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Financial Advisors Are Biased, Study Finds

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

Filed by Loren Berlin