To Seek or not to Seek Financial Advice

To Seek or not to Seek Financial Advice: A Synthesis of International Evidence Bersant Hobdari, Associate Professor bh. int@cbs. dk March 22, 2017

Agenda • Financial advice industry • Motivation and approach of this study • Models of financial advice – how financial advice is expected to create value • Findings • Implications

Financial Advice Industry • The size of global financial advisory market has been steadily increasing. Data from 2011 to 2016 show that the global financial advisory market grew from 54. 9 billion U. S. dollars in 2011 to 70. 4 billion in 2016, an increase of about 27%. • The size of financial advice industry is difficult to estimate, in part because of its diversity. In the US, the Bureau of Labor Statistics reports that 208, 400 individuals were employed as financial advisers in 2008, a number expected to increase to 271, 200 (30% increase) by 2018. • Limited public Nordic Numbers – so far

Motivation and Approach of this Study I • Demand for financial advice is a global phenomenon but frequently also highly disputed. • In general, individual (retail) investor demand for the following forms of financial advice has been steadily increasing: (1) debt advice (2) investment advice (3) loan advice (4) insurance advice and (5) tax advice.

Motivation and Approach of this Study II • Industry participants routinely claim that advice contributes by, among other things, improving savings and investment behaviors, selecting appropriate financial products, optimizing asset mix for personal circumstances, etc. • Public opinion surveys commissioned by the financial services industry consistently observe that those who seek advice are also those who are financially better off on several dimensions.

Motivation and Approach of this Study III • Not surprisingly, the impact, or value, of advice has drawn considerable attention, academic interest included. There are however numerous challenges to overcome when investigating a seemingly complex set of interrelated processes. Among these challenges is the type and volume of reliable data required to measure the various values or impacts of advice which is difficult to obtain. • This challenge is reflected in the academic literature, which is relatively scarce but steadily growing. Giving that the field is reaching a stage of maturity, in this study, I review the existing academic literature on the impact, or value, of financial advice to individual investors. • Only few Nordic studies

Geographical Representation Nationality Frequency US 19 Canada 6 Germany 9 Sweden 2 Italy 1 UK 5 Australia 2 France 1 The Netherlands 2 Switzerland 1 Turkey 2 China 1 New Zealand 1 In total 52 studies over 15 years

Models of Financial Advice • The literature identifies four types of financial advice providers: A. technical experts B. transactional agents C. counselors D. coaches – as this is not a common form of advice and very little evidence exists, it is left out of the review. In general, theoretical literature regarding why each form of advice is expected to affect financial behavior and longer-term outcomes is scarce.

Articles in the Survey Journal Review of Financial Studies Financial Review National Bureau of Economic Research SSRN Journal of Financial Intermediation Journal of Real Estate Research Finance Journal of Banking & Finance The Journal of Finance Swiss Institute of Banking and Finance RAND Corporation Financial Management Journal of Financial Economics Annals of Economics and Finance Applied Economics Australasian Accounting, Business and Finance Journal of Personal Finance Journal of Financial Services Research The New Zealand Finance Colloquium Journal of Financial Service Professionals Journal of Behavioral and Experimental Finance Journal of Retailing and Consumer Services Decision Support Systems Journal of Law and Society International Journal of Forecasting Personality and Individual Differences Journal of Family and Economic Issues Economics Letters Unpublished Frequency 5 2 3 11 1 2 2 1 1 1 1 1 3

Outcomes Investigated Dependent Variable Asset allocation Total assets held Investment risk level Returns/earning Wealth Savings Human bias Volatility Stock alpha Volume of trade Investment fees Type of assets held Equity/Debt shares Yield Spread Frequency 7 10 8 8 6 4 3 2 4 2 1 12 4 2 1

Examples of Definitions of Financial Advice Definition The author adopts The Employee Retirement Income Security Act (ERISA) definition of financial advice: “ERISA defines financial advice narrowly, as a recommendation that is immediately actionable. ” The advisory mandate allows the clients to make all their own investment decisions, whilst they have the access to the bank’s research advice and execution services. The discretionary mandate authorizes the bank to manage a client’s investment based on his investment objectives. Author Chalmers et al. (2013) Advised variable that equals one for trades executed within five days of an advisory contact, that is, between t = 0 and t = 4, and zero otherwise. Advisor-initiated variable that equals one for advised trades that follows a contact that was initiated by the advisor, and zero otherwise. Hoechle et al. (2015) Financial Advice Intensity is a continuous variable and can take a value between zero and one, where zero implies self-managed accounts and one suggests full delegation of portfolio decisions to the professional advisors. Karabulut (2013) Financial service firms helping clients to reach their objectives. Advice measured as either normal or extended. Musto et al. (2015) Cao et al. (2017)

Findings – Technical Experts I • The academic literature on financial advice is rich, with most studies in this area focus on investment advisors. Overall, it appears that advising does not yield substantial benefits in terms of investment returns, with analysis yielding either non-significant or even negative effects on short-term financial outcomes (Hackethal et al. , 2010; Karabulut, 2013) • Studies not supportive to the value of financial advice find, among others, that clients who used financial advisors had lower average returns and were more likely to incur substantial losses on their investments. Furthermore, working with a financial advisor was not associated with better market timing or diversification strategies, and financial advising was linked to more trading, higher turnover, and higher trading costs.

Findings – Technical Experts II • Studies supportive to the value of financial advice generally find that financial advice increases investors' risk adjusted returns and asset composition, and that financial advice helps clients avoid tax and investment mistakes. (Gerhard & Hackethal, 2009; Montmarquette, 2015; Cici et al, 2016) • In this type of studies, selection issues are a major determinant of result reliability. Because investors who seek financial advice likely differ from investors who do not seek such advice in ways that affect financial outcomes, studies that fail to control for selection processes are likely biased. The high likelihood of selection bias makes it difficult to estimate the causal effects of financial advising using existing data.

Channels of Purchase of Financial Asset Eurobarometer Report on “Retail Financial Services”, 2011

Findings – Transactional Experts • Surprisingly, empirical research on the impact of compensation on transactional agents’ objectivity is fairly scarce. It is also difficult to compare studies with each other due to differences in the definition of compensation. • Several conclusions about transactional agents can be drawn from the limited literature. (a) First, it is clear that financial planners and advisors are compensated from a variety of sources including fees, commissions, salaries, and retainers. (b) Second, financial advisors who earn commissions appear to have an incentive to sell products that will garner the highest commissions, and their compensation is rarely if ever tied to the longterm success of their advice. However, what little evidence does exist suggests that concerns about commission-based pricing may be overstated.

Findings – Financial Consulting • The financial counseling research has focused on different types of counseling provided to individuals such as mortgage servicing, credit issues (credit card and non-mortgage consumer loans) and homeownership counseling. • Overall, the literature on financial counseling is subject to many of the same issues as the literature on technical financial advisors, especially in terms of potential selection biases and heterogeneous program designs. Initial descriptive findings across many of these studies (which simply compare outcomes between participants and nonparticipants but do not control for baseline differences between the two groups) suggest that counseling has significant impacts. However, once selection effects are controlled, most of the descriptive findings disappear.

Where do we go from here? • Several important issues emerge from the survey • There is evidence to suggest financial advice matters. Yet, the selection issues make the findings not fully reliable. More needs to be done through large-scale analysis controlling for investor and advisor characteristics, or experimental designs isolating the selection issues • Other questions of interests to address: – – – Complementarity between financial literacy and advice. Where does the value of advice reside: in “alpha”, “beta” or “gamma”? Why do investors drop or change advisers? How much is one willing to pay for advice if it has value? Do low-balance or low-income investors benefit from advice?