Are We Able to Judge Financial Advisers?

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Let’s get this out of the way first: the vast majority of financial advisers would not take advantage of you.

But that doesn’t eliminate the problem of discerning whether an individual adviser can be trusted. About 7 percent of U.S. advisers have misconduct records in civil or regulatory proceedings.  If someone draws an unlucky card and picks a bad one, how would they know?

In certain situations, they might not. A new study finds that various things can trip people up and make them trust an adviser who is giving out bad advice. These influences included a good first impression of the adviser. And one way for an adviser to make a good first impression is by initially confirming the client’s own views on investing before introducing poor advice.

The subject of this study – judging the quality of financial advice – is important at a time workers are carrying a heavy load of responsibilities for managing their 401(k) accounts, and the accounts are becoming more critical to their retirement outlook.

The adviser study was conducted by an international group of researchers. Their online experiment was done in Australia, where employers are required to provide workers with a retirement savings and investment plan – Superannuation Accounts – similar to 401(k)s.

Trust is tricky to evaluate, and the researchers put a lot of thought into designing the experiment to minimize flaws in the results. They asked nearly 1,300 Australians to evaluate advice online about four investment topics. Under each topic, one adviser presented good advice, while the other presented bad. The researchers varied the order for presenting the good and bad advice to the participants.

They generally had a good sense of when they were getting good advice. But there were exceptions:

First impressions. Financial advisers are aware they need to make a good impression when courting a prospective client. The problem can come if the adviser, having made that good first impression, uses it to exploit the relationship. Advisers who start out with solid advice but follow up with bad advice are often trusted the second time, the researchers found.

Catering to the client. People like others to agree with them – their feelings about financial advisers are no different. Advisers can cater to potential clients either by confirming what they believe or by not contradicting them. When advisers “catered to the client to make a good first impression,” the advisers “can go on to give bad advice on hard topics and still maintain a client’s trust,” the study found.

Degree of difficulty. The people in the experiment were savvy about a manager’s advice – when that advice involved an easy topic like paying credit cards. But consider the complex concept of investment diversification. An earlier study by Agnew had shown that two out of three people do not understand that the purpose of a diverse portfolio is to balance out market ups and downs by spreading money across a variety of companies and industries.

Not surprisingly, participants asked about this challenging topic had difficulty discerning good advice from bad. The researchers found that if the adviser started out with good advice on easy topics, they could follow with bad advice on difficult topics and still maintain the trust of the participants.

Credentials. In each of the experiment’s four topics, credentials were displayed on the screen for one of the two advisers and not for the other one. Credentialed advisers were more often viewed as trustworthy “regardless of the quality of the advice,” the study found.

Left to their own devices, the public’s financial acumen is generally poor, and a good adviser will steer them toward sound decisions. But this research indicates that investors can get into trouble if they aren’t able to detect when they’re getting bad advice.

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Ken Pidcock

I would imagine that it’s difficult for an adviser to give self-serving advice regarding a 401(k) account, one good reason to pause before rolling such an account into an IRA.

Paul Brustowicz

Remember the marshmallow test? I have the feeling that the folks who failed it are willing to believe anyone who tells them what they want to hear.

Advisors on the other side of the table must be honest and give folks bad news as well as good news. Having been credentialed myself, I find the last item a little disconcerting. However, I know that credentials do not make the advisor.

Thank you for another great article.

    Don Mayfield

    I had never read the ‘marshmallow test’. But it is just another way of saying ‘a bird in the hand is worth two in the bush’ which I subscribe to.

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