Financial Advice and Trust

AbstractThis article exploits new questions in the National Financial Capability Study to examine the determinants of trust in financial professionals and the impact of trust on the use of five types of financial advice. We find that trust declines with age and increases with willingness to take investment risk. Having some financial literacy increases trust, but having too much decreases it. Controlling for financial exposure, trust and cost are the two most important determinants of financial advice-seeking behavior. Saving advice is most affected with use increasing from 17% for the least trusting group to 44% for the most trusting group. © 2012 Academy of Financial Services. All rights reserved.JEL classification: D12; D14; G20Keywords: Financial advice; Trust; Financial literacy; Risk tolerance; Household finance1. IntroductionTrust plays a ubiquitous role in many facets of life, from personal relationships to international trade. For financial advisors, establishing and maintaining clients' trust is critical. Surveys conducted by the Certified Financial Planner Board of Standards (2004) and State Street Global Advisors (2007) rank trustworthiness as the most important criterion when choosing a financial adviser. Several factors make trust paramount in a financial context: large sums of money are entrusted to advisors, significant investment risk is present, sales-based incentives can create conflicts of interest, and fee schedules often lack transparency. With the recent financial crisis and die Madoff scandal, investors are now more acutely aware of these issues. This trend is captured by the General Social Survey (GSS) with the proportion of people with hardly any confidence in banks and financial institutions doubling from 21% in 2008 to 41% in 2010. In addition, the latest installment of the Financial Trust Index in December 201 1 shows that trust levels have not yet recovered from the 2008 crisis (Sapienza and Zingales, 2012). Needless to say, repairing trust is a key concern for financial professionals and institutions.The importance of trust has long been recognized by scholars in a variety of research areas including sociology (Luhmann, 1979), marketing (Morgan and Hunt, 1994), organizational behavior (Kramer and Tyler, 1996), and online commerce (Gefen et al., 2003). The attention to this topic in finance is relatively more recent with Guiso et al. (2008) showing that stock market participation increases with trust. From this multidisciplinary effort, several views of trust have emerged. Trust is in part a personal trait shaped by experiences, personality, and culture (Mayer et al., 1995). It is also context-specific and influenced by the characteristics of the trustee (competence, benevolence, and integrity) and the institutional environment. Rousseau et al. (1998) emphasize that trust is a multilevel concept, for example one might trust his banker but not the bank's officers.While the importance of trust is widely acknowledged, previous studies on the use of financial advice have not considered the role of trust because of data limitations. The literature on the determinants of financial advice-seeking behavior has largely focused on demographic and socio-economic factors; a few studies have also analyzed additional factors such as risk tolerance, positive/negative financial behaviors, and financial literacy.1 The recent release of the 2009 National Financial Capability Study (NFCS) gives us a unique opportunity to fill this gap in the literature. Specifically, this dataset assesses trust with the question "I would trust financial professionals and accept what they recommend. " It also asks respondents whether they received financial advice in the last five years for five categories: savings and investments, tax planning, insurance, mortgage or loan, and debt counseling. The NFCS data are particularly useful because it has both depth and breadth: it boasts over 28,000 observations and features questions on a wide range of financial topics including banking, credit cards, mortgages, insurance, and retirement savings. …