Wednesday, October 1, 2014

Do Financial Advisors Boost Savings Rates?

Recently, The Conference Board of Canada came out with the report Boosting Retirement Readiness and the Economy Through Financial Advice (sign up required—readers may prefer to simply search for the title online). They conclude that if more people used financial advisors, they would save more money, and the country would benefit over the long term. Unfortunately, it relies on a flawed study.

This new study does not do any original research into the effects of financial advisors; the authors rely on previous work. They acknowledge that advisors do not produce enough extra returns to cover their fees, but that “the real benefit of having an advisor may not be performance-related at all. It may have more to do with engendering beneficial savings behaviour among clients.”

Unfortunately, the authors rely primarily on the 2012 study Econometric Models on the Value of Advice of a Financial Advisor to justify the claim that financial advisors boost savings. A couple of years ago I pointed out the serious flaws in this study. I’ll briefly summarize.

Advisors seek out clients who already have significant savings. The 2012 study did not control for initial wealth. Advisors tend to drop clients who fail to save enough money over time; these clients don’t generate enough fees to justify the effort of providing them financial advice. The 2012 study did not account for this factor which created survivorship bias in their data.

Based on the flawed 2012 study, The Conference Board simply presumed that if enough people currently not receiving advice began using an advisor, their savings rates would rise by amounts indicated by the 2012 study. Even if we had a solid study showing that advisors encourage higher savings, it is very likely that the amount of increased savings would be far less than indicated by the 2012 study.

There is another source of bias here. Those people who actually have the skills to handle their own money tend not to use advisors. When The Conference Board study presumes that a fraction of people not using an advisor start doing so, this will include some people already managing their money well. If some of these people started paying for advice, their savings would be lower over time due to advisor fees. In my case, if I used a financial advisor, I’d have paid fees over the years adding up to the price of a house.

I have no doubt that most people could use good financial advice. However, the current Canadian model where advisors sell expensive actively-managed mutual funds leads to high costs and minimal real advice. We need a model where people pay for advisors separately from paying for mutual fund management. This will lead to increasing the number of advisors who are more than just mutual fund salespeople.

11 comments:

  1. It's the kind of argument that Personal Trainers use as well, if you have a trainer you are more likely to stay in shape, because the trainer will keep you to a strict regimen of exercise, but will they? Do they stop you from eating crap? If you don't call them, do they call you to set up exercise things?

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    1. @Big Cajun Man: My guess is that personal trainers work well for most people, but the question each of us has to ask is whether the cost is worth it.

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  2. In my view, the easiest way to boost savings rates is to increase CPP contributions.

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    1. @Anonymous: Since the main concern is to boost savings rates among people who don't already save, some mandatory program like CPP seems like the best candidate. However, the frightening rise in investment costs within CPP makes me very nervous.

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    2. As long as you can opt out of the additional CPP then I agree, however I save enough money and would much rather invest where I see fit and not where the government decides. Also teaching people basic personal finance in high school would probably help aswell. The majority of people have no idea how to build a budget, how to save money and where they are overspending. Most people say they don't have enough money to save, but I see the same people turn down employer RRSP matching programs. If you don't have enough money how can you afford not to be given more free money?

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    3. @Anonymous: I doubt that much can be done about people who don't save unless you make saving mandatory (such as with CPP). This has the unfortunate side effect of forcing others who don't need help saving to divert some of their savings into CPP. I'm not sure where the best balance point is, but I'd sure feel better about higher CPP contributions if they kept their management costs lower.

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  3. Ah, a net worth clue! but I notice you cleverly didn't tell us whether the advisor could buy this house in rural Newfoundland or downtown Toronto.

    In the meantime, I agree that the study sounds fundamentally flawed. It's like many of the medical stories that confuse correlation with causation.

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    1. @Bet Crooks: I try to be vague about personal income and net worth. Not only did I not specify the house, but I've been somewhat vague about how long I've been investing.

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  4. I think it all comes down to value-for-money with any service.

    "We need a model where people pay for advisors separately from paying for mutual fund management."

    Absolutely, financial advisors should be required to perform a fiduciary duty. I doubt we'll (Canada) ever get there....

    We regulate plumbers and electricians but not financial advisors. Funny country.

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    1. @My Own Advisor: Unfortunately, people seem much less wary of their financial advisors than their plumbers and electricians.

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    2. This industry carries too many shingles to add to the confusion - CFP, CFA, PFP . Who adds value? Definitely need separation from sales and advice if one actually believes that's what you're getting when recommended a mutual fund. You are being sold something, buyer beware!

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