How we react to financial advice

Will my pension enable me to live a good life when I retire? If not, how can I save up and invest my money in ways that will allow me to live comfortably in old age? Most of us do not have the expertise, time or confidence needed to answer such questions. Instead, we look to financial advisers for help and guidance.

Although these are important questions that are relevant to many people, we lack systematic knowledge of why we, as clients, decide to follow (or not follow) the recommendations we get from our advisers, and what makes us repeatedly seek advice from financial advisers. This has now been investigated by Charline Uhr, Associate Professor in Economics at Aarhus BSS, Aarhus University.

Using a unique data set covering advisory meetings with 10,063 German online brokerage clients between 2005 and 2015, Charline Uhr has shed light on what it takes for us to reach out to an investment advisor and ask for help with our investments.

"Recommendations leading to positive outcomes make people more inclined to seek advice a second time, while a negative performance is associated with lower-quality advice"

^{Charline Uhr, associate professor, Department of Economics and Business Economics}

Charline Uhr’s study shows that a positive performance based on the initial financial advice received by clients encourages them to seek financial advice more often in the future and make them more likely to follow the recommendations they receive.

“Based on their initial experience, clients evaluate the advice they have received and adjust their demand for and use of financial advice. Recommendations leading to positive outcomes make people more inclined to seek advice a second time, while a negative performance is associated with lower-quality advice and therefore makes people less inclined to seek advice again,” says Charline Uhr.

Specifically, clients who experience a positive outcome from assets recommended by their financial adviser during their first meeting are twice as likely to contact the advisory service a second time, compared to clients who experience a negative outcome.

The data also shows that clients experiencing a positive outcome based on the advisor’s recommendations at the first meeting subsequently follow 13% more of the recommendations they received, compared to clients experiencing a negative outcome.

The average investor in Charline Uhr’s data set is a 54-year-old married male. His self-reported risk profile is 3.91 on a scale of 1–5, where 1 indicates high risk aversion and 5 indicates low risk aversion. He has a portfolio of EUR 77,082 (DKK 575,000) and is more highly educated than the general population.

The data from Germany provides a picture of the trading activities and decisions of these clients, the timing of their advisory meetings and all the recommendations received from their financial advisers.

The advice was provided on the client’s initiative, and clients were randomly matched to advisors each time. So no special relations existed between the clients and the advisers. All the advice was provided free of charge over the phone based on a list of recommended investment opportunities compiled by the bank. There were no incentives for advisers to push clients in a particular direction as the advisers did not generate any income from the investments, for example in the form of bonuses or other commissions. Nor were the advisers allowed to pressure the clients into taking on risks that exceeded their risk profile. After the advisory meetings, it was up to the clients to decide whether or not to follow the advice they had been given.

"If you are managing perfectly well on your own, why not just carry on without an adviser’s help?"

^{Charline Uhr, associate professor, Department of Economics and Business Economics}

Charline Uhr discusses two types of investors: ‘validators’ and ‘delegators’. Validators identify relevant investment opportunities themselves and then seek reassurance from financial advisors that the purchase they are about to make is a sound one. They are effectively looking for a second opinion. Delegators, on the other hand, do not have the necessary time, expertise or confidence to identify relevant investment opportunities and therefore leave it up to their adviser to recommend which investments they should focus on. Despite the differences, the responses of validators and delegators to positive investment outcomes are the same: They come back for more advice.

Even though the sampled investors received financial advice, they still conducted trades that were not based on recommendations from financial advisers. These actions can be called self-directed trades, where investors throw themselves into investing on their own. Interestingly, they also seek more financial advice when their self-directed trades do well, despite the fact that no adviser was involved when they first bought these securities. Charline Uhr is surprised:

“One might imagine that investors who have invested on their own would not reach out to an adviser until their investments started performing poorly. In other words: If you are managing perfectly well on your own, why not just carry on without an adviser’s help? However, it turns out that these investors are also more likely to seek financial advice afterwards. Perhaps their positive experience causes attention to the portfolio that triggers a reaction by the investor. The investor then starts seeking more information by also seeking financial advisory services. This is in line with earlier research showing that attention causes investors to log in more often and to purchase securities with a high past return. We call the latter strategy “performance chasing”,” says Charline Uhr.  

Like for the performance of securities recommended by a financial adviser, the performance of self-directedly purchased securities is related to investors seeking advice almost twice as often after a positive investment compared to investors who experience poor returns on their own investment efforts.

"Past performance is not indicative of future returns"

^{Charline Uhr, associate professor, Department of Economics and Business Economics}

As is the case in many other areas of life, we learn from and are influenced by previous experiences when it comes to investing. This applies not only to investors engaging in self-directed trades, but also to investors who delegate investment decisions. According to Charline Uhr, this gives cause for further reflection:

“In general, investors should not base their decision to seek and follow financial advice on past performance, as past performance is not indicative of future returns. Bearing this in mind, the authorities and decision-makers could think about providing more relevant and easily understandable signals about the quality of financial advice,” says Charline Uhr, elaborating:

“Potential measures could include providing more information on portfolio diversification and risk, which are far better indicators of portfolio quality. Tools could be added that allow investors to check how their own portfolio or the portfolio recommended by their adviser scores in terms of diversification and risk.”

Banks may also like to take note of the findings of Charline Uhr’s study. They could become better at asking financial advisers to contact their clients in situations where the recommended products have performed poorly. According to the study, investors are less inclined to reach out to their financial adviser in such situations. By taking the initiative, the banks would be better able to retain clients and help them to avoid making poorly informed decisions, such as holding on to loss-making investments for too long.

Facts

We strive to comply with Universities Denmark’s principles for good research communication. For this reason, we provide the following information as a supplement to this article:

Type of study	This paper is an empirical study based on transaction-level data of portfolio trades and holdings, checking, savings, and settlement account balances and transactions from an online bank. These are proprietary data that are not collected by Charline Uhr but are archived via the bank's regular business operations. The data include (de-identified) information regarding individual clients’ financial account positions, transaction activities and some demographic statistics. All raw data are proprietary and belong to the bank; thus, Charline Uhr is unable to share the raw data with other researchers who are not approved by the data protection contract. However, several German and international researchers are currently using these data and have published research papers using these data. The average investor in this dataset is representative of the average stock market participant (cf. the research article).
External collaborators	This research article is a part of an ongoing data-sharing relationship with a large German brokerage, and the data are not collected by Charline Uhr but are archived via the bank's regular business operations.
External funding	This research project received funding by the Danmarks Frie Forskningsfonds Inge Lehmann as part of the project titled “Help needed? Private investors and financial advice”.
Conflict of interest	None
Other	No
Link to the scientific article	When Financial Advice Leads to Positive Performance: Evidence from Repeated Client–Advisor Interactions
Contact	Charline Uhr, c.uhr@econ.au.dk, +45 20585116 www.au.dk/en/c.uhr@econ.au.dk sites.google.com/view/charline-uhr