When Advisors Underperform, So Do Clients
Clients invest similarly to their advisors, which leads to correlation in their investment performance.
We sort advisors into deciles based on their personal investment returns. Clients of bottom-decile advisors underperform those of top-decile advisors by 1.61% per year.
A common view of retail finance is that conflicts of interest contribute to the high cost of advice. Using detailed data on financial advisors and their clients, however, we show that most advisors invest their personal portfolios just like they advise their clients. They trade frequently, prefer expensive, actively managed funds, chase returns, and under-diversify. Differences in advisors’ beliefs affect not only their own investment choices, but also cause substantial variation in the quality and cost of their advice. Advisors do not hold expensive portfolios only to convince clients to do the same—their own performance would actually improve if they held exact copies of their clients’ portfolios, and they trade similarly even after they leave the industry. These results suggest that many advisors offer well-meaning, but misguided, recommendations rather than self-serving ones. Policies aimed at resolving conflicts of interest between advisors and clients do not address this problem.
Linnainmaa, Juhani T., Brian T. Melzer, and Alessandro Previtero, The Misguided Beliefs of Financial Advisors, Working paper, 2016.