Investors are too pessimistic. Financial advisors are not. – Center for Retirement Research

But can advisors help clients see the bright side?

I admit, I have always been skeptical of the financial advisory industry. To be fair, that's probably because I spent my entire 20s living on a grad school stipend in the not-so-cheap city of Boston. I spent most of my thirties in recovery. Questions like “How many packs of ramen noodles can a person safely eat per week?” and “How much is the rent!?” Financial gurus are rarely interested. But even as I get older and have more money to save, I tend to rely on index funds and my own expertise. Plus, as I've written before, target-date funds and inertia can do a good job of putting many people on a legitimate downward path toward the end of their careers.

So when I saw a recent study on financial advice conducted by colleagues at Boston College's Center for Retirement Research, I tried to keep an open mind. This study explores two questions. First, what stock allocations do financial advisors recommend? Secondly, will this suggestion affect the customer’s investment behavior? (This study is part of a broader initiative conducted in partnership with Jackson National Life Insurance Company.) These questions are important—market risk is an important consideration for people who rely on financial assets in retirement. Although perhaps one in four Americans employs a financial advisor, the academic literature is unclear about advisors' advice about risk and its impact on clients.

As a skeptic, I think the answer to the first question is that advisors recommend assets with higher commissions. As a teacher, I think the answer to the second question is that a minority of clients will listen to the advice and the majority will ignore it. sigh. However, I continued reading with an open mind. To answer these two questions, researchers surveyed financial advisors and investors. On the advisory side, the sample included 400 advisors with at least 3 years of experience, $30 million in assets under management, and 75 clients. For investors, the sample includes 1,016 individuals aged 48 to 78 years with total investable assets of at least $100,000. Unfortunately, these surveys didn't link advisors and clients, but the researchers tried a weighted approach to compare advisors' recommendations to investors' decisions.

Regarding the first question, advisor surveys show that there is wide variation in recommended stock allocations and, therefore, wide variation in risk. For benchmark clients, the average recommendation is to allocate 48% to stocks, but the standard deviation is large – 18%. So the researchers wanted to know what caused this difference. One of the first things they found heightened my suspicions—advisors who relied on fees calculated as a percentage of assets recommended increasing stock allocations. This makes sense if advisors are just trying to maximize their fees, since stocks have higher returns on average but have greater downside risk. Then, again, I reminded myself—trying to keep an open mind—that advisors only get higher fees if they make their clients more money. As long as the advisor respects the client's wishes regarding risk, seeking higher returns is not a bad thing.

So my skepticism diminished when I saw that advisors were actually very responsive to their clients' risk appetite—they weren't just recommending tons of stocks all the time. For clients with lower risk tolerance, the advisor only recommends allocating 30% of assets to stocks, more than one standard deviation below the baseline. Advisors' decisions were also influenced by their own preferred strategies—those seeking to maximize total returns selected more stocks, while those targeting the income floor recommended fewer stocks. Clearly, there's more going on here than simple self-interested advice.

Okay, so what impact does this advice have on the customer? It turns out that most investors prefer to hold fewer stocks than a theoretically optimal portfolio, especially before retirement. Surveys of investors find that for pre-retirement savers, their preferred stock allocations are well below even the most conservative recommended glide paths based on economic theory. Essentially, investors want to accept too little risk and thereby give up returns. Advisors appear to help offset this effect. Among investors who said advisor advice changed their behavior, 60% said it caused them to take greater risks. This shift is almost certainly a good thing, given that many investors have less than optimal risk tolerance and advisors have a more rational perspective.

Finally, my colleagues' research assuaged some of my skepticism about the recommendations. Given the overly cautious attitude toward risk among many investors, it seems a healthy push to boost stock allocations would be useful. Maybe when I'm far away from my ramen days and closer to retirement I'll consider getting some help too.