Financial Advice and Investor Beliefs: Experimental Evidence on Active vs. Passive Strategies

Households in the U.S. and other developed countries frequently face complex financial decisions, such as managing retirement savings or health insurance. To help navigate these challenges, a growing range of financial advice options has emerged. These include traditional face-to-face guidance from advisors, automated robo-advice, and an expanding selection of online educational resources and videos. While extensive research has focused on the supply side of financial advice, particularly issues like conflicts of interest, much less is known about how individuals receive or respond to advice.

In the study “Financial Advice and Investor Beliefs: Experimental Evidence on Active vs. Passive Strategies,” we conduct a randomized controlled trial (RCT) to investigate how investors assess advice that either aligns with or goes against their priors, and the extent to which financial advice can shape their beliefs about investment strategies and their portfolio decisions.

We focus on advice about two most prominent investment strategies for retail investors: active versus passive. Active strategies aim to beat the market through stock selection and market timing, while passive strategies simply track an index. Most academic research favors passive strategies for retail investors with limited time and expertise, yet active strategies still hold a large market share. In 2022, passive strategies accounted for 46% of all fund assets, up from 13% in 2005.

To present both active and passive investment advice in our lab experiment, we collaborated with real financial advisors to develop scripts, which were then recorded as short videos using trained actors. The scripts reflect typical industry language, recommending either low-fee, diversified passive index investing or actively managed strategies focused on identifying “hot” sectors. The videos promoting passive strategies emphasized the challenge of predicting stock returns, the fact that index funds generally outperform active funds, and the importance of minimizing fees. In contrast, those advocating for active strategies highlighted market timing and pointed out that more active funds tend to perform in the upper tail of fund returns.

We recruited participants from various employers in the Boston and Cambridge area and invited them to a lab. They completed a survey on their demographics and pre-existing beliefs about financial markets and investment strategies. According to their responses, we classified them as either “Pro-Active” or “Pro-Passive,” depending on whether they favored active stock selection and market timing or low-fee diversification. We also assessed their financial literacy levels.

Our experiment follows a 2-by-2 design, where participants are randomly assigned to watch a video that either supports or contradicts their existing investment beliefs. This creates four groups: (1) Pro-Active, saw Active video; (2) Pro-Active, saw Passive video; (3) Pro-Passive, saw Active video; and (4) Pro-Passive, saw Passive video. After watching the videos, participants rate the quality of the advice and the advisor, and we reassess their beliefs about the two strategies. To address any potential bias from the initial videos, all participants then watch a debriefing video that provides academic insights into sound investment strategies.

We document four main results. First, the perception of financial advice is shaped by both the individuals’ prior beliefs and the type of the advice. While passive advice is generally rated higher than active advice, any advice that contradicts a person’s existing views is rated lower. The lowest ratings came from pro-passive individuals who watched the active advice video. When we divided participants by financial literacy, those with high literacy showed clear differences in their ratings across the groups, whereas those with low literacy rated all advice similarly. This suggests that people with lower financial literacy may struggle to effectively assess the quality of financial advice.

Second, while advice that contradicts prior beliefs is rated lower, it leads to more belief changes. On average, people who watched the active advice became more pro-active, and those who watched the passive advice became more pro-passive. However, the way people updated their beliefs depended on financial literacy. More financially literate participants only changed their views after watching the passive advice, while those with lower literacy were strongly influenced by both types of advice. This susceptibility of the financially less literate individuals may make them vulnerable to lower quality financial advice.

Third, at the end of the session, participants chose one of six portfolios, as if investing their own money, with a chance to win $3,000 based on their selection. The six portfolios included three pairs of index and actively managed funds with similar risk and net-of-fee returns. We found that both prior beliefs and the advice received influenced their choices. Moreover, advice promoting active management had a strong impact on the decisions of participants with lower financial literacy.

Lastly, we explore how people respond to information about advisors’ incentives, specifically whether they recognize conflicts of interest and how this affects their view of the advice. We varied the videos to show advisors being paid either flat fees or commissions, with some videos leaving this out. We found that participants rated advice as higher quality when the advisor was paid a flat fee rather than a commission. Additionally, people were more likely to revise their beliefs following the advice of flat-fee advisors. These effects were stronger for those with lower financial literacy, possibly because they were more aware of their limited ability to judge the advice.

Our study shows that participants, especially those with low financial literacy, are receptive to financial advice and willing to let it shape their investment beliefs, suggesting that their reluctance to seek advice may stem more from a lack of awareness than from resistance. However, these individuals tend to follow advice without assessing its quality, leaving them vulnerable to unsuitable advice. This highlights the need for policies that improve the quality of financial advice accessible to them. In contrast, more financially literate individuals are more selective, adopting sound principles like diversification and fee minimization while remaining skeptical of active management strategies, such as market timing. Finally, transparency regarding the incentives behind financial advice is crucial for all investors, particularly those with lower financial literacy.