What Researchers Learned from Visits to Financial Advisers

What Researchers Learned from Visits to Financial Advisers

The National Bureau of Economic Research recently sent actors to visit Boston-area financial advisers to seek advice on how to invest their retirement savings. Here's what they found.

“Acting” In the Best Interests of Investors?

What Researchers Learned When they Visited Financial Advisers

"The Market for Financial Advice: An Audit Study" is a working paper from the National Bureau of Economic Research. The three authors set up 284 contrived visits to Boston-area financial advisors in 2008. They sent trained, professional auditors to impersonate regular customers who were seeking advice on how to invest their retirement savings outside of their 401(k) plan. The advisers tended to work for a bank, a retail investment firm, or their own independent operation, focusing on the lower end of the retail segment. Most of them were paid on commissions based on the fees and trading costs they generate. Only a small subset of the advisers was independent and paid on assets under management, due mainly to the fact that the fake prospective clients had between $50,000 and $100,000 and thus did not meet the minimum for most registered investment advisers.

Each of the fake prospective clients had one of the following four portfolio types:

  • Chasing returns—invested in a sector fund that recently outperformed the S&P 500 Index
  • Company stock—invested in the stock of the prospective client’s company
  • Index funds—invested in a diversified portfolio with only low-fee index funds
  • All cash


(Click to enlarge)

Not surprisingly, the highest level of opposition came against the indexing strategy, and the least amount against the chasing returns strategy. The authors summarize their findings: "We document that advisers fail to de-bias their clients and often reinforce biases that are in their [the advisers] interests. Advisers encourage returns-chasing behavior and push for actively managed fund that have higher fees, even if the client starts with a well-diversified, low-fee portfolio." As the two pie charts below indicate, only in 7.4% (or 21) of the 284 adviser/prospective client interactions did the adviser recommend index funds while active funds were recommended 50% of the time.

Even for the 7.4% of instances where index funds were recommended, they could well have been for exchange-traded funds that would have been rapidly turned over to generate commissions, resulting in below-market performance.

At the heart of their findings is the difference between the "suitability" standard (to which brokers are held) and the "fiduciary" standard (to which registered investment advisers are held).


Someday the government may choose to impose the fiduciary standard on all financial advisers, but until that happens, investors need to look out for their own best interests by hiring fiduciary advisers who are obligated to act in the best interests of their clients.

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