It’s worse than we thought
It’s no secret many investors underperform the market indexes with disastrous consequences for their retirement savings.
The list of bad investing behaviour is unfortunately all too familiar:
- jumping in and out of investments
- buying high-fee, actively managed funds
- chasing returns
- failing to broadly diversify portfolios
We know these are losing strategies thanks to decades of academic research. So why don’t more investment advisors steer their clients toward better, more rational decisions?
I’ve always put a large share of the blame on conflicts of interest, as have a lot of other industry observers. Advisors sell inappropriate, expensive investments because they are compensated to do so. That’s bad, but at least it’s understandable.
An alternative explanation for poor performance
Now, there’s another explanation for the poor performance that turns out to be even more troubling. It’s contained in a remarkable recent study entitled The Misguided Beliefs of Financial Advisors.
The study found many advisors are labouring under dangerously misguided beliefs. Those beliefs are costing not only their clients, but the advisors themselves, untold millions in squandered savings.
How do authors of the study know? They looked at data from two large Canadian financial institutions, comprised of the trading and account records of more than 4,000 advisors and 500,000 clients.
Importantly, the data included the personal investment records of the advisors themselves. What the paper reveals is that most advisors indulge in the same harmful investment behaviours in their personal portfolios as the clients they advise.
Advisors indulge in harmful behaviors
“They under-diversify, trade frequently and favour expensive, actively managed mutual funds with high past returns, despite evidence that these strategies often underperform,” the paper says.
So, it’s reasonable to conclude that sheer advisor incompetence plays a huge role in the poor performance of many investor portfolios, according to this study.
That doesn’t mean we should stop fighting to get conflicts of interest out of the investment industry. But, as the study notes, solving the problem of misguided beliefs would require improved advisor training, screening and licensing requirements.
For individual investors, this study is just one more reason to seek out advisors who manage portfolios based on time-tested, scientific principles of investing. If you’re a PWL client, you’ve already arrived.