Why do so many financial advisors make investing complex, even scary – especially
when data shows that simple is better than complicated, and that advisors who go the
complex route are making things worse and not better?
Hey, let’s face it. The best investment advice – know your goals, know your risk, look
for value and opportunity, opt for index funds, and diversify – all fits easily onto one
sheet of paper (or in this day and age – on one Tweet.)
But financial advisors can’t say that to customers, and that’s hurting financial
consumers where they live – right in the pocketbook.
In a landmark study from the National Bureau of Academic Research http://
www.nber.org/papers/w17929?ntw, the data reveals that simple is better when it
comes to investment management.
This from the study:
Do financial advisers undo or reinforce the behavioral biases and misconceptions of
their clients? We use an audit methodology where trained auditors meet with financial
advisers and present different types of portfolios. These portfolios reflect either biases
that are in line with the financial interests of the advisers (e.g., returns-chasing
portfolio) or run counter to their interests (e.g., a portfolio with company stock or
very low-fee index funds). We document that advisers fail to de-bias their clients and
often reinforce biases that are in their interests. Advisers 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.
Specific “complicated” (i.e., actively managed and deemed as higher risk) portfolios
tracked by the NBER, entitled “The Market for Financial Advice: An Audit Study”
underperformed the S&P 500 by 6.5%
That’s not by coincidence.
“Given the reality that tens of millions of people make very poor financial decisions,
one might hope that the financial advice industry would “de-bias” its customers in a
more sensible direction, encourage people to diversify their portfolios through low-
cost index funds,” NBER researchers say. “Instead, the advisors audited in this study
pushed their customers towards costly, actively-managed funds that happen to generate
lucrative fees. In gauging advisors’ reactions to consumers’ existing investment
Advisors just don’t seem to “get it” on how complicating things hurts clients’
investment performance. The study notes that 59.4% of financial advisors urged clients
to change in their current active strategy, but 85.4% advocated getting out of index
funds and into a more actively managed investment strategy.
Additional research backs up the NBER report. Data from two financial analysts,
Jason Hsu and Vitali Arnott https://www.researchaffiliates.com/Our%20Ideas/
from Research Affiliates, applies what the duo call the “new skepticism” to investment
research - research that offers complicated strategies to simple fund performance
Rallying around the term “if you torture data long enough, it will confess anything”,
Hsu and Kalesnik cite investment quant models used by advisors that call for 81
unique investment “factors” in building equity-based portfolios, when only four factors
are needed (market risk factor and the value, small-cap, and momentum return factors)
for the vast majority of investors.)
Additionally, Cam Harvey, former editor of the Journal of Finance, analyzed 315
similar “investment factors” from top financial and economic journal articles and
highly regarded working papers. Adjusting for “data-snooping,” Harvey, Liu, and Zhu
(2014) conclude that only a” handful of the factors in the “financial zoo” are actually
“We will gladly bet a simple blend of market, value, low beta, and momentum
exposures against anyone’s optimized 81-factor portfolio,” Hsu and Kalesknik
Unfortunately, way too many investment advisors don’t see it that way – and they’ll
show you 81, risky, expensive reasons why that is so.
If you’re not sure you’re getting the maximum performance from your financial
advisor, talk to GuardVest – we’ll set you on the right path and guide you to a more
beneficial relationship with your advisor. Contact us at http://www.guardvest.com
contact/ and follow us on Twitter at www.twitter.com/guardvest.