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Why American Finance Is Likely to Be a Value-Subtracting Industry

Harold Pollack on Sendhil Mullainathan, Marcus North, and Antionette Schoar:

Think twice about that financial advisor: The correct advice pretty much fits on a single sheet of paper that is available for free at the public library. Moreover, the products one should recommend buying are inexpensive, and are widely-available at leading websites. Thus the predicament of the modern financial advisor. Thus also the predicament of her unsophisticated customers. If the right advice is simple and free, at-best the expensive and complicated advice she will sell you will be overpriced, and probably more than a little wrong. Moreover, if the correct products to buy are cheap, no-load index funds that generate little sales commission, your advisor has obvious incentives to offer you something riskier or fundamentally more costly.

Thus, we have the results of an important, if cosmically unsurprising experiment: “The Market for Financial Advice: An Audit Study,” by Sendhil Mullainathan, Marcus North, and Antionette Schoar. These respected authors used an audit methodology in which trained auditors met with different Boston-area financial advisors and claimed to have different existing investment portfolios and different personal strategies for retirement savings…. [O]ne might hope that the financial advice industry would “de-bias” its customers in a more sensible direction, encourage people to diversify their portfolios through low-cost index funds. Instead, the advisors audited in this study pushed their customers towards costly, actively-managed funds that happen to generate lucrative fees…. These disgraceful findings are not the result of a few bad apples blighting the name of their industry.  Rather, the majority of audited advisors are following a predatory business model that harms many of their customers…