Investors better off without investment advice?

A study by researchers at Goethe University in Frankfurt am Main and the University of Naples has yielded surprising results on the use of conventional advisory services for private investors.

Andreas Hackethal, Professor of Finance, and Michael Haliassos, Professor of Macroeconomics und Financial Markets at the House of Finance at Goethe University, conducted an extensive study in which they analyzed investor information from a large German bank, as well as a large online broker with affiliated independent financial consultants. In both cases, they found that the portfolios of investors who made use of advisory services did not develop better than portfolios of comparable investors who did not seek advice.

“The results can be attributed to the fact that consultants do not adequately correct the systematic investment mistakes of their customers and often also create higher costs,” explained Andreas Hackethal. The study discusses the false incentive structure for investment advisors, whose first priority is not the benefit to the customer as the main reason for the findings. It is much more attractive for them to sell investment products for which they can earn commissions. The study shows, for example, that customers restructure their portfolios much more frequently after a consultation – with the corresponding management costs – than customers who manage their own portfolios.

State regulation of investment advisory services does not seem like an adequate solution for the modest investment success of private investors. Another current research paper from the House of Finance also exposes serious problems on the demand side. Many customers steer clear of qualified advisory services and prefer to rely on their own investing skills, which are usually moderate (Bhattacharya et al. 2011). The study shows that 95% of investors do not accept an offer of free unbiased investment advice – the advisor here had no financial incentive in recommending specific products. Only around half of the remaining 5% act on the recommendation of the qualified advisor and by no means completely, even though the recommendations would have consistently led to improved performance.

Regulation that only focuses on the product side of investment advice without taking the problems on the demand side mentioned above into consideration, such as the product information sheets to be introduced in Germany starting in July, could miss the mark. “Study results seem to justify the skepticism as to whether product information sheets bring about the transparency and learning effect desired,” says Andreas Hackethal.

The research also shows which groups of people typically take advantage of investment advisory services. Predominantly older, affluent and experienced investors seek the services of an advisor. “According to our findings, one should not assume that financial advice is directed mainly at inexperienced investors who would therefore be in special need of protection,” says Andreas Hackethal.

The research papers can be downloaded at:

Hackethal, Haliassos, Japelli
– http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1360440
Bhattacharya et al.
– http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1669015