Is Conflicted Investment Advice Better than No Advice?

The value that brokers generate depends on both the quality of their investment recommendations and their clients’ counterfactual portfolios. To identify counterfactual portfolios inside a defined contribution retirement plan, we exploit time-series variation in access to brokers. When brokers are available, the correlations with age, income, and educational attainment suggest that brokers are chosen by participants who value advice on asset allocation and fund selection because they are less financially sophisticated. When brokers are no longer available, demand for target-date funds (TDFs), which combine portfolio management with asset allocation, increases differentially among participants with the highest predicted demand for brokers. We find that broker client portfolios earn significantly lower risk-adjusted returns and Sharpe ratios than matched portfolios based on TDFS—due in part to broker commissions that average 0.90% per year—but offer similar levels of risk. Exploiting across-fund variation in the level of broker fees, we find that broker clients allocate more dollars to high-fee funds. This finding increases our confidence that actual broker client portfolios reflect broker recommendations, and it highlights an agency conflict that can be eliminated when TDFs replace brokers. JEL classification: D14, G11, G23