A new report from the Center for Retirement Research at Boston College uses two surveys of financial advisors and retirement investors to assess advisors’ portfolio recommendations and explore their apparent influence on clients’ risk appetite in ways that affect retirement security.
The results suggest that advisor use is associated with riskier portfolio allocations compared with the stated preferences of non-advised investors with an average self-identified risk tolerance.
Other findings show that advisors generally tailor their recommendations to clients’ risk tolerance during the accumulation phase, although not necessarily to the level that investors would seemingly choose on their own. This effect seems to be reversed, however, in the retirement income phase, with stock allocations among advised clients who own annuities being lower than the researchers anticipated.
Taken together, these findings may imply that advisors have a financial incentive to build riskier retirement portfolios during the accumulation phase, according to the CRR researchers. The analysis also shows that advisors seem to be delivering beneficial outcomes for many investors.
This is possibly due to advisors instilling a more realistic assessment of risks and returns in their retirement clients, the researchers conclude, even if their allocation advice is potentially motivated by a desire to collect larger asset-based fees.
Running the Analysis
In testing these conclusions, the report presents the results of regression analyses that relate advisors’ recommended stock allocations for a theoretical baseline client to various aspects of the advisors’ practice — including assumptions and perceptions on stock returns, compensation structure, whether practicing as an RIA and frequently used income strategies.
One key finding, according to the researchers, is that the higher the share of the advisor’s compensation derived from percentage-of-asset fees, the higher the recommended allocation to stocks under the baseline scenario.
The type of income strategy also matters. In particular, advisors who frequently use the total return approach recommend higher stock allocations on average, while those who frequently use the floor strategy recommend lower stock allocations. This latter finding likely reflects a higher priority being given to securing essential spending, according to the report.
“Interestingly, however, neither the risk premium for stocks in their financial models, nor their beliefs about the riskiness of stocks, appear to matter,” the authors point out. “Also, whether the advisor works for an RIA does not seem to have any direct impact on their recommendations or affect the impact of their compensation structure on recommendations.”
Bottom Line
The discrepancy between advisors’ recommendations and investors’ desired stock allocations, the report suggests, reflects that advisors tend to counsel their clients — at least those with low or moderate risk tolerance — to increase their stock allocations.
“This implication is consistent with the fact that actual stock allocations for investors are much closer to advisors’ recommended allocations than to investors’ desired allocations,” the authors conclude. “This interpretation is also supported by what investors say directly about working with an advisor.”
Namely, 33% of retirement investors who work with an advisor think that doing so has changed their risk appetite. Among this group, about three-fifths say it has increased their risk appetite rather than decreased it.
Given that advisors do affect some of their clients’ appetite for risk, the authors note, a natural follow-up is whether that influence improves their clients’ retirement security. Two primary pieces of evidence support the idea that advisor recommendations do, broadly, help, the authors say.
First, comparing data from the investor and advisor surveys suggests that advisors on average have a more rational view of the risks and returns of stocks versus bonds. One would expect retirement investors to benefit from advisors’ greater knowledge and expertise, according to the report.
Second, advisors’ average recommendations look “quite similar” to the stock allocations prescribed by target-date funds. For example, advisors’ recommended allocations for hypothetical clients with moderate and lower risk tolerance (48% and 30%, respectively) closely match the stock allocations of the moderate and conservative variants of the Morningstar Lifetime Allocation Index (48% and 32%).
“TDFs are designed to reflect the optimal asset allocation that economic and finance theory would predict for a rational investor within the lifecycle-model framework,” the authors say. “One would expect retirement investors to benefit from advisor recommendations that align broadly with optimal allocations based on long-standing principles of economic and finance theory.”
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