The advice you don't get

Which raises the question. Could it be that people are misinformed about what to expect from such services, and that conventional financial advice fails to put them right?

Economic thinking - much of it based in new economic psychology - suggests so. Here, then, is a rundown of some financial advice you don't hear, but should.

1. A lot of financial advice is not useless. It's worse than that.

Establishing this for sure is tricky. Everyone likes to blame advisers for their bad investments, but take credit themselves for the good ones. We need, then, some rigorous academic studies. And there have been a couple recently.

First, some Dutch researchers studied the market in deferred annuities. They found that investors who bought these through brokers, and took advice, got worse payouts than those who bought direct. What's more, they found that among those who took advice there was no correlation between individuals' level of risk-aversion and the riskiness of the product they bought. By contrast, among those who didn't take advice, there was such a correlation. Financial advice, they concluded, was counterproductive (Read the full study here).

Some German researchers have corroborated this. They found that financial advisers put clients into excessively equity-weighted investments, regardless of their risk preferences.

This suggests that financial advice can be not just wrong, but systematically wrong.

2. Financial advice is not futurology.

The most important fact about investing is that the average professional stock-picker underperforms the market. According to Trustnet, a website that tracks fund performance, only 59 of 259 funds in the UK all companies sector have beaten Scottish Widows UK All-Share Tracker Fund (which I've invested in) over the past five years.

This means there's no point paying anyone for their insights into future returns. On average, the professionals don't have any such insights.

3. Proper financial advice is like good tailoring. It's about finding what fits you.

This doesn't mean all financial advice is bad. Quite the opposite. Proper financial advice will do three things.

First, it'll help you minimise charges.

Second, it help you minimise taxes. It's a good idea, for example, to put lots of money into your pension as you get great tax relief on it. Beyond this, though, much of the advice you need is bespoke - it depends upon your own personal circumstances.

This is where advice can, in theory at least, play a third role. It can help you tailor a portfolio to fit your particular needs.

Bog-standard advice does not do this. It thinks attitudes to risk just fall into three boxes: cautious, medium or adventurous.

There's more to it. Imagine two people with similar 'cautious' attitudes. One owns a small business which is vulnerable to recession. The other has retired on a flat-rate annuity. Should they own the same assets?

Not necessarily. Our first investor has taken recession risk before he's bought a single share, because he's a business owner. So he might want to avoid shares that, while attractive on average, are also vulnerable to recession; these are value stocks.

Our second investor won't suffer from recession; he hasn't a job to lose. So he can afford to hold more of the stocks that are sensitive to recession than our first investor.

What he is exposed to, though, is inflation risk; rising prices will erode the purchasing power of his annuity. This suggests he should avoid stocks that do badly when inflation rises, and maybe hold more of those stocks (such as commodity producers) that do well when inflation rises.

Good financial advice will help these two investors. It will ask the questions Chicago University's John Cochrane posed. What are your risks? What are not your risks? And it will help tailor portfolios accordingly.

But it will also remember a tautology that should be the basis for asset allocation. The average investor holds an average basket of stocks - that is, the market. So you should hold tracker funds except to the extent that your risks differ from the average investor. If the only difference between you and the average investor is that you are more (or less) willing to take risks, you should simply hold more of the tracker fund and fewer safe assets.

4. Money doesn't much matter.

One finding from the fashionable research on the economics of happiness is that money makes us happier, but not by much. Researchers at Warwick University have estimated that a windfall of £50,000 leads to an increase in subjective well-being of around one-fifth of a standard deviation. £50,000 is a lot of money - almost two years of average earnings - but a fifth of a standard deviation is not much.

And the impact of wealth upon happiness diminishes as we get richer - there's diminishing marginal utility to wealth. John Helliwell of the University of British Columbia has estimated that moving from the fourth to five decile of incomes (that is, from just below-average to average) increases happiness by 0.1 points on a 1-to-10 scale. But moving from the second-richest decile to richest decile improves happiness by just 0.01 points.

This suggests we should not worry much about money. Unless you're different from the average person, getting richer won't make you much happier.

Instead, researchers have found, what really matters for happiness is a good marriage. Warwick University's Andrew Oswald has calculated that someone who gets separated from their spouse would need an additional income of £8,000 a month to offset the loss of well-being caused by the break-up. This is a lot of money partly because break-ups make us really miserable, but also because we need big rises in income to attain even small increases in happiness.

In this sense, a happy marriage is a much better investment than anything you'll find on the stock market. And a nasty divorce is a worse disaster than almost any financial investment you can make. So, worry less about money and more about finding Miss (or Mr) Right. And if you've found her (or him), keep them happy.

5. Don’t just think about financial planning. Think about character planning too.

This finding suggests we should think about financial planning from the opposite direction.

I've said that the best financial advice is like good tailoring, designed to fit you. But if you want to look good, there's an alternative to paying a skilled tailor to hide what he calls evidence of sir's prosperity. You can lose weight instead.

Just as it might be better for you to adapt yourself to your suits, so it might be better to adapt your requirements to your means.

Just ask yourself: do I really need a lot of money, when psychological research suggests that it won't make me much happier? What's the point of owning a big house when you can only sleep in one bed at a time and the place becomes impossible to heat when the boiler breaks down? Why have an expensive car when you'll only get caught by speed cameras? Who needs vintage champagne instead of Grainstore Cooking? And why leave money to your children when, as Andrew Carnegie said, he who dies rich dies disgraced?

One reason why I consider myself comfortably off is not that I've made great investments but that I've answered these questions and reduced my requirements. A lot of our desire for wealth arises from a desire to impress others, to keep up with the Jones's. But you only have to listen to the Jones's for a while to realise that it's not worth impressing such idiots.

6. Learn to play a musical instrument.

I'm serious. This has three pay-offs.

First, it's acquiring a cheap taste, something that makes you happy without costing a lot of money.

Second, it's a way of changing our priorities. Bruno Frey of the University of Zurich, one of the leaders of happiness research, says that people who value intrinsic goods tend to be happier than those who value extrinsic ones such as wealth, power or fame. Learning a musical instrument focuses our attention upon an intrinsic good - musical excellence - and distracts us from what Adam Smith called the trinkets and baubles of frivolous utility.

Third, it stops us thinking about financial markets. And thinking too much can be fatal.

A friend of mine explained why. A few years ago, he left the City and traded for himself, with some success. Then he was tempted to work for a hedge fund. When he did, he found that his investment performance deteriorated. He told me: "When I traded for myself, if I could think of no good ideas I'd just forget it and go for a game of golf. Now I'm working for someone else, I feel obliged to do things. This is no way to make money.”

This is an example of a common finding in psychology. As we gather more information, confidence in our judgment rises by more than the accuracy of those judgments. The upshot is that we take more decisions than we should. We trade too often, which can be disastrous. So we need something to distract us from the markets.

This is true in another sense. Let's assume shares were to return 10 per cent a year, with annualised volatility of 20 per cent with returns in one period uncorrelated with those in the next. If you were to look at these shares every day, you'd see them lose money almost as often as not (49 per cent of days). But if you were to look only every year, you'd see only a 31 per cent chance of a loss. Looking at the market too hard, then, might lead you to exaggerate its riskiness.

Playing a musical instrument can help you avoid this error.

Of course, it needn't be an instrument. Getting an allotment would do as well. Or even golf, as long as this doesn't lead to an urge to play the Old Course at St Andrews too often. Anything that blocks out Robert Peston will do.

7. Beware of your friends.

Friends do more than money to improve our subjective well-being. But they can be dangerous.

For one thing, a desire to keep up with their (perceived) livings standards can lead us to overvalue wealth and to chase higher returns.

And for another thing, friends can lose us money by creating a buzz around fashionable investments, with the result that we buy at the top. How many people bought into tech stocks or buy-to-let schemes at their peak because they finally succumbed to their friends' talk that doing so was an easy way to make money?

Bernard Madoff seems to have exploited just this habit, using word-of-mouth and an aura of fashionableness to tempt people into his Ponzi scheme.

Yes, momentum investing works. But it does so if you are first onto the bandwagon, not last. By the time everyone is talking about a good investment, it's probably time to sell.

8. Start investing young.

Many financial advisers claim that the stock market is less risky over the long-run than short, so young people should own more stocks than older ones.

This is wrong. Yes, most economists think there is less chance of the market falling over, say, a five-year period than over a one-year one - though some doubt even this. But for many people, a loss over five years is a nastier event than a loss over one year. So, whereas equities offer a high chance of a tolerable loss in the short term, they offer a small chance of an intolerable loss in the long run. For many investors, these prospects are equivalent, making shares as good (or bad) a long-run investment as a short-run one.

So, why should younger people invest in stocks?

For one thing, they are the exception to the many investors. Say shares were to fall over the next five years. If you're in your 50s, this would be really nasty. It would jeopardise your chances of retiring early. But if you're in your 20s, it wouldn't hurt so much. Quite the opposite. You have - with luck - years of working with which you can offset such losses anyway. And the losses give you a buying opportunity; they'll allow you to buy into a cheap stock market and enjoy 20 years of possible good returns before you retire.

There's another reason to start investing early. Most of us are creatures of habit. As Richard Thaler and Cass Sunstein say in their book Nudge: "People have a general tendency to stick with their current situation". So it's easier for us to save in our 30s if we have already begun doing so than it is if we have to change our habits.

This raises the question: if it's a good idea to start saving young, should we really be encouraging so many people to go to university and so be burdened with tens of thousands of pounds of debt in their 20s?

9. Remember - you can save too much.

We're often told that we are not saving enough for our retirement. This is a con, perpetuated by a pension fund industry that can't think of honest ways of attracting savers, despite generous tax breaks (which you should take advantage of) and amplified by a government that has contempt for the intelligence of the people.

The academic justification for this view was research in the 1990s which showed that people cut their spending after they retired. Economists called this the retirement consumption puzzle. It suggested that - contrary to the predictions of standard economic theory - people did not save enough for their later years and so had to scrimp after they stopped working.

More recent research, however, has cast doubt upon this. Sarah Smith of the University of Bristol has found that spending falls only for people who have to retire early involuntarily, through ill-health or redundancy. People who can choose when to retire, she's found, maintain their spending.

Researchers at the Institute for Fiscal Studies have found that the same thing is true even in the US, where - we are told - the people save even less than they do in the UK. "There is no retirement consumption puzzle," they've concluded.

Yet other researchers say that even if spending does fall it doesn't mean retirees are hard-up. Instead, it's because when people stop working, they cut work-related expenses. They spend less money on transport or work clothes; they can make their own coffee rather than buy expensive cups at Starbucks; and they have time to cook cheaply for themselves rather than buy expensive ready-meals.

Less cheerfully, other economists point out that as our health declines, so does the marginal utility of consumption, which means our spending should decline. What's the point of buying CDs if you are deaf? Or having a skinful in the Wheatsheaf if it means getting up five times in the night? And the attraction of expensive foreign holidays wanes if one isn't feeling well.

Of course, some people save too little for their retirement. But anything is true of some people. On average, people have saved enough for retirement.

This raises a possibility. Maybe some of us are saving too much. Wealth is not the only stock worth having. What also matters is our stock of happy memories. Often, in working hard and saving, we merely build up one at the expense of the latter. No one on their death-bed wishes they had saved more.

So, perhaps the truth is that - for people who are moderately well off - money just doesn't matter much.