digest
Short Summary
Main recommendation: Be skeptical of financial advice from advisors who favor expensive actively managed mutual funds, and prefer an advisor with advanced financial education who understands the evidence for index funds. Ben Felix argues that many poor recommendations come from advisors' misguided beliefs rather than only from commission incentives. Advisors' own personal portfolios showed the same tendencies, which suggests they genuinely believe in those products.
Key Points
- Commissions are commonly blamed for poor advice, but Felix suggests a more innocent explanation: advisors may simply be misguided, since barriers to becoming an advisor are low.
- A 2016 study, "The Misguided Beliefs of Financial Advisors," examined more than 4,000 Canadian advisors and almost 500,000 clients from 1993 to 2013 by comparing advisors' personal accounts with their clients' accounts.
- Advisors and clients both showed performance-chasing, a strong preference for actively managed mutual funds, poor diversification, and high fees, with advisors' own portfolios often worse than their clients'.
- Advisors kept these behaviors after retiring, which the study uses to rule out the idea that they held expensive funds only to convince clients.
- A 2017 Vanguard white paper, "Trust and Financial Advice," found that investors' top trust factor is the expectation that the advisor acts in their best interest, and Felix argues well-meaning but misguided advice is as damaging as malicious advice.
Details Worth Noting
- Concrete instructions: If you seek financial advice, look for an advisor with advanced financial education and an understanding of the evidence supporting index funds. Ask the advisor directly what they think about index funds. Per Felix, the right answer is that index funds are the most sensible approach to investing for most people. Be wary of advisors whose own portfolios hold expensive actively managed funds.
- As of December 2017, 89% of Canadian investment fund assets were in mutual funds and 11% in ETFs, per the video.
- A 2017 Morningstar study showed most Canadian mutual fund assets were in commission-based products, typically actively managed funds paying a trailing commission to the selling advisor.
- A 2015 study commissioned by the Canadian Securities Administrators found Canadian advisors are likely influenced by commissions, and some countries have banned mutual fund commissions altogether.
Bottom Line
Poor financial advice may stem as much from advisors' own sincere but mistaken beliefs as from conflicts of interest, so verify an advisor's understanding of index investing before trusting them.
