An interesting article recently appeared in the Wall Street Journal (Advisors Failed This Test, Antoinette Schoar, 11/7/2016). “Mystery shoppers” sought out financial advisors in the greater Boston area. Schoar explained “By and large, the advice our shoppers received did not correct any of their misconceptions”. She went on to say “…the advisors seemed to exaggerate the existing misconceptions of clients if it made it easier to sell more expensive and higher-fee products.”
This may come as a surprise to many, but it’s consistent with what I’ve seen over the last several years. I’ve had the opportunity to review accounts that investors have held at other firms. In the majority of cases I’ve been dismayed at how far advisors and firms will go to enrich themselves without regard to the welfare of their clients. In one case an investor was paying an investment advisor fee and didn’t even know they had an advisor. In another case an investor sold an annuity and bought another, an expensive trade. When I asked the investor about it they hadn’t realized that they had even done it! The bottom line is that the vast majority of so-called advisors are really sales people looking to increase their commissions and bonuses.
Professional investors (pension funds, foundations, etc. known as “Plan Sponsors”) also seem to fall victim to the “tell them what they want to hear” trap. These investors typically hire consultants to help them find the best investment managers. The consultants fail to do this. An academic study (Picking winners? Investment consultants’ recommendations of fund managers) found that recommendations are driven largely by “soft factors”. The study also showed that the recommendations don’t add value by improving investment returns. One of the things the authors hypothesize is that “consultants may provide plan sponsors with a ‘narrative’ to explain their actions, which provide comfort to plan sponsors, and allow plan sponsors to explain their actions to their own stakeholders”. My interpretation is that the consultants are both telling the investors what they want to hear and, and at the same time, giving them job protection in the event that the investments don’t work out as expected.
Does any of this even matter? Even a small decrease in investment returns has a large effect over the long term. For example, an investment of $10,000 will grow to about $46,000 over 20 years at 8%. But it will only grow to $32,000 at 6%! This is a steep price to pay to someone for telling you what you want to hear. I suggest investors select an advisor based on the advisor’s investment expertise. This should be demonstrated by actual advisor performance and not by slick marketing and presentations. In other words, ask a potential advisor “why are you better than investing in index funds?”. If they can’t demonstrate that they are better by sharing past performance of their strategies, then leave. If you invest with them then ask for an annual review of your investment performance (after fees) that is benchmarked against other investment options, such as a target date mutual fund (in the case of diversified accounts) or an S&P 500 index fund (in the case of 100% U.S. stock accounts). Advisors can’t beat the market every year, but you should at least understand what your money is buying you.