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Investor Psychology

Don't Fall for the Halo

To pick a good adviser, try to eliminate as many personal biases as you can.

Talk about irony. We investors choose financial advisers in part to help us overcome our worst instincts. Unfortunately, those same instincts may lead us to choose an inept adviser. What’s worse, the adviser we select could have the same bad habits we do.

In one study, for example, people expressed trust in an adviser simply because he was well dressed and held a prestigious diploma. Some participants were shown a picture of a broker in a suit and were told he had graduated from Cornell University. Others were shown the same man but casually dressed and with a diploma from Elmira College.

There’s no reason to believe that Elmira College graduates are more prone to criminal behavior or turpitude than Cornell alums are. Yet subjects in the study judged Mr. Ivy League to be less in need of a background check. “If an adviser went to Harvard as opposed to a community college, it might be reasonable to think he or she would be better educated,” says the study’s author, Emily Pronin, a professor of psychology at Princeton University. “But it isn’t reasonable to assume that the adviser is more trustworthy and that you can skip a background check.” In fact, says Pronin, without such a check you wouldn’t know for sure that the adviser had actually attended Harvard.

Many qualities can contribute to the halo effect, says Pronin. People who are friendly and warm generally are also considered to be smart and competent.

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The halo effect may explain why a recent study shows that our favorite source for financial advice is a family member (43%), followed by a friend (39%). Interestingly, the study, by Sun Life Financial, also shows that older survey respondents rely less on family and friends and more on experts. Maybe that’s because the older we get, the less we are blinded by halos. Ask yourself: Do your family and friends really know more about personal finance than you do, or are you just assuming they do?

Find an analyst. So what should you look for, psychologically speaking, in an adviser? Finance professor John Nofsinger, of Washington State University, suggests starting with someone who thinks analytically. Nofsinger tested a number of planners to determine whether they were analytical or intuitive thinkers. (Take our quiz to determine whether you are an analytical or intuitive thinker -- and whether you might benefit from the help of an adviser.)

Those who ranked high on the analytical scale were more successful in avoiding some of the psychological pitfalls that plague many investors. For example, they were better able to plan for the future. By contrast, intuitive thinkers tended to be too risk-averse, and they were prone to selling winning investments too quickly and holding on to losers for too long.

The good news, Nofsinger says, is that most planners are analytical thinkers. “The more procedural and numbers-oriented a person is, the less likely emotions will enter the mix,” he says.

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To pick a good adviser impartially, Pronin suggests trying to eliminate as many personal biases as you can. She uses the analogy of musicians who audition for an orchestra behind a screen. That way, the judges aren’t swayed by the appearance or gender of the musician.

Instead of letting a halo form, she and Nofsinger agree that you should look first at an adviser’s investing philosophy, methods and results. Does he or she have discipline? Ask a number of clients -- preferably people you don’t know -- or their opinions. Finally, see whether there’s chemistry between you and the adviser. And don’t forget that background check.