Investor Biases and the Role of
Financial Advisers
Antoinette Schoar, MIT and NBER
September 18th, 2015
Hutchins 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?
Advisors suggest change of current strategy?
initial reaction positive
initial reaction negative
13%
66%
83%
40%
87%
34%
17%
60%
206
206
206
206
Recommend Index Funds
Recommend Actively Managed Funds
7%
50%
93%
50%
284
284
Auditor would go back to this advisor with own
money
70%
30%
284
VARIABLES
Company Stock PF
Index Funds PF
log(Auditor's Age)
log(Annual Income)
Observations
R-squared
(1)
(2)
advisor encouraged client to
invest more in the existing
strategy
-0.165**
-0.185**
(0.0807)
(0.0780)
-0.284**
-0.304**
(0.111)
(0.116)
0.0965
0.0121
(0.152)
(0.396)
-0.266
-0.249
(0.228)
(0.260)
204
0.093
203
0.116
(5)
(6)
advisor discouraged client to
invest more in the existing
strategy
0.110
0.162
(0.0908)
(0.111)
0.397***
0.438***
(0.0989)
(0.109)
-0.0175
0.380
(0.181)
(0.485)
0.358
0.381
(0.252)
(0.262)
204
0.107
203
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