Are investment advisors worth the price? In the August 2012 version of their paper entitled “The Impact of Financial Advisors on the Stock Portfolios of Retail Investors”, Marc Kramer and Robert Lensink investigate the impact of financial advisors on individual investor portfolio returns, risk, trading frequency and diversification. For sampled investors, the sponsoring bank standardizes strategic asset allocation advice, but the advisors made available to investors by the bank have great latitude in recommending specific stocks. While all investors are eligible for advice, each elects either an advisory relationship (randomly selected advisors) or self-directed trading. The study emphasizes controlling for any self-selection bias associated with the type of investors who seek advice, and focuses on common stock holdings to avoid any conflicts associated with mutual fund incentives. Using demographics and complete histories of common stock positions and trades for 5,661 individual advised and self-directed Dutch investors during April 2003 through August 2007 (193,418 monthly returns), they find that:
- The typical investor in the sample (both advised and self-directed) is a man or couple over 50 years old, with middle-class income and wealth.
- The average sampled investor underperforms the market by 0.2% per month. The average advised investor outperforms the average self-directed investor based on raw and market-adjusted gross and net returns, but the gaps are small.
- The average sampled investor holds 4.4 stocks and experiences a monthly net return volatility of 5.45%, compared to just 3.51% for the Dutch stock market. Equity portfolios of advised investors (5.2 stocks on average) exhibit significantly lower average volatility and idiosyncratic risk than those of self-directed investors (3.3 stocks on average).
- Simple assessments that assume no self-selection bias indicate that advisors add little or no value.
- More complex analyses that control for self-selection bias in advice seeking indicate that advisors:
- Modestly increase average gross return.
- Substantially increase average gross risk-adjusted return by suppressing portfolio volatility. This improvement derives from sophisticated diversification (attentive to correlations) and not from naive diversification (simply increasing the number of stocks held).
- Reduce average trading frequency, but increase average trading cost (due to a higher commission compared to self-directed).
- Modestly increase average net return, because improvement in average gross return more than offsets the higher average trading cost.
In summary, evidence indicates that advisors improve retail investor portfolio performance after minimizing conflicts of interest and accounting for self-selection bias.
Cautions regarding findings include:
- The sample (one bull market) does not encompass a variety of market conditions.
- Study conditions (common stocks only and a fixed advisory fee) may not be typical of market conditions for advisory services.
See the summaries of closely related research at “The Advised Versus the Self-directed”.
