Financial advice: Can we guard against bad experts?

A new study pinpoints the dangers in our readiness to trust

A new multi-university study provides a fascinating – and sometimes concerning – insight into the relationship between financial advisers and their clients.

The resultant paper, to be published in international journal Management Science, highlights the potential for advisers to manipulate clients who have low levels of financial literacy, leaving them exposed to the prospect of poor investment decisions.

With the spotlight on an ageing population and the increasing importance of people properly managing their finances in retirement, the implications of the findings are significant.

One of the paper's authors, UNSW Business School professor Hazel Bateman, who heads the school of risk and actuarial studies, says the research demonstrates that advisers could set out to build trust with a client by giving industry-accepted advice on simple subjects early in their professional relationship as a means of extending work with that person.

"What we show is that this manipulation is possible, but not that it specifically happens," Bateman says. "However, because it's possible for this to happen it would be good to see certain changes in terms of the way financial advice is regulated and with the training of financial advisers."

'We still need to make sure the incentives align so that financial advisers are giving advice in the best interests of clients rather than in ways that might benefit themselves'

HAZEL BATEMAN

They keep going back

The paper, First Impressions Matter: An Experimental Investigation of Online Financial Advice, is the work of Bateman; professor Susan Thorp from University of Sydney Business School; professor Julie Agnew from Raymond A. Mason School of Business in the US; Christine Eckert from UTS Business School; Fedor Iskhakov from Australian National University; and professor Jordan Louviere from University of South Australia.

It explores how individuals assess the quality of financial advice they receive and the manner in which they form judgments about advisers. A clear finding is that first impressions count; that is, advisers who earn the respect of clients through initial interactions by affirming clients' views on investment-related issues are more likely to gain their trust and keep their business.

Other key findings include the need for greater financial literacy in the community, a tendency for many clients to retain the services of their financial adviser even if they are getting poor advice, and the inability of some clients to tell the difference between genuine and fake qualifications of advisers.

The study builds on earlier research, including from the Australian Securities & Investments Commission, indicating that clients often continue to trust advisers who give poor-quality or self-interested advice.

According to Bateman, there is a mismatch between consumers who view the advice they are given as very good even when an objective evaluation of that advice finds it to be poor.

"Because they trust the adviser they keep going back," she says.

Clients are vulnerable

The researchers conducted an online experiment in which they produced videos of professional actors who played the role of advisers and delivered recommendations on a range of financial topics. Within each topic, correct and incorrect advice was given. The videos were then shown to groups of people who were asked to identify which of the advisers they would trust.

Thorp says it is clear that advisers who gave bad advice early in the process on relatively straightforward matters, such as paying off credit cards and debts, were much less likely to be trusted with later recommendations.

"To some extent it worked in reverse," she says. "If they gave good advice on easy topics, they were more likely to be trusted later."

With more complicated decisions, such as superannuation investments, far fewer people were able to tell the difference between good and bad advice. As a result of the research, Thorp has called for a tightening of regulations to protect "vulnerable" clients.

The findings, she says, indicate the requirement for higher qualifications and standards for financial advisers, while the advisory industry and regulators need to more rigorously enforce laws protecting consumers.

"What's important here is that the skill gap between the client and the adviser can be large. The potential for misunderstanding or manipulation is quite high in this situation. In other words, clients are vulnerable so they need to be properly protected."

Bateman notes that clear steps have already been taken to improve practices in the sector through Future of Financial Advice (FoFA) reforms that have targeted sales commissions and other forms of conflicted remuneration to advisers, along with a shift to fee for service.

"But we still need to make sure the incentives align so that financial advisers are giving advice in the best interests of clients rather than in ways that might benefit themselves," Bateman says.

'There wasn't a wide understanding of what the good credentials were or what the real credentials were'

SUSAN THORP

Ongoing education

David Cox, head of government relations at Challenger, a leading Australian investment management firm, believes the research is a reminder of the inherent difficulty that clients often have in understanding the advice they are given.

"Because they're not familiar with the concepts and terms, it makes it very difficult for them to come to a judgment about the advice they're being given," Cox says.

Adding to the complexity, he notes, is that advisers and their clients have to contend with market risk, so advice that may have been entirely appropriate at one time may look ill-conceived in hindsight.

Challenger partnered with UNSW Business School when the university developed its leading courses for financial planners in Australia on advice for retirement planning and aged care.

With the risks around the retirement phase for investments differing markedly from the accumulation phase, Cox says retirees are grappling with a very complex set of issues. They do not know how long they will live; what markets will do immediately and over the long term; how to manage the effect of inflation on their buying power; how much income they can safely draw from their superannuation; and what products are available to help them manage these risks.

It is a specialist area that is developing rapidly and that underlines the importance of ongoing education for financial advisers.

"It's absolutely critical. If people don't have an excellent understanding of these things themselves then they're reliant on getting good advice."

The Australian government is about to legislate to establish a new standards-making body which will be responsible for educational requirements for financial advisers. Cox says one of its priorities should be ensuring best practice for retirement planning.

"It needs to be done sooner rather than later. The 700 Australians retiring every day – the baby-boomer cohort – are moving through the point of retirement quickly and every delay means that people are moving into retirement without necessarily getting the advice they deserve."

Credentials – real or fake

The researchers also raise interesting questions about the impact of an adviser's qualifications on clients, finding that consumers may not be able to distinguish between genuine and fake qualifications.

For example, participants in pre-testing as part of the study rightly regarded 'certified financial planner' – the foremost credential in Australia – as the highest qualification.

But worryingly, they gave more credence to some fake credentials, including 'master financial planner' and 'qualified financial planner with high designation', than other genuine qualifications.

"There wasn't a wide understanding of what the good credentials were or what the real credentials were," Thorp says.

She has no doubt the issue of adviser standards will stay on the radar given the increasing reliance on retirement savings for Australians as they enter the final stage of their lives.

"This is going to matter to more and more Australians as people reach retirement with bigger superannuation accumulations because that's clearly one of the key times people will go looking for advice. What we need to do is make sure the advisers are acting in the best interests of their clients."

According to Bateman, any debate about improving the financial literacy of consumers comes with some unknowns. Should the focus be on improving consumer education across the board, or should the priority be to teach people about specific financial products?

"There's an awful lot of uncertainty out there," she says. "Financial literacy is part of the story, but having good advice whereby the interests of the client are the most important thing is absolutely critical."

For information on advisers, visit the Australian Securities & Investments Commission's MoneySmart site at www.moneysmart.gov.au and see the link to a register of financial advisers.