The Certified Financial Planner Board of Standards’ Center for Financial Planning recently announced the winners of its Academic Research Colloquium for Financial Planning and Related Disciplines Best Paper Awards. Below are some of the papers that we thought were especially relevant to investment advisors.
1. Who Pays the Price for Bad Advice? The Role of Financial Vulnerability, Learning and Confirmation Bias By Julie Agnew, Hazel Bateman, Christine Eckert, Fedor Iskhakov, Jordan Louviere and Susan Thorp
Bernie Madoff committed a $17 billion fraud against 1,000 wealthy clients, but as this paper states, fraud isn’t limited to only wealthy clients. “Evidence of persistent misconduct by advisers, when combined with findings that cast doubt on whether advisers actually improve their clients’ portfolio outcomes, underscores the importance of choosing a high-quality financial adviser,” the researchers state.
This paper explores mechanisms that drive client choice of advisor and the willingness to pay for financial advice. As the authors state, “We show how consumers with certain characteristics can incur higher economic costs, and we find that predatory advisers can exacerbate these costs.”
What kinds of people will pay bad financial advisors? Younger, more trusting, more impulsive, less financially literate and less math-savvy participants were most vulnerable to paying a poor-quality advisor. Further, not only do these consumers seem to pay the higher price for bad advice, bad advisors will prey upon these groups.
“Poor financial advice can leave a lasting trail of destruction among unquestioning clients, as the Madoff case and numerous others show. This paper provides an explanation for why some clients are more likely to ignore bad signals about financial advisers and identifies those clients most vulnerable to manipulation by advisers.
“That is, they are more likely to follow a learning process that is consistent with confirmation bias,” the authors state in their conclusion, noting that combined with limited knowledge “can make a client too ready to follow an adviser of dubious quality and make them willing to pay more in fees.”
2. Measuring Financial Advice: Aligning Client Elicited and Revealed Risk By John Thompson, Longlong Feng, R. Mark Reesor, Chuck Grace and Adam Metzler
Financial advisors use questionnaires and discussions with clients to determine a suitable portfolio of assets that will allow clients to reach their investment objectives. This paper compares Know Your Client (KYC) profile risk allocations to their investment portfolio risk selections using a value-at-risk discrepancy methodology.
VaR is used to measure elicited and revealed risk to show whether clients are over-risked or under-risked, whether changes in KYC risk lead to changes in portfolio configuration and how cash flow affects a client’s portfolio risk.
The team demonstrated the effectiveness of VaR at measuring clients’ elicited and revealed risk on a dataset provided by a private Canadian financial dealership of over 50,000 accounts for over 27,000 clients and 300 advisors. By measuring both elicited and revealed risk using the same measure, they could determine how well a client’s portfolio aligns with their stated goals.
The study determined that using VaR to measure client risk provides valuable insight to advisors: to ensure that their practice is KYC compliant, to better tailor their client portfolios to stated goals, communicate advice to clients to either align their portfolios to stated goals or refresh their goals, and to monitor changes to the clients’ risk positions across their practice.
3. Racial Animosity and Black Financial Advisor Underrepresentation By Derek Tharp, Jeffrey A. DiBartolomeo, Michael G. Kothakota and Elizabeth Parks-Stamm.
Although Blacks represent 13.4% of U.S. population as of 2018, Black advisors represent only 1.6% of CFP professionals, according to CFP Board data from 2019. This number may be higher when the definition of financial advisors is expanded. However, representation of Black advisors is not consistent across the United States.