June 20, 2011

Why Do Most Advisors Think They're Above Average in Intelligence?

Studies have proven that consumers of financial products are more likely to follow the advice of an advisor if the advisor appears confident, even if the advice is bad. In my early days of training with the Bull, we were taught how to greet a client at the door. First, look them straight in the eye, next, shake their hand firmly, third, greet them verbally, and lastly, turn and lead them to the conference room. Direct, firm, confident, that was the key.

Does this type of training have anything to do with the fact that the majority of advisors believe they possess above-average intelligence? Daniel Kahneman highlighted this overconfidence bias by asking a room full of advisors to indicate if they thought their intelligence was above average. Nearly 70% of the advisors raised their hand. Confidence is surely important, but what if this confidence is unwarranted? Case in point: Watch the financial soothsayers prognosticate on the direction of the stock market. Some will be bullish, some bearish, but most are confident of their assessment.

I was on a conference call at the end of May just before this latest correction began. The host company is a sub-advisor to financial advisors who wish to "farm out" the asset management portion of their business. I believe this particular economist holds a Ph.D. and is what I would consider to be an intelligent individual. When asked what he believed the stock market would do in the near term, he said that stocks were undervalued and would rise. I mentioned that Tobin's Q Ratio and one other credible source believed that stocks were about 65% over valued. I then asked how confident he was of his bullish assessment. His answer was quick, authoritative, and confident: "Absolutely certain!" This was one or two days before June began and we all know what happened then. Stocks fell for the first six days of the month and have closed lower in eight of the first eleven trading days in June. Oh, by the way, of that, I am supremely confident!

My point is not to speak poorly of this analyst. However, it is worth noting that the forecasts of even the brightest in the business should be viewed with a healthy level of skepticism. Some will have a "dog in the hunt" and some will not. Even if we could accurately filter out all human biases, the fact remains that the future is quite uncertain. Given the fact that when stocks do fall, they tend to fall hard, I will retain a healthy respect for stocks and keep them on the lower end of the allocation spectrum. At least until the government gets a handle on its overspending problem, Europe gets its fiscal house in order, the Middle East settles down and my aunt Mabel's bursitis clears up.

Have a great week and thanks for reading!

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