It has been trendy lately to pile on the financial advisor or financial planner. The typical complaints are that financial advisors actually lower returns, increase risk exposure, turnover stock/mutual fund/ETF portfolios unnecessarily and charge fees disproportional to their value. Stories have been written about suing financial advisors and, in a grossly unfair generalization, financial advisors have been lumped in with the Bernie Madoff’s of the world.

The question turns, therefore, what would investor returns be like without financial advisors? In other words, what if we all became DIY investors?

Sweden is mostly known for its knock-off designer furniture and talented hockey players but it has implemented the closest real life experiment of a life without advisors. The results may show that, in some cases, blaming the advisor is nothing more than shifting responsibility for failing to control our worse excesses.

The Sweden Pension System

Sweden’s social security is a mixture of pension benefits, income support and individual and self-directed investment accounts. The latter is funded by a 2.5% payroll tax collected annually and deposited into the contributor’s account based on the previous year’s income. The accounts launched in 2000.

Each contributor is given a booklet complied by the government outlining what funds can be purchased and a contributor can pick up to 5 funds. There are now over 700 choices to pick from. The information package divides the funds by category, risk factor, 5 year returns, management fees and total assets under management.

If a contributor does not pick a fund (a reasonable conclusion with over 700 choices), the default fund, the Premiesparfonden (the “Default Fund”), is chosen for them. The Default Fund is restricted from advertising and, until recently, once you make an active choice, you cannot opt back into the Default Fund.

As I understand it (not being Swedish or being able to read Swedish), the funds may advertise, other than the Default Fund, but the individual investment accounts are self-managed without financial advisors.

While contributors have no restrictions in asking their financial advisors for advice, this is the closest system I have found which replicates an investing world without financial advisors since managing individual investment accounts are carried out without intermediaries (other than the government who administers the program).

How does the typical Swedish DIY Investor do?

Between 2000 and 2007, a contributor who was not in the Default Fund was more likely to:

1. Have greater risk exposure than the Default Fund with a mean equities exposure of 96.2% vs. 82% in the Default Fund;
2. Be highly concentrated in their equity exposure with 48.2% mean exposure to the Swedish public markets (a country of approximately 9.2 million people) vs. 17% in the Default Fund;
3. Ignore passive investing with only 4.1% of its portfolio in index products vs. 60% of the Default Fund;
4. Purchase higher fee products with a mean fee of 0.77% vs. 0.17% of the Default Fund (a fee that would make most North Americans happy);
5. Chase returns since the most actively picked fund when the investment account launched in 2000 was the high-tech Roburs Aktiefond Contura which returned over 500% in the previous 5 years but lost 32% in 2001; and
6. Experience worse returns than the Default Fund with a mean return of 5.1% vs. 21.5% of the Default Fund.

The only sin missing from a contributor’s investing decision is account activity. A 2005 Brookings Institute study found that only 6% of contributors made a single fund switch in 2004 and only 600 of 5.3 million account holders switching more than 20 funds that year.

(Assuming low investor portfolio activity in 2004 is the rule rather than the exception, excess trading may not be as large a culprit of poor investor return as some studies indicate. It could be we invest like we date in high school; we chase the attention seekers and heart breakers rather than the steady and dependable.)

What is more galling for investors who picked funds is that the Default Fund continues to be a superior choice to most of the other 700 funds. The Default Fund outperformed the average of all other funds 23.2% vs. 22.3% for the first 9 months of 2009 (although it did poorly compared to the average return of other funds in 2008). The Default Fund has done so well that on September 30, 2009, the Swedish government changed its rules to allow contributors to actively pick the fund rather than only investing in the fund if no choice is made.

As a side note, if you had a build a perfect fund: low fee, indexed, proper asset allocation, a small allocation in alternate investments, you may end up with the Default Fund (see this recent paper on more information on how this fund outperforms its peers).

What are we to make of all of this?

Other than decreased trading in an account, the Swedish experience shows that DIY investors suffer from the same behavioral tendencies as generally attributed to poor financial advisors. Sweden has literary and education rates which are comparable to North America’s. Thus, one cannot assume differing education levels could produce different results if the investment accounts were applied in North America. In fact, studies show the more educated a Swedish contributors, the more likely they actively picked funds rather than being given the Default Fund.

Could it be that as DIY investors we would do no better than having a financial advisor and our finger-pointing distracts us from the larger issue: we, as a society, are not financial literate or savvy and we have collectively found an easy scapegoat?

This is not to suggest that we need all need a financial advisor. Enough studies show that, despite the title, financial advisors tend to be pretty mediocre portfolio managers. However, as other non-advisors have suggested, to boil down the value of a financial advisor purely to a ROI number misses the fact that value is given in many different manners by a good financial advisor.

Does there need to be an overhaul of the financial advisor and financial planner industry? Certainly. The system is broken in many different respects and the stakeholders in the system are all equally at fault.

But, if the Swedish example is applicable to North America (and Bush proposed individual investment accounts as part of his failed social security reforms), it is unreasonable to assume a poor investment advisor is the ONLY reason stopping anyone from superior investment returns. Blaming a financial advisor may make one feel better but the Swedish example shows it may not necessarily produce any different results.

Instead, I likely sit with the majority of other financial bloggers in believing financial self-education and improvement should be a corner-stone of any personal financial strategy. To the extent an advisor or planner can add value to this exercise, then retain accordingly. Best of luck. Thanks for your indulgence in a long post.