How Do Client Trust and Financial Literacy Add to the Value of Financial Advice?

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1 Banking on the Future Rethinking the Financial Sector CBS 100 year celebration event October 30th, 2017 How Do Client Trust and Financial Literacy Add to the Value of Financial Advice? Prof. Dr. Oscar A. Stolper Institute of Accounting & Finance Philipps-Universität Marburg

2 Financial advice and the good society How can finance (...) be used to advance the goals of the good society (...)? Shiller, 2012 Finance exists to support goals College education Home ownership Retirement income Financial advice as a tool to achieve personal goals Good financial advice is goal-driven and not about making money per se Source: Hackethal/Inderst,

3 Roads towards informed financial decisions 3

4 Roads towards informed financial decisions 4

5 Roads towards informed financial decisions Financial advice as a substitute for financial literacy? Does financial advice benefit advisees? The role of trust in financial advice 5

6 FA as a substitute for financial literacy? The act of seeking advice requires the recognition of one s own ignorance Kruger and Dunning, 1999 / Least financially sophisticated DC plan holders most likely to take advice (Hung/Yoong, 2010; Chalmers and Reuter, 2012) Low literate indebted individuals more likely to ask for professional credit counseling (Disney et al., 2015) & Individuals with higher levels of financial literacy more likely to receive financial advice (Collins, 2012; Finke, 2013) Financial advisors as babysitters (Hackethal et al., 2012) Less financially literate rely more on informal sources of financial advice, e.g. friends and family (Van Rooij et al., 2011) 6

7 FA as a substitute for financial literacy? [Even] unbiased financial advice is useless unless it is followed Bhattacharya et al., 2012 Less financially sophisticated bank clients more often fully delegate investment decisions (Calcagno/Monticone, 2015) Financially sophisticated retail investors less likely to implement investment advice (Hackethal et al., 2011) advice on retirement planning (Bucher- Koenen/Koenen, 2015; Stolper, 2017a) standardized FA (Stolper, 2017a) advice on insurance of major life risks (Stolper, 2017a) 7

8 Does financial advice benefit advisees? FA enhances general PF efficiency (Bhattacharya et al, 2012) FA improves PF diversification (Kramer, 2012; Von Gaudecker, 2015) FA mitigates disposition effect (Shapira/Venezia, 2001; Hoechle et al., 2016) FA provides tax-related benefits (Finke, 2013; Cici et al., 2017) Advisor-managed PF underperform passive benchmarks (Bergstresser et al., 2009; Von Gaudecker et al., 2015) Advisor-managed PF underperform self-directed investments (Hoechle et al., 2016) FA fails to de-bias clients (Mullainathan et al., 2012) FA encourages clients to trade excessively (Hackethal et al., 2011) 8

9 Does financial advice benefit advisees? NFGS-Project: The causal impact of financial education and financial advice on stock-market participation: an interventional study Aims & Scope How to promote and secure an equity culture in Denmark? How to make individuals take advantage of the equity premium? Conclusions provide (participating) financial institutes with a valuable competitive advantage 9

10 The role of trust in financial advice Majority of retail clients trust their advisor (Mullainathan et al., 2012; Monti et al., 2014; Gennaioli et al., 2015) Interpersonal trust formation key to understanding the client-advisor interaction and counseling outcomes 10

11 The role of trust in financial advice How does trust evolve? Clients typically cannot discern good from bad advice (Chater et al., 2010; Agnew et al., 2016) Advisees turn to salient factors when forming impressions about trustworthiness of FA (Monti et al., 2014; Agnew et al., 2016; Stolper/Walter, 2017) The riskier the investment advice, the more likely clients are to discount it if advisor does not hold securities herself (Stolper, 2017b) Is trust in financial advisors warranted? Advisors cater to client s misperceptions (Anagol et al., 2015; Mullainathan et al., 2016) Advisors employ confirmation strategies (Gennaioli et al., 2015; Agnew et al., 2016) 11

12 Financial advice the road ahead What is your job s risk of computerization over the following 20 years? Source: BBC.com; Frey/Osborne (2017) 12

13 Financial advice the road ahead Estimating the market for robo advice (example: Germany) = Revenue Assets x x x % Advisees % Market share RA Mgmt. Fees Assets (total) Assets (Generations X and Y) % Advised Individuals % Market Share RA Mgmt. Fees ca. 1,000,000,000,000 EUR ca. 130,000,000,000 EUR ca. 66% ca. 10% (prospected) ca. 50 bp (prospected) Revenue Robo Advice Industry Germany ca. 43,000,000 EUR Source: Etheber (2016) 13

14 Financial advice the road ahead Estimating the market for robo advice (example: Germany) = Revenue Assets x x x % Advisees % Market share RA Mgmt. Fees Assets (total) ca. 1,000,000,000,000 EUR AuM Robo Assets Advice (Generations X and Y) (prospected) % Advised Individuals AuM Robo Advice (2015) % Market Share RA m EUR 170 m EUR Mgmt. Fees Revenue Robo Advice Industry Germany ca. 130,000,000,000 EUR ca. 66% ca. 10% (prospected) ca. 50 bp (prospected) ca. 43,000,000 EUR Source: Etheber (2016) 14

15 References Agnew, J.R., Bateman, H., Eckert, C., Iskhakov, F., Louviere, J., Thorp, S., First Impressions Matter: An Experimental Investigation of Online Financial Advice. Manage. Sci. Anagol, S., Sarkar, S., Cole, S., Understanding the Advice of Commissions-Motivated Agents: Evidence from the Indian Life Insurance Market, HBS Working Paper Bergstresser, D., Chalmers, J., Tufano, P., Assessing the costs and benefits of brokers in the mutual fund industry. Rev. Financ. Stud. 22, Bhattacharya, U., Hackethal, A., Kaesler, S., Loos, B., Meyer, S., Is unbiased financial advice to retail investors sufficient? Answers from a large field study. Rev. Financ. Stud. 25, Bucher-Koenen, T., Koenen, J., Do seemingly smarter consumers get better advice? MEA Discussion Paper. Calcagno, R., Monticone, C., Financial literacy and the demand for financial advice. J. Bank. Financ. 50, Chalmers, J., Reuter, J., Is conflicted investment advice better than no advice?, NBER Working Paper No Chater, N., Huck, S., Inderst, R., Consumer decision-making in retail investment services : A behavioural economics perspective, Report to the European Commission. Cici, G., Kempf, A., Sorhage, C., Do Financial Advisors Provide Tangible Benefits for Investors? Evidence from Tax-Motivated Mutual Fund Flows. Rev. Financ. Collins, J.M., Financial advice: a substitute for financial literacy? Financ. Serv. Rev. 21, Disney, R., Gathergood, J., Weber, J., Credit counseling: a substitute for consumer financial literacy? J. Pension Econ. Financ. 14, Etheber, T Quo Vadis Robo Advice? Das Robo Advice-Dossier. IT-Finanzmagazin, Ausgabe 15. April. Finke, M., Financial advice: does it make a difference?, in: Mitchell, O.S., Smetters, K. (Eds.), The Market for Retirement Financial Advice. Oxford University Press. Frey, C.B., Osborne, M.A., The future of employment: How susceptible are jobs to computerisation? Technol. Forecast. Soc. Change 114, Gennaioli, N., Shleifer, A., Vishny, R., Money doctors. J. Finance 70,

16 References Hackethal, A., Haliassos, M., Jappelli, T., 2012a. Financial advisors: A case of babysitters? J. Bank. Financ. 36, Hackethal, A., Inderst, R Auswirkungen der Regulatorik auf kleinere und mittlere Banken am Beispiel der deutschen Genossenschaftsbanken. Gutachten im Auftrag des Bundesverbandes der Deutschen Volksbanken und Raiffeisenbanken (BVR) Hackethal, A., Inderst, R., Meyer, S., 2012b. Trading on Advice. Work. Pap. Hoechle, D., Ruenzi, S., Schaub, N., Schmid, M., The Impact of Financial Advice on Trade Performance and Behavioral Biases. Rev. Financ. 50. Hung, A., Yoong, J., Asking for Help: Survey and Experimental Evidence on Financial Advice and Behavior Change, in: Mitchell, O.S., Smetters, K. (Eds.), The Market for Retirement Financial Advice. Oxford University Press, pp Kramer, M.M., Financial Advice and Individual Investor Portfolio Performance. Financ. Manag. 41, Kruger, J., Dunning, D., Unskilled and unaware of it: how difficulties in recognizing one s own imcompetence lead to... J. Pers. Soc. Psychol. 77, Monti, M., Pelligra, V., Martignon, L., Berg, N., Retail investors and financial advisors: New evidence on trust and advice taking heuristics. J. Bus. Res. 67, Mullainathan, S., Noeth, M., Schoar, A., The Market for Retirement Financial Advice. NBER Work. Pap. No Pauls, T., Stolper, O., Walter, A., Broad-scope trust and financial advice. Work. Pap. Shapira, Z, Venezia, I Patterns of behavior of professionally managed and independent investors. J. Bank. Financ. 25, Stolper, O., 2017a. It takes two to Tango: Households response to financial advice and the role of financial literacy. Forthcoming in: J. Bank. Financ. Stolper, O., 2017b. Do actions speak louder than words? Advisors personal portfolios and client response to investment advice. Work. Pap. Stolper, O., Walter, A., 2017a. Financial literacy, financial advice, and financial behavior. J. Bus. Econ. Stolper, O., Walter, A., 2017b. Birds of a feather: The impact of social proximity on the propensity to follow financial advice. Work. Pap. 16

17 References van Rooij, M.C.J., Lusardi, A., Alessie, R.J.M., Financial literacy and stock market participation. J. Financ. Econ. 101, von Gaudecker, H.M., How Does Household Portfolio Diversification Vary with Financial Literacy and Financial Advice? J. Finance 70,