THE EFFECTS OF 

CONFLICTED INVESTMENT 

ADVICE ON RETIREMENT

SAVINGS

 

February 2015
Contents

Executive Summary................................................................................................................................................. 2

I. The U.S. Retirement System............................................................................................................................. 4

II. The Economic Cost of Conflicted Investment Advice..................................................................................... 10

The Evidence on Underperformance.............................................................................................................. 10

The Effect of Conflicted Advice on Investment Returns................................................................................. 15

The Dollar Cost of Conflicted Investment Advice........................................................................................... 18

III. Alternative Explanations for Underperformance........................................................................................... 22

Is Underperformance the Fair Price of Advice and Other Intangible Benefits? ............................................. 22

Does Underperformance Reflect the Characteristics of Households Receiving Conflicted Advice Rather than 

Conflict Itself?................................................................................................................................................. 23

IV. Conclusion ...................................................................................................................................................... 26

References............................................................................................................................................................. 27

1
Executive Summary

Americans’ retirement income is derived from many sources, including Social Security, traditional 

pensions, employer-based retirement savings plans such as 401(k)s, and Individual Retirement 

Accounts (IRAs). While this landscape is familiar today, it reflects a dramatic change from the 

landscape 40 years ago. The share of working Americans covered by traditional pension plans—which 

offer a guaranteed income stream in retirement—has fallen sharply. Today, most workers 

participating in a retirement plan at work are covered by a defined contribution plan, such as a 

401(k). Importantly, the income available in retirement from a defined contribution plan depends on 

both the amount initially saved and the return on those savings. The shift from traditional pensions to 

defined contribution plans raises important policy issues about investment responsibilities and the 

roles of individual households, employers, and investment advisers in ensuring the retirement 

security of Americans.

Defined contribution plans and IRAs are intricately linked, as the overwhelming majority of money 

flowing into IRAs comes from rollovers from an employer-based retirement plan, not direct IRA 

contributions. Collectively, more than 40 million American families have savings of more than $7 

trillion in IRAs. More than 75 million families have an employer-based retirement plan, own an IRA, or 

both. Rollovers to IRAs exceeded $300 billion in 2012 and are expected to increase steadily in the 

coming years. The decision whether to roll over one’s assets into an IRA can be confusing and the set 

of financial products that can be held in an IRA is vast, including savings accounts, money market 

accounts, mutual funds, exchange-traded funds, individual stocks and bonds, and annuities. Selecting 

and managing IRA investments can be a challenging and time-consuming task, frequently one of the 

most complex financial decisions in a person’s life, and many Americans turn to professional advisers 

for assistance. However, financial advisers are often compensated through fees and commissions that 

depend on their clients’ actions. Such fee structures generate acute conflicts of interest: the best 

recommendation for the saver may not be the best recommendation for the adviser’s bottom line. 

This report examines the evidence on the cost of conflicted investment advice and its effects on 

Americans’ retirement savings, focusing on IRAs. Investment losses due to conflicted advice result 

from the incentives conflicted payments generate for financial advisers to steer savers into products 

or investment strategies that provide larger payments to the adviser but are not necessarily the best 

choice for the saver. 

CEA’s survey of the literature finds that:

• Conflicted advice leads to lower investment returns. Savers receiving conflicted advice earn 

returns roughly 1 percentage point lower each year (for example, conflicted advice reduces 

what would be a 6 percent return to a 5 percent return).

• An estimated $1.7 trillion of IRA assets are invested in products that generally provide 

payments that generate conflicts of interest. Thus, we estimate the aggregate annual cost of 

conflicted advice is about $17 billion each year.

2
• A retiree who receives conflicted advice when rolling over a 401(k) balance to an IRA at 

retirement will lose an estimated 12 percent of the value of his or her savings if drawn down 

over 30 years. If a retiree receiving conflicted advice takes withdrawals at the rate possible 

absent conflicted advice, his or her savings would run out more than 5 years earlier.

• The average IRA rollover for individuals 55 to 64 in 2012 was more than $100,000; losing 12 

percent from conflicted advice has the same effect on feasible future withdrawals as if 

$12,000 was lost in the transfer. 

The conclusions of this report are based on a careful review of the relevant academic literature but, 

as with any such analysis, are subject to uncertainty. However, this uncertainty should not mask the 

essential finding of this report: conflicted advice leads to large and economically meaningful costs for 

Americans’ retirement savings. Even a far more conservative estimate of the investment losses due to 

conflicted advice, such as half of a percentage point, would indicate annual losses of more than $8 

billion. On the other hand, if conflicted advice affects a larger portion of IRA assets than the $1.7 

trillion considered here—or if the estimate were extended to other forms of retirement savings—the 

total annual cost would exceed $17 billion.

3
I. The U.S. Retirement System

Americans’ retirement income comes from many sources. Social Security provides a basic foundation 

for retirement security. Traditional pensions, employer-based retirement savings plans such as 

401(k)s, and Individual Retirement Accounts (IRAs) allow workers to set aside additional earnings 

explicitly designated for retirement in a tax-advantaged way. (Table 1 provides an overview of these 

forms of savings.) Other savings, whether in a bank account or a home, provide additional resources 

that can be tapped in retirement. While this landscape is familiar today, it reflects a dramatic change 

from the landscape 40 years ago. The share of working Americans covered by traditional pension 

plans—which offer a guaranteed income stream in retirement—has fallen sharply. Today the majority 

of workers participating in a retirement plan at work are covered by a defined contribution plan, such 

as a 401(k). 

Table 1. Select Forms of Tax-Preferred Retirement Savings1

Type of Plan Description

Defined Benefit (DB) 

Plan

Traditional pensions that provide a guaranteed 

payment for life. Benefits typically determined 

according to a formula involving some 

combination of age, earnings, and tenure.

Defined Contribution 

(DC) Plan

Retirement savings plans that allow employee 

and/or employer contributions. Benefits depend 

on both the amount saved and the investment 

returns net of fees on those assets. Workers bear 

the risk associated with asset returns. Examples 

include 401(k)s, 403(b)s, the Federal Thrift Savings 

Plan, and profit-sharing plans.

Individual Retirement 

Account (IRA)

Retirement savings plans independent of 

employment that allow individual contributions. 

Benefits depend on both the amount saved and 

the investment returns net of fees on those 

assets. Individual savers bear the risk associated 

with asset returns.

1 This report uses the term defined contribution plan to refer to employer-based defined contribution retirement plans 

(i.e. excluding IRAs).

4

 
Figure 1 shows the composition of Americans’ tax-preferred retirement savings for the period 1978 to 

2013. In 1978, traditional pensions accounted for nearly 70 percent of all retirement assets. Defined 

contribution plans accounted for less than 20 percent and IRAs accounted for only 2 percent. 

Annuities accounted for the remainder.2 By the end of 2013, traditional pensions accounted for only 

35 percent of retirement assets, a decrease of 32 percentage points; defined contribution plans and 

IRAs accounted for more than half of all retirement assets.

This widely discussed shift from traditional pensions to defined contribution plans and IRAs raises 

important policy issues. In a traditional pension, investment decisions are largely handled by 

professional managers. In an IRA, investment decisions are almost entirely left to the individual saver. 

Defined contribution plans, such as 401(k)s, reflect a middle ground where employers may 

automatically enroll workers in particular default products and may provide workers with access to 

various forms of advice, but may also provide a large menu of options and nearly unrestricted choice

of investment products (Vanguard 2014).

This shift in investment responsibility has coincided with an explosion in the investment options and 

trading platforms available. The period since 1974 has seen the advent and proliferation of index 

mutual funds, discount brokerage, exchange-traded funds, online trading, and more. The number and 

complexity of the products available can make financial decisionmaking difficult (Campbell 2006, 

Lusardi and Mitchell 2007). Moreover, an abundance of investment options and the way in which 

investment decisions are framed may challenge financial decisionmaking and lead to worse outcomes 

for savers (Iyengar et al. 2004, Benartzi et al. 2009). All of these factors in combination have led to an 

increasing role for financial advice. According to one survey, roughly half of traditional IRA-owning

households have a retirement strategy created with the help of a professional financial adviser 

(Holden and Schrass 2015).

2 In Figure 1, the annuities category excludes annuities held by IRAs, 403(b) plans, 457 plans, and private pension funds.

0

10

20

30

40

50

60

70

80

90

100

1978 1983 1988 1993 1998 2003 2008 2013

Source: Investment Company Institute.

Figure 1: Retirement Assets by Type, 1978-2013

Percent

Annuities

Private DB Plans

Government DB Plans

IRAs

DC Plans

2013

5

 
Table 2: Sources of Investment Advice

Retirement savers may obtain investment advice from a range of sources, including two primary 

groups of professionals: brokers and registered investment advisers (RIAs). Table 2 summarizes select 

sources of investment advice.

3 In addition to investment and asset allocation recommendations, 

these advisers may provide overall savings advice, tax planning, estate planning, advice on claiming 

Social Security, and other services. In this report, we use “financial adviser” broadly to include all 

kinds of professionals providing advice, not just RIAs.

Two important ways in which advisers differ are (i) the legal and conduct standards that their advice 

must meet and (ii) the ways in which they are compensated for the advice they provide. For example, 

advice provided by RIAs must serve the best interest of their clients and satisfy duties of loyalty and 

care. Brokers’ recommendations must be suitable for the client taking into account factors such as 

age and income. Moreover, only registered investment advisers are permitted to give holistic advice, 

while brokers are restricted to providing incidental advice (Securities and Exchange Commission (SEC) 

2011). However, individual advisers can switch back and forth between the two regimes as they 

engage in different activities, a practice known as dual hatting. As a result, consumers may not know 

which legal or conduct regime applies to the advice they are receiving at any moment.

The distinctions between the relevant legal standards are important, but they also interact with an 

important second difference between advisers: differences in the ways in which they are 

compensated for the advice provided. The key difference is between those advisers who receive

conflicted payments and those who do not. Conflicted payments are payments to the adviser that 

depend on the actions taken by the advisee. For example, an adviser may receive an annual payment 

for each dollar invested in certain products. Advisers who do not accept conflicted payments may 

charge an hourly rate, a percentage of assets, or other similar fees that do not directly depend on the 

investment decisions made by the client. Advisers may also receive both types of compensation: 

conflicted payments and payments that do not directly depend on their clients’ investment decisions.

Advisers accepting conflicted payments face a conflict of interest because the advice that is best for 

their own bottom line may not be the advice that is best for their customers’ savings. These 

3 For simplicity, this report refers to both firms and the individual advisers working at those firms as brokers and RIAs.

Adviser Description Legal Standard

Registered Investment 

Advisers (RIAs)

Receives compensation in exchange for 

giving investment advice. May also 

manage a portfolio for clients.

Fiduciary duty to client, including a 

duty of loyalty and a duty of care. 

Must serve the best interest of the

client.

Broker Dealers 

(brokers)

Makes trades for a fee or commission. A 

broker makes trades for a client’s 

account, while a dealer makes trades for 

his or her own account. 

Recommendations must be suitable 

for a client’s investment profile 

taking into account factors such as 

age, income, net worth, and 

investment goals.

Other Potential Sources Examples include friends, family, bankers, 

insurance agents, accountants, and 

lawyers.

Standards vary.

6

 
misaligned interests can arise from a wide range of payment arrangements. Examples include 

revenue-sharing arrangements and front-end and back-end loads.

4 Table 3 summarizes select forms 

of conflicted payment arrangements. Advice provided by advisers who accept conflicted payments is 

referred to as conflicted investment advice. While this report discusses the costs of conflicted 

investment advice, it is important to keep in mind that many financial advisers hold themselves to 

high professional standards.

Table 3. Select Types of Payments Generating Conflicts of Interest5

Type of Payment Description of Adviser’s Monetary Interest Potential Consequences

Ongoing revenue-sharing 

arrangements, including 

12b-1 fees

Mutual funds may make ongoing annual 

payments to advisers based on the advisers’ 

clients’ investments, often specified as a 

percentage of assets. Known by the SEC rule 

that created them, 12b-1 fees are one example 

of ongoing revenue-sharing payments.

Creates a financial incentive to 

direct clients to funds with higher 

revenue-sharing payments. 

Front-end sales load, 

back-end sales load

Mutual funds may charge investors a fee when 

an investor buys shares (a front-end load) or 

sells shares (a back-end load). Most or all of this 

charge is generally passed on to the advisers 

selling the product. 

Creates a financial incentive to 

steer investors into funds with 

higher loads and that pass on a 

larger portion of that load to 

advisers. Loads also encourage 

excessive trading as more trades 

increase load payments. 

Sales targets, payouts Advisers may receive payouts when they 

achieve certain sales targets. The payout can 

vary by asset class and product. In some cases, 

proprietary products receive higher payouts. 

Creates a financial incentive to 

recommend trading and selling 

specific products over others 

based on the schedule of payouts. 

Variable commissions Advisers may receive compensation through 

commissions for selling individual stocks, 

insurance products, and other financial 

products. The amount of the commission can 

vary across products and asset classes.

Creates a financial incentive to 

recommend products that 

generate higher commissions and 

can encourage excessive trading.

The potential for negative effects of these conflicted payments may be invisible to consumers 

because they are often unaware of the differences in payment structures and legal standards across 

advisers and the conflicts they create. Moreover, even when consumers are aware of the differences, 

they can struggle to know which legal and conduct standard is relevant because advisers can switch 

between legal and conduct regimes in a given conversation with a client. In surveys, a majority of 

households reports satisfaction with their advisers and at the same time express confusion and make 

mistakes about the different titles, legal obligations, and consumer protections that exist in the 

advice industry (Consumer Financial Protection Bureau (CFPB) 2013, Government Accountability 

Office (GAO) 2011, Investment Company Institute 1997, SEC 2011). Households also express 

confusion over the fees that they are charged, reflecting the indirect and sometimes complex pricing 

of financial advice, which further widens the scope for abuse (Hung et al. 2008).

4 See Financial Industry Regulatory Authority (FINRA) (2013), Howat and Reid (2007), Hung et al. (2008), Turner and Muir 

(2013), and Prentice (2011) for additional discussion of conflicts. 5 Conflicted payments are often split between the adviser and the adviser’s firm. The allocation between the two affects 

the size of the financial incentive the payments create, but not generally the nature of the incentive created.

7

 
This report focuses on the impact of conflicted advice as it affects IRA owners. Unique features of the 

IRA market suggest that IRA investors are particularly vulnerable to conflicted advice. First, few 

individuals contribute to IRAs directly and, instead, most of the money flowing into these accounts 

accumulates in employer plans and is then rolled over into an IRA when workers change jobs or 

retire. In 2012, Americans contributed roughly $30 billion to traditional and Roth IRAs. In the same 

year, they rolled over more than $300 billion to traditional and Roth IRAs. At the point of rollover, 

savers are making decisions about large quantities of money relative to the sums involved in other 

more common financial decisions. Many savers may not have full knowledge about their options or a 

complete understanding of the detailed regulatory differences between their employer plan and an 

IRA—most notably that advice to roll money out of the plan into an IRA is generally subject to much 

lower standards of care than advice received in the plan. Moreover, investment fees in a typical IRA 

may exceed investment fees in a typical 401(k) according to a series of recent GAO reports (GAO 

2009, 2011, 2013). While rolling over balances to an IRA makes financial sense for many people, 

when doing so incurs meaningfully higher fees, it generally does not.

Second, for many Americans making decisions about their IRA investments will be one of the only 

times they must confront the full set of investment products available in the marketplace and as such 

will be one of the most complicated savings decisions they will face in their lifetime.6 Third, IRA assets 

are largest for older households who may be more vulnerable to losses due to conflicts than other 

savers (Agarwal et al. 2009, Lusardi et al. 2009). SEC and CFPB reports have found consumer financial 

protection abuses that are specifically targeted at elderly households (CFPB 2013, SEC 2007).

While many different financial products provide conflicted payments, the analysis in the next section 

will largely focus on mutual fund assets. This focus is driven by the existence of high-quality empirical 

evidence on the issue of conflicts of interest for this subset of the market. As shown in Figure 2, 

mutual funds accounted for about half of all IRA assets in 2013, or roughly $3.5 trillion.7 However, to 

the degree that conflicted payments impose costs outside of mutual funds held in IRAs, the total 

costs imposed would be larger than the headline estimates in this report.

6 According to the Survey of Consumer Finances, nearly half of American families held retirement savings accounts,

including DC plans and IRAs, in 2013. Outside of retirement accounts and pension plans, only 14 percent held individual 

stocks, only 8 percent held mutual funds or other pooled investment funds, and even fewer held CDs, individual bonds, or 

other managed assets.

7 Variable annuity mutual fund assets are classified with mutual funds, not annuities.

8

 
 

48%

7%

5%

40%

Mutual Funds Stocks, Bonds, 

and Other Assets

Annuities

Source: Investment Company Institute.Bank and Thrift Deposits

Figure 2: Allocation of IRA Assets in 2013

Percent

9
II. The Economic Cost of Conflicted Investment Advice

The efficiency losses arising from economic relationships involving conflicting incentives—that is, 

scenarios where the best financial outcome for each party in an economic relationship differs and the

behavior of one or more parties can only be imperfectly monitored—have been studied extensively in 

the economics literature. These principal-agent problems have been studied across a range of 

industries and relationships, including medical care (Arrow 1963), corporate management (Jensen 

and Meckling 1976), performance management (Holmstrom 1982), and the mutual fund industry 

(Chen et al. 2013).

This report focuses on quantifying the impact of conflicting incentives in the particular case of 

financial advisers providing conflicted advice to IRA account holders. To do so, it turns to the 

empirical literature that examines conflicted payments and investment products characterized by 

conflicted payments. Numerous empirical studies, summarized in Table 4, identify the many costs

that result. Most of the studies in the literature summarize their results in terms of 

underperformance: the amount by which investment returns for affected products fall short of a 

suitably-defined comparison group. 

In the academic literature, practices vary in whether investment returns are presented before (gross) 

or after (net) expenses have been taken into account and in exactly which expenses are subtracted 

before reporting the net return. CEA’s estimated cost of conflict reflects the impact of conflicted 

advice on a saver’s net return. In the discussion of the empirical evidence in this section, 

underperformance is often expressed in basis points. Basis points provide a convenient rescaling of 

percentage points for use when discussing numbers close to 1 percentage point: 1 basis point is equal 

to 0.01 percentage points, and 100 basis points is 1 percentage point.

This section of the report first reviews the relevant academic literature and then applies the results 

found in that literature to estimate the effect of conflicted advice on investment returns and the 

aggregate dollar cost of conflicted investment advice.

The Evidence on Underperformance

A natural place to begin estimating the costs of conflicted investment advice is with a comparison of 

the investment returns for mutual funds sold through intermediaries and characterized by conflicts of 

interest with the investment returns for funds sold directly to savers and generally not providing 

conflicted payments. Importantly, the distinction between these two groups of funds is not identical 

to the distinction between funds purchased with advice and those without. Savers purchasing funds 

sold directly to the public may be receiving advice (for example, from a fee-only adviser). Research 

making this comparison consistently finds that funds characterized by conflicted payments

significantly underperform funds sold directly to savers. 

Bergstresser et al. (2009) compare the performance of funds sold through intermediaries that tend to 

offer conflicted payments with that of funds sold directly to savers, where conflicts of interest are 

significantly weaker. They find that funds sold through intermediaries deliver lower risk-adjusted 

10
returns. The researchers examine returns net of operating expenses, but do not include the costs of 

marketing and selling fund shares such as loads and 12b-1 fees (defined above). Since loads and 12b1 fees are primary sources of compensation for the intermediaries recommending the funds, the 

authors’ finding indicates that it is not merely the cost of paying those intermediaries that leads to 

underperformance. During the period covered by the study, the annual returns on domestic equity 

funds sold through intermediaries were 77 basis points lower than the returns of observationally 

equivalent direct-sold funds. The annual returns on bond funds sold through intermediaries were 90 

basis points lower than equivalent direct-sold funds. The authors estimate that this 

underperformance amounted to $4.6 billion in 2004.

8

Del Guercio and Reuter (2014) corroborate the result in Bergstresser et al. (2009): direct-sold funds 

outperform funds sold through intermediaries, a difference they estimate to be 115 basis points per 

year. Moreover, looking just at funds characterized by conflicted payments, the authors find that 

actively-managed funds sold through intermediaries, which comprise the vast majority of all funds

sold through intermediaries and feature larger conflicted payments, underperform lower-fee,

passively-managed funds sold through intermediaries by 112 to 132 basis points per year; this result 

does not extend to funds that are sold directly to savers. In other words, underperformance among 

actively-managed funds is limited to the segment of the mutual fund market where the conflicted 

payments are the largest. The authors conclude that this result “likely reflect[s] an agency conflict 

between brokers and their clients” as both actively-managed and passively-managed funds sold 

through intermediaries provide the same portfolio management and advisory services but provide 

different payments to the adviser.

These first two studies compare investment returns for funds that tend to make conflicted payments 

with those that do not. One limitation of this type of comparison is that it may incorporate 

differences other than the presence of conflicted advice between the types of investors purchasing 

funds through these two sources. For instance, investors purchasing funds through intermediaries 

may be more risk-averse and less experienced with investing than those buying direct-sold shares 

from a mutual fund sponsor. Failing to account for such differences may potentially overstate or 

understate the losses due to conflicts of interest. However, results from another strand of research 

that is not affected by this limitation find broadly similar patterns. 

In one study, Chalmers and Reuter (2014) compare the performance of accounts in an Oregon

workplace retirement plan when plan participants lose access to conflicted advisers. They find that 

participants who would have otherwise used conflicted advisers when available were 

disproportionately more likely to rely on the plan’s default investment options in their absence, and 

that those default investment options performed better than the portfolios of those receiving 

conflicted advice. In the authors’ words, “brokers significantly increased annual fees, significantly 

decreased annual after-fee returns, and slightly increased risk-taking relative to the counterfactual 

portfolio” (that is, the default investment option). The estimated magnitude of underperformance in 

this study is large: 298 basis points relative to the plan’s default investment option. A portion of this 

8 The authors find outperformance of foreign equity funds, but this result is attributable to a small number of large funds 

sold through a single fund family.

11

 
large underperformance estimate is explained by a higher exposure to risky assets in broker clients’ 

portfolios at a time when risky assets performed poorly. The authors also estimate 

underperformance between portfolios selected on the basis of conflicted advice and those that are 

not after controlling for various measures of investor traits, and find that these portfolios still 

underperform by approximately 125 basis points. Similarly, researchers examining retail investment 

advice in Canada and Germany, where the legal regimes differ but advisers also derive substantial 

compensation from conflicted payments, find that advised accounts underperform by more than 150

basis points (Foerster et al. 2014, Hackethal et al. 2012a).

Conflicted payments can also lead to underperformance as a result of poor timing in investment 

decisions. Studies that compare the performance of mutual funds do not necessarily capture this 

effect, which results from the timing of individual investors’ decisions to buy and sell. While poor 

timing in investment decisions, referred to as market mis-timing, exists for reasons other than 

conflicted payments, conflicted payments can exacerbate the problem as trading strategies with poor 

timing may generate higher conflicted payments. Friesen and Sapp (2007) estimate that timing issues

from all sources could lead to 100 to 200 basis points of annual underperformance and that these 

losses appear to be larger among a particular group of funds (load funds) offering conflicted 

payments. Other research also suggests that conflicted advisers often do not steer clients away from 

excessive trading, another source of investment losses due to poor timing (Hackethal et al. 2012b). 

12
Table 4. Evidence on the Impact of Conflicted Investment Advice

Study Impact of Conflict Discussion

Bergstresser et 

al. (2009)

Lower returns, 

higher fees

Broker-sold equity, bond, and money market funds underperform 

corresponding direct-sold funds by 14 to 90 basis points between 1996 and 

2004 before accounting for distribution fees that provide compensation for 

the adviser. Results also show that compensation to advisers is positively 

associated with net inflows. Study finds little evidence of superior asset 

allocation or market timing abilities among advisers.

Chalmers and 

Reuter (2014)

Lower returns, 

higher fees, biased 

advice

Investors in a university-sponsored retirement plan receiving conflicted 

advice underperform self-directed investors and a counterfactual targetdate fund by 125 and 298 basis points, respectively. Within the portfolios of 

those receiving conflicted advice, fund flows are sensitive to the level of 

fees, with a 50 basis point increase in broker fees corresponding to a 17.2 

percentage point higher allocation to the fund with higher fees. Advisers also 

steer investors away from high-fee funds when those fees do not benefit the 

advisers.

Christoffersen 

et al. (2013)

Biased advice, 

lower returns, 

higher fees

Between 1993 and 2009, among mutual funds with loads or revenuesharing, higher payments to advisers lead to higher inflows, suggesting that 

advisers’ recommendations are biased by the payments they receive. Net 

returns are approximately 50 basis points lower for every 100 basis points of 

loads that are shared with advisers. 

Del Guercio and 

Reuter (2014)

Lower returns, 

higher fees

Actively managed broker-sold mutual funds earn returns 112 to 132 basis 

points lower than passively managed broker-sold funds, after accounting for 

distribution fees that provide compensation for the adviser. The authors 

conclude that this underperformance likely reflects an agency conflict 

between advisers and their clients.

Foerster et al. 

(2014)

Lower returns, 

higher fees, 

inappropriate risktaking, advice is 

not customized

Among Canadian investors, advised portfolios primarily relying on conflicted 

advice pay 170 basis points more than a lifecycle fund but experience worse 

market timing and fund selection. Advisers encourage additional risk-taking, 

but the gain in returns is offset by the higher fees charged by the adviser, 

leaving the investor with lower risk-adjusted performance than with a 

lifecycle fund or passive index.

Friesen and 

Sapp (2007)

Market mis-timing Investors in load funds experience larger losses (194 basis points) from 

market mis-timing than those in no-load funds (96 basis points). Losses for 

both groups are relative to a buy-and-hold strategy. 

GAO (2011) Inappropriate 

rollovers

In a review of the market, certain advisers’ compensation can range from 

$6,000 to $9,000 if an employer-based plan participant were to purchase an 

IRA but only $50 to $100 if the same participant were to remain in the plan. 

Hackethal et al. 

(2012a)

Lower returns, 

higher turnover

Clients of a German brokerage and a German bank receiving advice from 

advisers primarily compensated through conflicted payments earn lower net 

returns not justified by reduced risk. Clients’ accounts also exhibited higher 

turnover.

Hackethal et al. 

(2012b)

Excessive trading, 

biased advice, 

higher fees

Investors receiving conflicted advice from a German retail bank between 

2005 and 2007 trade more heavily, are more likely to purchase 

“incentivized” products (e.g. funds with higher loads), and generate higher 

bank revenues, holding investor characteristics, including financial 

sophistication, constant.

Mullainathan et 

al. (2012)

Market mis-timing, 

higher fees, 

inappropriate 

diversification, 

asset misallocation

In 284 mystery shopper visits to financial advisers, a majority of advisers 

recommend investment strategies that are in line with their financial 

interests, such as return chasing and buying actively managed funds. 

Moreover, advisers steer clients away from low-fee, passively managed 

portfolios toward higher-fee products.

13
The studies reviewed so far in this section provide a consistently negative view of the risk-adjusted, 

post-fee performance of portfolios invested according to conflicted advice but they do not directly 

link the extent of the underperformance to the magnitude of the conflicted payments. To establish 

the direct link between conflicts of interest and underperformance, we turn to another set of results 

in the academic literature. In one study, researchers connected the payments an intermediary 

receives for selling a particular mutual fund to underperformance (Christoffersen et al. 2013). 

Comparing data on flows and performance for mutual funds that have unusually high or low 

payments to intermediaries, the researchers find that inflows are larger for funds with unusually high 

payments and smaller for those with unusually low payments. Put somewhat differently, if two funds 

appear otherwise identical but one shares a higher portion of load payments with advisers, the 

amount of money flowing into that fund will tend to be higher. The authors also find that higher 

revenue-sharing payments lead to greater inflows. These results provide direct evidence that two 

important sources of conflicts—namely, load payments and revenue sharing—bias investment 

recommendations.

Further, the authors find that unusually high or low load-sharing payments lead to unusually low or 

high performance, respectively. That is, funds with unusually high payments to intermediaries tend to 

generate unusually low returns.9 In particular, the average conflicted payment to certain advisers in 

their data “corresponds to a 1.13% reduction in annual performance” after fees.

The finding that conflicted payments drive investment decisions is corroborated by evidence 

presented in Chalmers and Reuter (2014). The researchers find that fund flows are sensitive to the 

level of fees more generally, concluding that a 50 basis point increase in adviser fees corresponds to a 

17.2 percentage point higher allocation to the fund. This study also finds evidence that advisers steer 

investors away from high-fee funds when those fees do not benefit the adviser.

The studies discussed to this point analyze the impact of conflicted payments on mutual fund flows 

and performance. An alternative perspective on advice can be obtained by examining how advisers 

treat individuals and assessing the degree to which their recommendations are motivated by the 

payments they receive. In a mystery shopper study, researchers sent hypothetical investors to 

financial advisers largely reliant on conflicted payments for their compensation to investigate the 

type of advice provided (Mullainathan et al. 2012). The mystery shoppers presented four portfolios to 

advisers: a return-chasing portfolio, an employer stock portfolio, a diversified low-fee portfolio, and a 

cash portfolio. The study finds that advisers recommend a change to the current investment strategy 

in about 60 percent of cases when the client had a return-chasing portfolio and in about 85 percent 

of cases in which the client had a diversified low-fee portfolio. The authors conclude that advisers 

“seem to support strategies that result in more transactions and higher management fees,” even 

when clients appear to hold the optimal portfolio. 

9 While the authors do not find a statistically significant effect of unusually high or low revenue-sharing payments on 

performance, their point estimate is negative, consistent with—though not dispositive of—reduced performance resulting 

from unusually high revenue-sharing payments as well.

14

 
In the U.S. retirement system, a particularly important financial decision occurs when employees who 

participate in a workplace retirement plan change jobs or retire and must decide what to do with 

their existing savings. The options at this point typically include leaving their savings in the current 

plan, rolling them over into a new employer’s plan, or rolling them over into an IRA. However, 

advisers may recommend inappropriate rollovers to plan participants to collect fees for managing the 

assets. According to a recent GAO report, certain advisers could earn $6,000 to $9,000 if a plan 

participant were to purchase an IRA but only $50 to $100 if the same participant were to invest 

within the employer plan (GAO 2011). Recent analyses have found that plan participants are 

frequently encouraged to roll over funds to an IRA with minimal knowledge of the participant’s 

financial situation, without acknowledging other options available, and without offering significant 

discussion of fees (GAO 2013). 

The Effect of Conflicted Advice on Investment Returns

As discussed above and seen in Table 4, academic research identifies several ways in which conflicted 

advice affects investment performance. Because the studies reviewed in this report examine 

different, partially overlapping aspects of conflict and because they vary in the extent to which their 

effects are directly attributed to conflict, it would not be appropriate to simply sum or average the 

estimates to obtain a single overall estimate of the effect of conflicted advice. But taken together, the 

evidence suggests that conflicted advice leads to underperformance of roughly 100 basis points per 

year. Here, we outline the various considerations that lead us to this estimate.

Our approach starts from a study that directly examines the relationship between payments to 

advisers and performance. Christoffersen et al. (2013) conclude that the magnitude of losses from 

conflict corresponding to the fund with the average load-sharing payment is 113 basis points, which is 

in line with our estimate. However, whether this estimate is a good indicator of conflict-driven 

underperformance today depends on the relative magnitudes of at least three adjustments that may 

either push the estimate higher or lower. First, average loads may be somewhat lower today than the 

average during the period studied in the paper (1993 to 2009), which would lead us to adjust the 

underperformance estimate down. Second, this estimate does not factor in the direct impact of the 

additional load payment the investor incurs as a result of the recommendation to invest in funds with 

higher loads, which would lead to an upward adjustment. Third, the authors estimate 

underperformance for the first year in which the funds are purchased rather than underperformance 

for every year that the saver holds the fund. Adjusting for this detail would increase or decrease the 

underperformance estimate depending on whether the effect grows or decays in subsequent years.

While the literature provides little formal guidance on this specific question, the authors control for 

cyclical fluctuations that might lead their underperformance estimate to differ depending on business 

cycle conditions. In addition, studies that estimate underperformance in portfolios, where a fund’s 

performance can be tracked beyond the first year of ownership, find annual estimates of 

underperformance over time that are consistent with the first-year effect (Hackethal et al. 2012b,

Chalmers and Reuter 2014, Foerster et al. 2014). Both of these explanations provide suggestive 

evidence that the one-year estimate of underperformance in Christoffersen et al. (2013) is a 

reasonable approximation for the persistent effect. Taking all three of these adjustments into 

15
consideration leads us to conclude that 100 basis points is a plausible estimate around which to 

center the magnitude of underperformance.

An alternative approach would build up the estimate from separate estimates for each of the ways 

conflicted investment advice can lead to underperformance: excessive fees, excessive trading, market 

mis-timing, and so forth. However, there is insufficient precision in the literature to separately 

estimate each of these sources of underperformance in such a calculation—although the individual 

estimates cited above support an aggregate estimate of 100 basis points in that many of the 

individual estimates in the literature are 100 basis points or higher.

As with any attempt to assign a specific value to an unobservable quantity, there is uncertainty in this 

estimated cost of conflict. For example, if a large fraction of market mis-timing reflects the impact of 

conflicted advice, the cost could be larger. If the impact of unusually high or low conflicted payments 

on performance (the basis for the Christoffersen et al. (2013) analysis) differs systematically from the 

impact of expected differences in conflicted payments, the cost of conflict could be either over or 

understated.

16
HOW CONFLICTED ADVICE ERODES RETIREMENT SAVINGS

The definition of underperformance used in this report is broad and encompasses a wide range of

channels through which returns can suffer, including high fees, high trading costs, poor market timing,

and increased risk exposure without increased returns. Because these sources of underperformance

reflect a mix of implicit and explicit costs that may not appear on any account statement, it can be

difficult to see how they reduce the returns a worker earns on his retirement savings. This box provides a

simplified example to illustrate what underperformance means in practice.

Consider two potential options for a worker who has recently changed jobs: leaving her 401(k) balance in

the old plan or rolling over to an IRA. (In many cases, the worker could also choose to roll over the

balance to a retirement plan at the new job. For simplicity, this example ignores this option as well as the

option to withdraw the balance from the account.)

Suppose the worker’s previous employer ran a large 401(k) plan with several low-cost investment

options, and the worker was invested in an index fund holding a mix of stocks and bonds. Suppose

further that the expected return for the fund’s portfolio before accounting for any expenses is 6.5

percent. In practice, it is not possible for the worker to earn this return because it is the return that would

be earned if the fund didn’t need to pay anyone to make trades, manage customer service, process

employee contributions to the plan, and so on. The trading costs for index funds tend to be quite low;

this example assumes they lower the saver’s expected return by 5 basis points. The fund’s management

and operating expenses reduce the returns by another 20 basis points. Finally, the costs of administering

the 401(k) plan itself reduce returns by another 25 basis points. Altogether, these expenses reduce the

return by 50 basis points. Thus, each year that the worker holds this investment, she can expect to earn

6.5 percent minus 0.5 percent for a net gain of 6.0 percent (see Table). Of course, in any particular year,

returns may be higher or lower depending on the performance of the market.

401(k) Recommended IRA

Portfolio’s gross return 6.50% 6.50%

- Trading costs 0.05% 0.20%

- Mutual fund expenses 0.20% 1.30%

- 401(k) plan expenses 0.25% 0.00%

Saver’s net return 6.00% 5.00%

Now suppose the worker receives a recommendation to roll over her balance to an IRA and invest in a

higher cost mutual fund with an investment strategy that involves more frequent trading. This type of

recommendation can arise because the person making the recommendation receives higher

compensation if the worker rolls over her balance to an IRA than if she keeps her funds in her 401(k).

However, unless the fund involves a significantly different risk profile than the index fund, the expected

return will likely be quite similar.

17
The Dollar Cost of Conflicted Investment Advice

Translating the effect of conflicted advice on investment returns into a dollar cost requires an 

estimate of the value of assets invested according to conflicted advice. We can then multiply the 

estimated value of affected assets by the effect of conflict on investment returns to obtain the total 

dollar cost of conflict.

Implementing this straightforward computation, however, is complicated by the number of different 

ways in which advice can be delivered, the methodological differences across empirical studies, and 

the limitations of the publicly available data. Systematic, quantitative evidence on the effects of 

conflict is richest for mutual funds. As a result, a conservative approach would apply the effect of 

conflicted advice on investment returns obtained above only to a pool of mutual fund assets affected 

by conflicts of interest. A less conservative approach would apply the cost of conflicted advice

This example simplifies and assumes the IRA investment matches the risk characteristics of the 401(k)

investment and earns an identical expected return before accounting for any costs. Yet the fund’s

frequent trading strategy results in significantly higher trading costs, reducing returns by 20 basis points

rather than 5. In addition, the mutual fund’s management and operating expenses are 130 basis points,

up from 20. However, in the IRA the worker would no longer need to pay the 401(k) plan management

fees, which reduced returns by 25 basis points. In combination, the costs for the IRA investment reduce

earnings by 150 basis points annually. Thus, each year the saver holds this investment she can expect to

earn 5 percent.

In this example, conflicted advice reduces the expected return on a saver’s investment each year from 6

percent to 5 percent. Over time, reduced annual returns add up to significant reductions in a saver’s

potential retirement savings. Suppose the worker’s rollover occurred at age 45 and she expects to retire

at 65. The 1 percentage point reduction in the expected annual return leads to a reduction in the

expected value of her savings from this account at age 65 of 17 percent.

Lower returns likewise reduce the value of accumulated savings in the retirement years. For a saver who

plans to take withdrawals over a 30-year period (beginning immediately), the lower return resulting from

conflicted advice will require her to reduce the annual withdrawals from the account by 12 percent

compared to what she could have withdrawn each year absent conflicts of interest.a Alternatively, if she

chooses to withdraw the amount that could have been withdrawn each year when earning the higher

return, she would run out of money more than five years earlier.

These losses in retirement come on top of the losses in the pre-retirement period for workers with a midcareer rollover. For the saver in this example who rolls over her 401(k) balance at 45, the combined effect

of a 17 percent loss leading up to retirement and a 12 percent loss after retirement is an overall loss of

more than 25 percent. That is, as a result of conflicted investment advice, the feasible retirement

withdrawals for this saver fall by more than 25 percent compared to what would have been possible with

unconflicted advice.

a. Withdrawal computations assume constant inflation-adjusted withdrawals and an inflation rate of 2 percent.

18
obtained for mutual funds to all assets affected by conflicts of interest, using the underperformance 

among mutual funds as indicative of the effect across investment products.

We identify three potential estimates of IRA assets subject to conflicted investment advice. The 

first—and narrowest—estimate corresponds to mutual funds with loads in IRAs. While using load 

funds as an indicator of conflicted payments is imperfect, as such funds can waive loads for certain 

investors and a saver could simply choose to invest in such a fund even without receiving advice, it 

almost certainly underestimates the pool of assets affected by conflicted advice by excluding an 

extremely large range of products, including variable annuities and no-load funds, that could be 

recommended on the basis of conflicted payments. We estimate the value of load funds in IRAs by 

multiplying the share of load funds among non-institutional mutual fund assets at the end of 2013 by 

the total value of mutual fund assets in IRAs. This yields an estimate of $1.05 trillion.10

Table 5. Estimates of IRA Assets Affected by Conflicted Investment Advice

IRA Assets Affected Asset Composition

Low $1.05 trillion Value of load mutual funds in IRAs

Middle $1.66 trillion Value of load mutual funds and annuities in IRAs

High $3.26 trillion Value of advised IRA assets

The second estimate of IRA assets invested according to conflicted investment advice is the 

combination of load funds and variable annuity mutual funds in IRAs. (Variable annuities often 

provide conflicted payments such as differential commissions and revenue-sharing payments.) This 

estimate captures a larger share of potentially affected assets and maintains a focus on the mutual 

fund products that were the focus of the empirical research reviewed above. We estimate this pool in 

the same manner as the pool above, taking the share of load funds and variable annuity mutual funds 

among non-institutional mutual fund assets and multiplying by the value of mutual fund assets in 

IRAs. This yields an estimate of $1.66 trillion.

The third estimate of IRA assets invested according to conflicted investment advice is a conservative 

estimate of IRA assets for which individuals receive any advice. We compute this by multiplying the 

value of IRA assets by the share of traditional IRA owners who consulted a professional financial 

adviser when creating a retirement strategy.11 This yields an estimate of $3.26 trillion. While this 

estimate likely underestimates the value of IRA assets invested according to professional advice, as 

large accounts are likely disproportionately advised, it likely overestimates the value invested 

according to conflicted advice as some advice does not involve conflicts of interest. Moreover, 

applying the estimated cost of conflict in this manner requires extending results obtained from 

analysis of mutual fund performance to many other kinds of assets. Despite these limitations of the 

analysis, it is important to understand the potential cost of conflict across all assets rather than 

assuming that conflicts of interest do not affect assets other than mutual funds. Finally, as this report 

10 The dollar value of load funds and non-institutional mutual fund assets in 2013 is from Investment Company Institute 

(ICI) (2014). The total value of mutual fund assets in IRAs at the end of 2013 is from ICI’s “The U.S. Retirement Market, 

Third Quarter 2014” available at http://www.ici.org/research/stats/retirement. 11 The share of IRA owners relying on professional retirement advice is from Holden and Schrass (2015).

19

 
focuses on quantifying the cost of conflicted advice on IRA savings, the estimates are inherently 

conservative as they exclude a substantial fraction of all savings.

Each of these three approaches has advantages and disadvantages. Focusing on load funds in IRAs 

limits attention to a set of investments most closely related to those analyzed in the academic 

research reviewed above. Moreover, it restricts attention to a pool of assets highly likely to be 

invested according to conflicted advice. And, by virtue of excluding all assets other than load funds, it

likely underestimates the relevant pool of assets even though some load fund assets may not be 

subject to conflict. However, this conservative approach likely substantially understates the total cost 

of conflict by ignoring conflicted advice to invest in other products. The second estimate’s focus on 

load funds and variable annuity mutual funds remains close to the subject of academic studies but 

encompasses a somewhat wider array of products. Finally, the full set of IRA assets subject to advice 

likely overstates the cost of conflicted advice for IRA owners as some of the advice may be provided 

by advisers who do not receive conflicted payments. Moreover, it applies empirical evidence 

obtained from studies primarily of mutual funds to a context where it may be less relevant. However, 

as noted above, the costs of conflicted advice extend beyond the IRA market considered here.

Applying the estimated effect of conflict on investment returns to the intermediate estimate of 

affected assets yields an annual cost of conflict for retirement savers of $17 billion. Importantly, while 

the precise magnitude of the underperformance depends on the point estimates chosen, the scale of 

the loss does not. Even if the effect of conflict on investment returns is half as large, retirement 

savers are losing $8.5 billion per year. On the other hand, if the pool of affected assets is better 

approximated by the high estimate above, retirement savers are losing $33 billion per year.

20
IS THE CURRENT SYSTEM THE ONLY WAY FOR AMERICANS

WITH MODEST SAVINGS TO OBTAIN ADVICE?

This analysis concludes that conflicted advice costs Americans about $17 billion in foregone retirement

earnings each year. The costly effects of conflicted advice may be particularly relevant for Americans with

modest retirement savings, as historically they have relied on types of advice often subject to conflicts.

Due to these patterns, some observers have asserted that advising structures using conflicted payments

are the only way that savers with lower balances can obtain advice and that without such advice the

adequacy of their retirement savings would suffer. This argument, however, falls short in multiple ways

and overlooks channels that could provide high-quality, conflict-free advice to moderate-income savers

at the same cost as conflicted advising structures.

First, advisers can provide the same quality of advice while receiving non-conflict-based payments as they

can when receiving a payment of equal amount based in conflict. The cost of advice depends primarily on

the resources necessary to provide it—the adviser’s time, IT infrastructure, and other inputs—rather than

the form of the adviser’s compensation. Thus, an adviser receiving payment through non-conflicted

structures should be able to provide advice at the same cost as an adviser receiving conflicted payments,

as long as the inputs in time and infrastructure are equal. If advisers serving moderate-income Americans

can remain profitable regardless of whether they receive conflicted or non-conflicted compensation, one

would expect the number of advisers working with lower-balance savers to remain the same regardless

of whether conflict-based payment systems remain in use.

Second, the prevalence of conflicted payments today may actually interfere with low-balance savers’

ability to get advice. Ongoing developments in the financial industry are sharply reducing the cost of

advice, but it may be difficult for new entrants providing quality, unconflicted, low-cost advice to

compete on price when other advice erroneously appears to be free. Therefore the prevalence of hidden

fees and conflicted payments may make it more difficult for low-cost, high-quality alternatives to

compete on a level playing field, reducing moderate-income Americans’ available options for inexpensive

advice. As just one example, new approaches to advice that exploit technological advances are allowing

firms to offer personalized advice at costs well below those of traditional advice.

Finally, savers with modest balances today tend to become savers with larger balances tomorrow.

According to the Employee Benefit Research Institute, more than 60 percent of IRA contributors in 2010

contributed in at least one of the next two years and nearly 40 percent contributed in every year from

2010 to 2012 (Copeland 2014). A significant motivator for the services provided to low-balance

customers today is likely their potential to become higher balance customers in the future. Financial

advisers have strong incentives to work with lower-balance savers regardless of whether using conflicted

or non-conflicted payment structures.

21
III. Alternative Explanations for Underperformance

The previous section reviews a range of studies that quantify the costs of conflicted investment 

advice in terms of underperformance. Some of the most compelling studies examine conflicted 

payments and advice directly, such as the study by Christoffersen et al. (2013) that finds higher 

conflicted payments drive increased investment in mutual funds and correspond to 

underperformance of such funds. Other studies provide evidence that mutual funds that tend to 

make conflicted payments underperform those that do not. While conflicted payments are a logical 

explanation for the underperformance identified in this second group of studies, other alternative 

explanations have been advanced for the finding. In this section, we explore two alternative 

explanations. Generally speaking, the support in the literature for these alternative explanations is 

unsatisfying. As a result, although we acknowledge the possibility that factors other than conflicts of 

interest could be at play, we do not find enough compelling evidence or justification to challenge our 

conclusion that advisers’ conflicts of interest are quantitatively significant and erode households’ 

retirement assets by billions of dollars each year. Moreover, even if these alternative explanations 

are a factor in generating underperformance in funds that typically make conflicted payments, they 

would not explain why atypically high conflicted payments generate additional flows and additional 

underperformance.

Is Underperformance the Fair Price of Advice and Other Intangible Benefits?

Advisers deserve fair compensation for their services. In many cases, their earnings are derived from 

conflicted payments. Thus, one alternative explanation for underperformance among funds offering 

conflicted payments is that this underperformance merely reflects the necessary and reasonable 

compensation for advisers. However, much of the research is careful to exclude fees used to 

compensate advisers from their underperformance calculation. For example, the baseline results 

reported in Bergstresser et al. (2009) report underperformance before fees used to provide adviser 

compensation are taken into account. Thus, it is unlikely that the underperformance reflects the fair 

price of advice. 

Relatedly, given the existence of underperformance in these funds, some question whether investors 

select such funds for intangible benefits provided by the funds or the advisers that recommend them. 

However, other research results raise doubts about this explanation. For example, studies find that 

households are mostly unaware of their advisers’ conflicts and compensation arrangements,

suggesting they have not built an assessment of those conflicts into their selection of the adviser 

(Malmendier and Shanthikumar 2007, Mullainathan et al. 2012, SEC 2011). Also, in an experimental 

setting where fees are made salient, Choi et al. (2010) conclude that investors are unlikely to buy 

high-fee funds for the bundled services they provide. Lastly, studies document how, in many 

consumer finance contexts, the opaque pricing of financial products can create opportunities for 

potential abuses, particularly affecting elderly consumers.12 All of these considerations suggest that 

the opaque and complex pricing structures are likely to pose challenges for households.

12 See Engel and McCoy (2002) for a discussion of loan markets; for a focus on elderly individuals in financial markets, see 

Infogroup/ORC (2010) and SEC (2007).

22

 
Does Underperformance Reflect the Characteristics of Households Receiving 

Conflicted Advice Rather than Conflict Itself?

Households differ in their financial characteristics, such as net worth and income; their knowledge of 

personal finance; and the competing demands on their time. Customers purchasing mutual funds 

characterized by conflicted payments differ modestly from those purchasing mutual funds directly 

along certain dimensions, such as income and education (Bergstresser et al. 2009). If correlated with 

their investment needs or abilities, these differences could lead to underperformance among funds 

characterized by conflicted payments. However, as noted in the original paper, while these 

differences could easily lead to differences in willingness to pay for advice (in either direction), it is 

not clear why they would necessarily lead to differences in underperformance after accounting for 

the fees that provide compensation for the adviser.

Households from all backgrounds fall subject to common behavioral biases, such as over-confidence,

over-optimism, and loss aversion. These biases often lead to lower investment returns because they 

lead households to (i) trade excessively by seeking active management or chasing returns, (ii) sell 

winning investments while holding losing investments, (iii) overweight past returns, or (iv) underdiversify.13 If households affected by these biases disproportionately hold funds characterized by 

conflicted payments, it may be the case that these biases, rather than the conflicts of interest among

financial advisers, lead to the underperformance. 

This second possibility is less directly addressed by papers that focus solely on underperformance at 

the fund level. However, turning to the other results reviewed above that directly examine financial 

advice provides insight. For example, Mullainathan et al. (2012) find that in a sample of advisers who 

predominantly rely on conflicted payments for their income, advisers often recommend substantial 

changes to portfolios that currently follow best practices and are less likely to recommend changes to 

portfolios that do not follow best practices when doing so would likely reduce their earnings. This 

finding raises significant doubts about the extent to which conflicted advice is serving as a brake on 

behavioral biases.

13 See, for example, Barber and Odean (2000, 2001, 2002, 2013), Benartzi and Thaler (2001), Choi et al. (2011), Calvet et 

al. (2007).

23

 
DO MANDATED DISCLOSURES PROVIDE A SOLUTION?

Mandated disclosures are a common regulatory tool for promoting the transparency and comprehension

of consumer financial products. Despite their ubiquity, when used to inform savers of the conflicts of

interest between them and their advisers, the effects of disclosure by itself are limited and, in many

cases, lead to harm and weaker consumer protections. Indeed, many financial advisers already provide

disclosures and the evidence discussed in this report suggests that they are not highly effective. Here, we

briefly explore some of the challenges with disclosures in the market for financial advice.a

Perhaps most importantly, current disclosure practices for IRAs and retail financial investment products

lack salience. They are often discussed in fine print sections using legal language or other terms whose

meaning may be opaque. It should not be surprising then that investors seldom read financial disclosures,

viewing them as meaningless, and therefore do not become informed by them (ICI 2006). Moreover,

when disclosures are presented at the point of sale, as is common in many financial transactions, it is

often too late for the disclosure to influence investors’ decisions, even for financially sophisticated

individuals.

Even if disclosures are highly salient, design challenges remain. Research suggests that disclosures are

most effective when they simultaneously satisfy three criteria: accessibility, accuracy, and relevance, and

it is difficult to simultaneously satisfy these three objectives. Nevertheless, the need to do so is especially

acute when the amount of information a consumer needs is vast and when products are complex, as is

the case with IRA investments. Because individuals can only process a limited amount of information at

one time, it is easy to overload them with too much information, which necessitates hard choices and

tradeoffs in what should be disclosed. Given how differently individuals process financial information, the

disclosure design must recognize that the same information can easily be interpreted differently by

different types of individuals.

Finally, in practice, disclosures of conflicts of interest can actually backfire (Cain et al. 2005, Loewenstein

et al. 2011). Research in behavioral economics and psychology demonstrates that when advisers disclose

their conflicts, they may be more willing to pursue their own interest over those of their clients and thus

give worse advice. Advisees may interpret the disclosure as a sign of honesty and become more likely to

follow their advisers’ biased advice.

a. For a fuller discussion of mandated disclosures, see Ben-Shahar and Schneider (2011).

24
INTERNATIONAL POLICY CHANGES TO MITIGATE CONFLICTED ADVICE

Several countries have recently enacted regulations to mitigate conflicts of interest for retail financial

products. The United Kingdom and Australia both banned payments from product providers to advisers

and increased disclosure requirements. The European Union Markets in Financial Instruments Directive 2

(MiFID 2), scheduled to take effect by early 2017, proposes to ban conflicted payments for certain

advisers and requires policies and procedures to ensure that any advisers who accept conflicted

payments are properly incentivized to serve clients’ interests.a The table below summarizes recent

international policy changes to address conflicted advice in select countries.b

Country Description

Australiac

Banned payments from product providers and conflicted remuneration

payments for retail investments and created a statutory duty for advisers to

act in the best interest of their clients.

Canada New regulations, implementation of which began in 2014, require much 

greater transparency about the direct and indirect costs to the client for 

each account and details on adviser compensation by clients and product 

providers.

India Banned all front loads for mutual fund products beginning in 2009. 

Implemented heightened requirements to disclose the value and 

justification for any commission payments to advisers.

Italy Banned commissions for discretionary portfolio management services 

beginning in 2007.

Germany Increased disclosures about the cost of advice and whether advisers are 

compensated solely through client fees or by payments from service 

providers.

The Netherlands Banned all payments by a product issuer to an adviser relating to advice 

beginning in 2013. The ban applies to investment, insurance, and mortgage 

and protection (annuity) products.

United Kingdomd Banned conflicted payments, increased education and credentialing 

standards, and required advisers to disclose whether they make 

recommendations from a restricted menu of products or across all products 

beginning in 2013.

a. European Parliament (2014).

b. Information in the table below comes from BlackRock (2014) unless otherwise noted.

c. Australian Securities & Investment Commission (2015).

d. Financial Conduct Authority (2014).

25
IV. Conclusion

This report examines the evidence on the cost of conflicted investment advice and its effects on 

Americans’ retirement savings, with a focus on IRAs. CEA’s survey of the evidence suggests that 

conflicted advice reduces investment returns by roughly 1 percentage point for savers receiving that 

advice. In the aggregate, such savers hold about $1.7 trillion of IRA assets. Thus, we estimate the 

aggregate annual cost of conflicted advice is about $17 billion each year. 

The conclusions of this report are based on a careful review of the relevant academic literature but, 

as with any such analysis, are subject to uncertainty. However, this uncertainty should not mask the 

essential finding of this report: conflicted advice leads to large and economically meaningful costs for 

Americans’ retirement savings. Even a far more conservative estimate of the investment losses due to 

conflicted advice, such as half of a percentage point, would yield annual losses of more than $8 

billion. On the other hand, if conflicted advice affects a larger portion of IRA assets than the $1.7 

trillion considered here—or if the estimate were extended to other forms of retirement savings—the 

total annual cost would exceed $17 billion.

26
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