Smart people prefer the passive

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How do people react to financial advice? It depends on who receives it, who gives it and what it consists of.

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

It probably won’t blow your mind that people have tended to value advice that suits them more. But – somewhat more surprisingly – the results indicate that most people update their beliefs in the direction of the advice they receive, regardless of their previous views.

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

However, digging into the details, it turns out that a promotional video in favor of passive investment funds (the cost of presentation and diversification) was, on average, much more persuasive than one in favor of traditional active funds (touting the benefits of storage and market timing ).

And this effect was “entirely” driven by the most financially savvy members of the sample rating it highly, even though they previously held proactive views. From paper:

Financially literate individuals perceive passive advice to be of higher quality and demonstrate a strong ability to differentiate their responses to different types of advice. They seem resistant to being convinced 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 makes them potentially vulnerable to poor quality financial advice.

. . . When examining whether subjects would return to the advisor with their 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 assessment of tips.

Even so, the paper noted that recommending passive funds was not necessarily a good idea for financial advisers:

Another finding is that although pro-passive subjects rated passive advice significantly higher compared to the reference group, they are no more likely to return to the adviser recommending the passive strategy. If generalized, this result implies that recommending passive funds is unlikely to be profitable for financial advisors.

If you think all of this fits perfectly with the priorities of at least some people at FTAV, you’d be right. But the data remains as damning as ever.

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