Garbage in, garbage out, as the saying goes. Author and behavioral economics professor Dan Ariely says financial advisors are doing a poor job helping their clients achieve their goals because they're asking the wrong questions.
In a controversial blog post sure to attract the attention and possibly the ire of financial advisors, author and behavioral economics professor Dan Ariely says "a simple algorithm" can do what "overpaid" advisors do, "probably with fewer errors."
A professor at Duke University and author of two bestselling books arguing against the assumption that consumers are rational actors, Ariely's post (an edited version of which is published in the September edition of the Harvard Business Review) calls standard financial advice "strange and not very useful" in that the two basic questions asked of clients are the wrong questions and generate very wrong answers.
The questions advisors ask are: "How much of your current salary will you need in retirement?" and "What is your risk attitude on a seven-point scale?" In Ariely's experiments, people typically say they need 75% of their income in retirement, feeding back to advisors in circular fashion the standard industry rule of thumb.
But that is nearly half the 135%-of-income calculation resulting from the more meaningful questions Ariely suggests, such as "How do you want to live in retirement? Where do you want to live? What activities you want to engage in? And that makes sense, Ariely says, since people are apt to want to do more than watch TV or take walks on the beach when retirement endows their days with another eight or more hours of free time.
"Says Ariely: You can see why I'm confused about the 1-percent-of-assets-under-management business model: Why pay someone to create a portfolio that's 60 percent too low in its estimation?"
On the second question concerning clients' risk tolerance, Ariely says people basically choose a level of risk slightly above or below the mean, depending on their self-perception as more or less risk-averse than others. And the way they report their risk attitude varies depending on the scales given them.
