The United States has seen a dramatic shift in how pensions are invested. Managed savings (government or employer defined benefit plans) have given way to individually directed savings (defined contribution plans). A growing body of lab - and to a lesser extent field - evidence in behavioral finance raises concerns over this trend, arguing that individual investors are ill informed or even biased in their investment choices. Examples range from owning too much employer stock to using heuristics such as naive diversification. Many argue, however, that biased investors can still make good investments choices because intermediaries like financial advisors will help to undo their biases. In fact, 67% of US households owning equities or bonds consulted with a least one advisor between 2003 and 2008. Little is known, however, how this market for financial advice functions and whether it indeed leads to the desired outcomes for investors. The PI's propose two experiments to examine the supply and demand sides of the financial advice market. The first experiment uses an audit study methodology, novel to finance. Trained auditors visit advisors posing as "clients". Different (randomly assigned) treatments capture a number of investor biases: auditors vary both in the portfolios they present and the investment strategies they initially espouse to advisors. Outcome measures include the nature of advice that is given and attempts to de-bias clients. The treatments further allow the PI's to test advisor moral hazard; do they de-bias only when it leads to greater fees. Before the financial crisis, the PI's conducted a medium scale pilot that showed the feasibility of this approach as well as interesting results about advisors? selective de-biasing. The second experiment analyzes how, in the lab, investors assess advisor quality. Subjects see videos featuring financial advice from different advisors. The advice is randomly matched to advisors and varies in the extent to which it caters to biases, maximizes fee income or represents high quality advice. Subjects are asked to rate the quality of the advisor and the advice. The sample of test subjects will be drawn from a representative cross section of people in the adult working population; across different demographic subgroups, such as age, income, education and genders. The PI's have secured consent from several large employers in the Boston area to sign up some of their employees for the study.
Intellectual Merit: Together these studies will present some of the first data on this very important market. The PI's will collect quantitative data on a question that has only been discussed in the abstract. They use novel methods and random assignment to allow for causal inference and provide conceptual insights into the forces that shape the market for financial advice. For example, do investors provide market discipline for advisors? Could fee-income distort advisors? Answers to these questions will provide an important empirical basis for future theorizing and empirical on the market for financial advice.
Broader Impact: A better understanding of how individuals invest their money has broad implications. Financial academics and regulators struggle to understand if and how behavioral biases affect market prices (as the recent debate on noise trader models in asset pricing highlights). Macroeconomists struggle to produce accurate models of individual consumption and investment. These debates have consequences for regulatory policy broadly construed. Shedding light on them can therefore impact a variety of areas. The results will also have immediate implications for regulating investor choices (e.g. disclosure) and the market for advice specifically. The financial crisis has renewed interest in designing smarter regulation of consumer finance products and the market for financial advice in the US and around the world. A firm empirical understanding of this and any potential market failure is essential in designing better regulation. Regulation would take a very different form if catering to investors' biased beliefs was the main problem rather than fee induced moral hazard of advisors.
