Investor Biases and the Role of Financial Advisers

Antoinette Schoar, MIT and NBER

September 18th, 2015Hutchins Center Event “The Power of the Nudge”

Motivation

• Recent demographic and regulatory trends have increased the reliance on individual decision making for retirement and financial planning– Move from defined-benefit to defined contribution plans– Potentially less reliance on social security in future

• Numerous studies have shown that individual investors are prone to make biased decisions– Bernartzi & Thaler (2007); Odean (2002)

• But individual decision biases might not necessarily lead to bad investments if there are good intermediaries

Overarching Question

• Do financial intermediaries such as brokers and financial advisers provide a private solution to improve the decision of retail investors?– Do advisers adhere to basic recommendations of

portfolio theory?– Do advisers exploit the biases of individual investors

based on their personal objectives

• Do advisers “de-bias” investors? – How do biases interact with the advisers’ incentives?– Are advisers constraint in their advice by the client’s

preexisting biases (catering)?

Research Design: Audit Study of the Market for Financial Advice

• How do advisers react to clients with different investment biases (Mullainathan, Noeth, Schoar, 2012)– How good is the quality of advice given– Compare biases that either work in the advisers interest to

those that would reduce fees to advisers– Compare brokers and ‘fiduciary’ advisers

• Sent auditors (‘clients’) to receive financial advice – Target financial advisory firms in the Boston and NYC area,

combined more than 600 visits– Auditors were assigned background characteristics to match

their own: College educated men and women– Two age/ investable funds groups will be clearly identified:

• Early 30s with investable funds around $50,000• Late 40s with investable funds around $100,000

Treatments

Treatment 1 – Chasing past returns:• Auditor was assigned a portfolio that has 30% of the funds invested

in sectors with high past returns. The auditor asked the advisor’s opinion investing a large fraction of the money in those sectors which had high returns in the past.

Treatment 2 – Company stock:• Auditor had a portfolio that has 30% of the funds invested in

company stock (stocks of the company s/he is assigned to say s/he works at). Auditor will ask the advisor’s opinion investing a large fraction of the money in his/her company stock.

Treatment 3 – Index portfolio: • Auditor had an efficient portfolio invested in index funds. Auditor

asked the advisor’s opinion about investing in index funds.

Treatment 4 – Cash Treatment (Control Group)• Mystery shopper was assigned a portfolio of cash and CDs. Auditor

asked the advisor for general advice on portfolio investing.

Key Findings

• Advisers support biases that are in their own economic interest– Lean strongly against investing in index funds– Less strongly against investing in own company stock

(relative to trend chasing)– Effect is stronger for brokers than fiduciary advisers

• Advisers show strong preferences for actively managed funds over index funds– Push actively managed funds even for index portfolio– More likely to offer index funds for cash treatment

What Do Advisers Mention?

   

  VARIABLES Yes No Total

       Advisors encourage more of current strategy? 13% 87% 206Advisors suggest change of current strategy? 66% 34% 206initial reaction positive 83% 17% 206initial reaction negative 40% 60% 206 Recommend Index Funds 7% 93% 284Recommend Actively Managed Funds 50% 50% 284 Auditor would go back to this advisor with own money 70% 30% 284

  (1) (2)   (5) (6)VARIABLES advisor encouraged client to

invest more in the existing strategy

advisor discouraged client to invest more in the existing

strategyCompany Stock PF -0.165** -0.185** 0.110 0.162

(0.0807) (0.0780) (0.0908) (0.111)Index Funds PF -0.284** -0.304** 0.397*** 0.438***

(0.111) (0.116) (0.0989) (0.109)log(Auditor's Age) 0.0965 0.0121 -0.0175 0.380

(0.152) (0.396) (0.181) (0.485)log(Annual Income) -0.266 -0.249 0.358 0.381

(0.228) (0.260) (0.252) (0.262)

Observations 204 203 204 203R-squared 0.093 0.116   0.107 0.127

Conclusion

• Advisers overall fail to de-bias their clients but seem to exaggerate existing biases– Adviser self-interest and incentives seem to play a role

in generating advice– Some evidence that advisors cater to clients pre-existing

biases at the initial stage (sales process)

• Ongoing Research– Supply Side: Test advisers’ own biases and knowledge– Demand Side: Understand how consumers select and

evaluate advisers and how it affects the type of advice that is provided