Home | Faculty and Research | Academic Groups | Finance | Finance Matters

Tag Archives: Antoinette Schoar

We Put Financial Advisers to the Test–and They Failed

From The Wall Street Journal

The world we live in asks us to make an abundance of financial decisions every day. These range from the inane, such as whether to risk a parking ticket when you stop for one minute to drop off your dry-cleaning; to the highly complex, such as which funds and investment products to pick for your retirement savings.

All of these decisions require risk-return tradeoffs. Unfortunately, while people have many opportunities in life to perfect their strategy concerning parking tickets, the same is not true for the complex and all-important decisions of how to invest retirement savings. By the time you learn whether a retirement strategy was the right choice, it is usually too late to change it.

Not surprisingly then, much research shows that a large fraction of the population is poorly prepared to make these financial decisions by themselves. Typically, when faced with complex and important decisions we rely on trusted experts for advice. Sick people turn to doctors, those accused of crimes seek the help of lawyers, and the list goes on. These cases all have a common feature: The expert adviser must abide by a strict code of conduct that puts the interest of the client first.

Surprisingly, the same is not always true for financial experts who advise people on their retirement savings. A majority of these professionals are not registered as financial advisers who have a fiduciary responsibility to their clients, which means putting their clients’ interest first. Instead, they are registered as brokers who only adhere to what is known as a “suitability” standard, which is much vaguer and only asks brokers to make recommendations that are consistent with the client’s interest.

In addition, the majority of brokers are not paid on the basis of the quality of their advice, but rather on the fee income they generate from their clients. To resort to a medical analogy, this is equivalent to simply prohibiting doctors from recommending drugs that kill you, while not actually requiring they prescribe the best drugs to cure your disease.

To better align the interest of advisers with their clients the Department of Labor issued rules earlier this year that require any investment professional who advises clients on their individual retirement accounts (rollover IRA) to act as fiduciaries, meaning they have to put their clients’ interests before their own. The new DOL rules only come into effect next year, but the industry has been aflutter with debates over these new rules. And there is still a lot of room for brokers who fall outside of the 401(k) and the rollover IRA area. So what should we expect?

In a  study with my co-authors Sendhil Mullainathan at Harvard University and Markus Noeth at Hamburg University, we set out to analyze the quality of financial advice commonly given to clients. We sent “mystery shoppers” to financial advisers in the greater Boston area who impersonated regular customers seeking advice on how to invest their retirement savings outside of their 401(k) plans. The mystery shoppers also represent different levels of bias or misinformation about financial markets. What we learned is highly troubling.By and large, the advice our shoppers received did not correct any of their misconceptions. Even more troubling, the advisers seemed to exaggerate the existing misconceptions of clients if it made it easier to sell more expensive and higher fee products.In addition, advisers strongly favored actively managed funds over index funds. In only 7.5% of sessions did advisers encourage investing in index funds.This is exactly counter to insights from finance research, which suggests that the average investor should choose low-cost index funds over actively managed funds. If advisers did happen to mention fees, they usually downplayed their importance.Of course, no one expects financial advisers to work pro-bono. But what is alarming is that adviser incentives seem to be set in such a way as to move clients away from the existing strategy regardless of its merit, i.e., even when they looked at a low‐fee-diversified portfolio. As a result, we found that advisers appeared willing to make their clients worse off in order to secure financial gain for themselves. This is bad new for savers–including the many baby boomers–seeking to boost their retirement nest egg.But our research also suggests that the proposed fiduciary standard can be beneficial. Indeed, we found that advisers who have a fiduciary responsibility toward their clients provided better and less biased advice than those that were merely registered as brokers. The former were less likely to move people away from index funds and to reinforce erroneous beliefs about the market.There is an important additional benefit to a policy that reduces conflicts of interest between clients and their advisers. It also helps in harnessing the market’s competitive forces to the benefit of consumers rather than to their detriment. As many responsible financial advisers will point out, if retail investors are poorly informed, advisers who provide sound financial advice often find it difficult to compete with less sanguine competitors.So holding financial advisers to higher fiduciary standards is not only good consumer financial protection but is also good market economics.

Read the full post at The Wall Street Journal

Antoinette Schoar is the Michael M. Koerner (1949) Professor of Entrepreneurship and Professor of Finance at the MIT Sloan School of Management.

Rethinking How the Housing Crisis Happened

New research casts into doubt the central storyline of 2008—that this was ever a subprime crisis to begin with.

“In 2006, Robert and Julia Tanner borrowed $30,000 to put an enclosed patio on their home that they had somehow managed to live without for 25 years. Why don’t you ask them about that when they’re spitting in your face while you walk them to the curb? Why don’t you ask the bank what the hell they were thinking giving these people an adjustable rate mortgage? And then you can go to the government and ask them why they listed every other regulation … You, Tanners, the banks, Washington, every other homeowner and investor from here to China turned my life into evictions.”

So Florida businessman Rick Carver lectures a young protégé in “99 Homes,” a 2014 film that casts the late-2000s housing collapse as a morality play. Carver, loaded with unforgiving moral certitude by the actor Michael Shannon, orders the Tanners’ eviction while standing in an empty McMansion. He’s living there part time after evicting the tenants when their mortgage went underwater.

“99 Homes” is littered with ruin. Nobody—the poor, the Tanners, the McMansion dwellers—escapes, or escapes blame for, the crisis. Now research from MIT Sloan finance professor Antoinette Schoar finds this picture more true than is commonly accepted. In fact, Schoar argues, it was middle-class borrowers with good credit who drove the largest number of dollars in default.

“A lot of the narrative of the financial crisis has been that this [loan] origination process was broken and therefore a lot of marginal and unsustainable borrowers got access to funding,” Schoar said in September at the MIT Golub Center for Finance and Policy’s annual conference. “In our opinion, the facts don’t line up with this narrative … Calling this crisis a subprime crisis is a misnomer. In fact, it was a prime crisis.”

Read the full article here>>

Reception Held in Honor of Bengt Holmström, co-recipient of the 2016 Nobel Prize in Economics Sciences

On  Tuesday, November 1st the MIT Sloan Office of the Dean, Finance Group and Applied Economics Group co-hosted a reception in honor of Professor Bengt Holmström. Approximately 175 faculty, students and staff members gathered to congratulate Professor Holmström on being selected as the co-recipient of the 2016 Svergies Riksbank Prize in Economics Sciences in Memory of Alfred Nobel.

Speakers included David Schmittlein, John C Head III Dean, Professor Robert Gibbons, Sloan Distinguished Professor of Management, Professor Stephen Ross, Franco Modigliani Professor of Financial Economics, and Professor Antoinette Schoar, Michael M. Koerner (1949) Professor of Entrepreneurship.

Photos from the event can be viewed here>>