Advisors give misguided advice because they believe it themselves

There’s a commonly held view – one I’ve strongly and vocally agreed with – that conflicts of interest are an issue in our industry and have contributed to the high cost of advice.

However, an academic paper from late 2016 quite persuasively upends this long-held assumption.

The three U.S.-based academics who wrote “The Misguided Beliefs of Financial Advisors” (Kelley School of Business Research Paper No. 18-9 ) reviewed 14 years of trading and portfolio data from more than 4,000 advisors and nearly 500,000 clients at two Canadian MFDA dealers. Here’s a summary of what they found:

“[M]ost advisors invest their personal portfolios just like they advise their clients. They trade frequently, prefer expensive, actively managed funds, chase returns, and under-diversify. Differences in advisors’ beliefs affect not only their own investment choices, but also cause substantial variation in the quality and cost of their advice. Advisors do not hold expensive portfolios only to convince clients to do the same – their own performance would actually improve if they held exact copies of their clients’ portfolios, and they trade similarly even after they leave the industry.”

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In short, many advisors don’t offer self-serving recommendations based on conflicts of interest but rather provide well-meaning and misguided advice based on their honest beliefs. Most importantly, the researchers conclude: “Policies aimed at resolving conflicts of interest between advisors and clients do not address this problem.”

I only came across this paper recently and I have to admit that, the moment I did, I realized I had been barking up the wrong tree for nearly 20 years. Ever since about the turn of the millennium, I have been writing about the need for greater transparency, the elimination of advisor bias caused by embedded compensation, improved professionalism and, ideally, the imposition of a statutory best interests standard. While these are all noble objectives that do build trust in our industry, I now realize they are minor concerns compared to the more pervasive issue of advisors’ misguided beliefs.

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In the past, in response to major regulatory changes, I’ve updated my book, The Professional Financial Advisor. But I now realize, another edition will no longer cut it – I need to write a whole new book to help advisors confront their misguided beliefs. (The planned release of Be Serious! (BS!) is for late 2018.)

It’s going to be a challenge. After all, I have unwittingly been part of the problem for nearly two decades. But no matter – to help advisors move toward offering true evidence-based, client-centric advice, there needs to be a push to demonstrate, without a hint of accusation or impugned motive, that there are errors in the way things have been done in the past. Beyond that, we’ll need to show advisors how to overcome those errors so they can provide more purposeful advice that offers their clients a positive investment experience.

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This won’t be a simple task. There’s likely to be significant advisor resistance. After all, it’s human nature to push back when you’re told you’ve been doing it all wrong. The challenge will be to respectfully educate and firmly provide recommendations to fix these almost imperceptible problems.

In the final analysis, the “Misguided Beliefs” paper might serve as a watershed, much like the 1964 U.S. Surgeon General’s Report that linked smoking with a series of health risks including cancer. It took doctors a couple of generations to internalize the message and change the advice they gave patients. For the sake of advisors and our clients, hopefully our industry can course-correct this issue more quickly.

John De Goey is a Portfolio Manager with Industrial Alliance Securities Inc. and the author of The Professional Financial Advisor IV. Industrial Alliance Inc.is a member of the Canadian Investor Protection Fund (CIPF). The opinions expressed herein are those of Mr. De Goey alone and may not be aligned with the opinions and values of Industrial Alliance Securities Inc. or any of its affiliated companies.