are the findings from an analysis of some 800,000 Canadian investors advised by 10,000 professionals. “We conclude that, for the average investor, investment advice alone does not justify the fees paid to advisers,” writes Chicago Booth’s Juhani Linnainmaa, with Stephen Foerster of the University of Western Ontario, Brian T. Melzer of Northwestern University, and University of Western Ontario’s Alessandro Previtero.

The researchers speculate that clients get benefits from financial advisers beyond portfolio choices, such as advice on saving for college and retirement, tax planning and estate planning, and, perhaps, reduced anxiety about investing generally. But using data from four large Canadian financial institutions, they find that financial advisers generally did not provide the customized portfolio advice the industry advertises.

Rather than crafting portfolios to conform to a client’s specific characteristics, such as risk preference, life situation, income, and investment horizon, advisers were more likely to build generic portfolios reflecting their own investment portfolios. “The picture that emerges here is that no matter what a client looks like, the adviser views the client as sharing his preferences and beliefs,” the researchers find.

They considered that perhaps advisers attracted clients that had characteristics predisposing them to their specific investment strategies. They were able to rule out this sort of selection by tracking investors who were forced to change advisers because of the professional’s death or withdrawal from the business. Again, the researchers find that the ultimate composition of these portfolios was influenced more by the new advisers’ preferences than factors such as age and risk tolerance.

And they find little to suggest that these one-size-fits-all portfolios were superior enough to justify their costs. In fact, the study finds on average that advisers’ stock selections and market timing decisions had virtually no impact on returns. Professional financial advice did raise client investment returns about 1.8 percent, by inducing clients to buy riskier assets such as equities instead of government bonds. But the average client pays more than 2.7 percent each year in fees for this advice, which wipes out any extra money
collected from risk-taking.

The researchers find that client characteristics accounted for about 13 percent of the variation in risky shares among portfolios. However, the level of risk in an adviser’s own portfolio was an even greater predictor of risk in clients’ portfolios. The preferences of an adviser explained up to 32 percent of the variation of risk, a significant chunk of which could be tracked to the adviser’s own risk tolerance. Controlling for client characteristics, advisers who took more risk in their own portfolios gave their clients substantially riskier portfolios.

Stephen Foerster, Juhani Linnainmaa, Brian T. Melzer, and Alessandro Previtero, “Retail Financial Advice: Does One Size Fit All?” Working paper, November 2014.

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