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First, Do No Harm

We're just as prone, maybe even more so, to making the classic behavioral mistakes.

Carl Richards, 02/10/2011

This article first appeared in the February/March 2011 issue of Morningstar Advisor magazine. Get your free subscription today! 

By now, you know that I'm constantly thinking about investing behavior and the mistakes investors make. During the past few months, I've started to consider the impact of advisors' behavior, too.

Morningstar's Don Phillips, who's never one to shy away from controversial topics, got me thinking about this "third rail" of our industry. In a recent column in this magazine, Phillips quoted an industry statistic claiming that 83% of assets going into mutual funds today are directed by financial advisors. At the same time, we're all familiar with the data that shows how poorly mutual fund investors perform. There's an obvious performance gap between fund and investor performance, one I've named the Behavior Gap.

One of the most common conversations at advisor conferences concerns how badly mutual fund investors do and how badly they need our help to close the gap. When you put these two facts together--the Behavior Gap and the 83% of assets--it's time we face a very large elephant in the room. As Phillips suggested, if 83% of mutual fund investors are getting advice from advisors and are doing poorly, maybe we advisors are part of the problem.

After seeing Phillips' piece, I read an article by Jason Zweig of The Wall Street Journal that discussed how advisors--not only investors--buy high and sell low. To demonstrate his point, Zweig highlighted how advisors who used TD Ameritrade had an average of 26% of client assets in bonds or cash in October 2007 (the market high), but then on March 9, 2009 (the market low), advisors had "jacked up their bonds and cash to 51%."

Based on my own mistakes and the ones I see other advisors make, it's obvious that we're just as prone, maybe even more so, to making the classic behavioral mistakes. We're often overconfident in our abilities because overconfidence bias is a problem of experts, and who better to think of oneself as an expert than a financial advisor? We may also be prone to make these behavioral mistakes because we spend so much time thinking, talking, and researching to stay informed.

For anyone who thinks I'm doing a hatchet job on our profession, please know that's not the point. My goal for myself and my hope for our industry is to acknowledge that these mistakes happen and to be honest with ourselves and our clients about why they happen. I know there's a tendency when we read things like this to point fingers at all the other advisors and say, "It's not me," but given the facts, there's certainly plenty of room for all of us to improve in 2011.

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