New research from Professor Simon Gervais finds that commissions incentivize advisors to recommend unsuitable investments to clients
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A paradox lies at the heart of the financial advice industry: the professionals we trust with our life savings are among the highest-paid yet among the least trusted in our economy, with significant records of misconduct within their ranks.
While advisors should always prioritize client-investment fit, the reality is that they are incentivized to recommend certain products over others, not necessarily to act in their clients’ best interests, said Professor Simon Gervais of Duke University’s Fuqua School of Business.
“The temptation comes from the fact that when they sell ‘specialized' products, they receive a commission,” Gervais said.
A “specialized product” — an investment mix featuring higher-risk, higher-reward financial assets (think of stock options, or cryptocurrencies) — may not be the right choice for people with a risk profile more suited to more standard investments (think of index funds).
In the working paper, “Ethics and Trust in the Market for Financial Advisors,” Gervais and John Thanassoulis of the University of Warwick, UK, found that investment funds maximize their profits by offering bonuses — commissions — to the advisors who sell risky products to their clients.
[This article has been reproduced with permission from Duke University's Fuqua School of Business. This piece originally appeared on Duke Fuqua Insights]