Smart people prefer passive

How do people react to financial advice? It depends on who is receiving it, who is giving it, and what it consists of.

That’s the main unsurprising finding of a randomised control trial conducted by Antoinette Schoar and Yang Sun of MIT and Brandeis respectively. But the resulting NBER paper still contains some fun details — at least to those of us who have spent a few years in the active-passive trenches.

Your mind probably won’t be blown by the fact that people tended to more highly rate advice that fit their priors. But — somewhat more surprisingly — the results indicate that most people DO update their beliefs in the direction of the advice they receive, irrespective of their previous views.

The paper also found that people preferred advice from advisers charging a flat fee rather than commissions, which is a relief given how riddled with conflict the latter approach can be.

However drilling into the details it turns out that an advertising video in favour of passive investment funds (touting cost and diversification) was on average far more persuasive than one in favour of traditional active funds (advocating the benefits of stockpicking and market timing).

And this effect was “entirely” driven by the financially savviest members of the sample rating it highly, even if they previously held pro-active views. From the paper:

Financially literate individuals find the passive advice to be higher quality and demonstrate a strong ability to differentiate their responses to different types of advice. They appear resistant to being persuaded by the active narrative. In contrast, less financially literate subjects struggle to make this distinction and respond with similar magnitudes to both types of advice. This susceptibility potentially makes them vulnerable to lower quality financial advice.

. . . When examining whether subjects would return to the advisor with their own money- a proxy for their “trust” in the advisor- we find that financially literate individuals are less likely to return to the advisor recommending the active strategy, consistent with their rating of the advice.

Even so, the paper noted that recommending passive funds wasn’t necessarily a good idea for financial advisors:

Another finding is that although pro-passive subjects rated the passive advice significantly higher compared with the reference group, they are not more likely to return to the advisor who recommends the passive strategy. If generalized, this result implies that recommending passive funds is unlikely to be profitable for financial advisors.

If you think all this perfectly fits the priors of at least some people at FTAV you’d be entirely correct. But the data remains as damning as always.

Further reading:
— Super passive goes ballistic; active is atrocious (FTAV)
— Markets are ‘fundamentally broken’ due to passive investing, says David Einhorn (MarketWatch)