Financial Advisors Are Biased, Study Finds

Financial advisors are biased towards investments that line their own pockets, according to a new study.

If you're looking to a financial advisor for investment strategies, be warned: Your advisor is biased and not towards you, according to a new report from the National Bureau of Economic Research.

Advisors are prejudiced towards investment strategies that maximize fees and, in turn, their personal payout, according to the report. Specifically, researchers found that only 7 percent of the surveyed advisors recommended index funds, low-cost investment vehicles that minimize the advisor's profit. In contrast, half recommended costlier funds that are actively managed by an advisor and thus charge higher fees.

This, despite the fact that research has consistently shown index funds outperform their more expensive counterparts.

"It is very hard, if not impossible, to justify the active management for most individual, taxable investors, if their goal is to grow wealth," wrote Mark Kritzman, president and chief executive of Windham Capital Management of Boston, in a 2009 study that compared the index funds to actively-managed investments. Kritzman went on to say that investors who still prefer actively managed funds are "deluding themselves," according to the New York Times.

Based on his research, Kritzman, who teaches a financial engineering class at M.I.T.'s Sloan School of Business, concluded that the index fund's average after-expense return was 8.5 percent a year, versus 8 percent for the actively managed funds and 7.7 percent for the even costlier hedge funds, according to the New York Times.

Standard and Poor's 10th annual report comparing the two types of investment vehicles draws similar conclusions. The researchers found that over the past five years the index funds produced better returns than actively-managed funds in nine of 11 investment categories, according to Forbes.com.

Perhaps then, John C. Bogle, founder of mutual fund giant the Vanguard Group and a long time proponent of index investing, is right.

"The grim irony of investing, then, is that we investors as a group not only don't get what we pay for, we get precisely what we don't pay for," he wrote in his popular investment guide, The Little Book of Common Sense Investing. "So if we pay for nothing, we get everything."

To learn more about index funds, check out this quick summary from The Motley Fool, or this more detailed primer from Investopedia.

From our partners

• How To Get Away With Being Bad At Your Job - The Billfold
• The Sharing Economy - LearnVest
• Uninsured: How To Get Health Care Without Insurance - The Billfold

Comments

[mcxncdextips]

08:16 AM on 05/31/2012

The first question most people ask financial advisor is "What has your performance been?"
and Of the approximately 300,000 practitioners who claim to offer financial planning in this country, only about 60,000 have passed the examination, subscribed to the code of ethical conduct and accumulated the years of experience necessary to earn the CFP designation.

PS: I am a commodity Investment Advisor http://gold-silver-tips.blogspot.com ;)

[arrowbiz]

10:28 AM on 03/29/2012

This article is nonsense.

Everytime the stock markets have a three year bull run (2009 through 2011), the mindless index fund promoters come out and tout index funds as the only logical equity investment.

When you add in the years 2002 and 2008 to the performance equation, index funds suck.

Writers like the writer are novices who thinks he or she is some hotshot consumer or investor advocate. This is pure grandiosity based on a manipulation of the facts.

The only truth to this article is that BAD "passive management" investment advisors don't outperform the indexes.

John Bogle retired after the turn of the decade tech bubble partially because his "index fund superiority" theory fell apart iwth a 26% loss in the S&P 500 index - with passive index fund investors getting hammered and forced to change careers.

The same thing happened in 2008 when the S&P 500 index fund lost 37%. Hence index fund investors made no money in the first decade of the 21st century.

[SeanN]

07:55 AM on 03/28/2012

Spot on! Skip the middle man and go directly to Vanguard, or another company operating on a non-profit basis, and buy low cost index finds. You'll doubtless see howls of protest here from financial "advisors," but don't listen. They're just trying to line their pockets with your money.

[Ground control]

08:52 PM on 03/27/2012

This article is an example of the worst type of Huff Post "reporting." It is intended to get attention by being provocative, and it tells you nothing.

What is a Financial Advisor? A friend with a hot stock tip? A broker like those in the picture? An Investment Advisor? A Certified Financial Planner?

What exactly does the comparison of Index Fund expenses vs Managed Fund expenses have to do with your financial situation which includes adequate cash reserves, life and disability insurance, taxes, estate plans, retirement savings, employer provided benefits, and more? Virtually nothing.

But, more to the point of the article - even if Index Funds are unequivocally cheaper than managed funds, not everyone knows how to do a proper portfolio allocation commensurate with their risk tolerance, re-balance when necessary, manage investments for optimal tax treatment, etc. etc.

The whole issue of management fees is specious and a waste of time. If you want to do the best for yourself financially, find a Certified Financial Planner you like, take their advice (their board of ethics does require they exercise a fiduciary standard), and you'll be better off than 98% of the population.

Disclosure: I am a Certified Financial Planner

[LVNVprog]

12:43 PM on 03/27/2012

When Financial Advisors have Fiduciary Responsibilities they can advise, until then hold on to your money. I wonder why Politicians Never pass laws that require any Financial person to have Fiduciary Responsibility to their Client? Insist on it, have your attorney draw up a contract - see if they'll sign it. Buyer Beware.