SAFT ON WEALTH-Expensive, one-size-fits-all advice

Wed Dec 10, 2014 4:49pm EST
 
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(James Saft is a Reuters columnist. The opinions expressed are his own)

By James Saft

Dec 10 (Reuters) - Financial advisors do not appear to be carrying their weight.

A new study based on Canadian data shows that while advisors are able to put clients into better performing assets, they simply do not outperform their costs.

Even more striking, the data shows a tendency by advisors to shoe-horn clients into portfolios with little attention to the client's own risk appetite or life situation.

"This one-size-fits-all advice does not come cheap. The average client pays more than 2.7 percent each year in fees and thus gives up all of the equity premium gained through increased risk-taking," write Stephen Foerster and Alessandro Previtero of Western University, Juhani Linnainmaa of the University of Chicago and Brian Melzer of Northwestern University (here)

Looking at data covering 10,000 advisors and 800,000 Canadian clients, the authors found a mix of some good effects from professional financial advice but little evidence that it is worth its costs.

One of the traditional ways in which advisors are said to help clients is by getting them comfortable with taking on a higher, more appropriate level of risk, usually through equity market exposure. Because of a change in regulation in Canada in 2001, which did not apply to Quebec, the authors were able to get an accurate view of this, even taking into account selection bias, i.e. the idea that people who seek out financial advice are more sophisticated and willing to take on risk. The study found that a financial advisor increases the marginal household's risky asset holdings by a chunky 30 percentage points.

That's great, and will produce extra returns, but what did not seem to be happening was the kind of tailoring that you would expect from a financial advisor. A good advisor will be sensitive to your own appetite for risk, which may be influenced not just by your own goals but by your particular life situation. A good advisor will also adjust a client's asset mix depending on where they are within the life cycle, typically taking on more risk early in a working life and trimming it as retirement approaches.   Continued...