Retail Financial Advice: Does One Size Fit All?

Abstract

Using unique data on Canadian households, we show that financial advisors exert substantial influence over their clients' asset allocation, but provide limited customization. Advisor fixed effects explain considerably more variation in portfolio risk and home bias than a broad set of investor attributes that includes risk tolerance, age, investment horizon, and financial sophistication. Advisor effects remain important even when controlling flexibly for unobserved heterogeneity through investor fixed effects. An advisor's own asset allocation strongly predicts the allocations chosen on clients' behalf. This one‐size‐fits‐all advice does not come cheap: advised portfolios cost 2.5% per year, or 1.5% more than life cycle funds.

The Influence of Sellers on Contract Choice: Evidence from Flood Insurance

“…First, we highlight households’ susceptibility to guidance in making complex financial decisions. Insurance choices are one of many consequential household financial decisions, and research in other complex domains suggests a similar susceptibility (e.g., in financial planning, Christoffersen, Evans, and Musto, ; Foerster et al, ). Improved risk communication and decision making guidelines, from independent public or private organizations (e.g., the Consumer Financial Protection Bureau or the Insurance Information Institute), may help households evaluate the quality of advice and identify suboptimal recommendations.…”

“…Our analysis complements theirs, in that we demonstrate the ability of sellers to influence the quantity demanded of a product which is sold at identical unit prices. Similarly, Foerster et al () show that financial advisors have a large influence on investment portfolio allocation, more than many investor‐level attributes. Our study can be interpreted as evidence of similar effects on consumer choice and risk attitudes.…”

Brokers versus Retail Investors: Conflicting Interests and Dominated Products

“…The SEC has recently investigated brokers for steering clients to particular product issuers because of preexisting relationships. 33 Similarly, evidence in Foerster et al (2017) suggests that broker preferences may be more important than consumer preferences when determining portfolios. For these reasons, I include fixed effects in the broker profit function.…”

Is Proprietary Trading Detrimental to Retail Investors?

“…Finally, our work also relates to the growing literature on financial advice and household investment decisions (Bergstresser, Chalmers, andTufano (2009), Hackethal, Haliassos, andJappelli (2012), Karabulut (2013), Foerster et al (2017). We contribute to this literature by broadening the analysis to account for the larger organizations to which bank advisors are tied.…”

“…This practice also includes selling customers financial instruments with an inferior risk-return profile. 3 Recent studies that address this issue, such as Hackethal, Haliassos, and Jappelli (2012), Karabulut (2013), and Foerster et al (2017), find evidence that the involvement of bank advisors negatively affects individual portfolio performance, despite having some benefits. However, these studies use data from only one advisory firm.…”