It’s not easy, being a financial advisor

By Felix Salmon
July 14, 2011
Scott Bell wrote a wonderful and heartfelt post about what it's like being a financial advisor.

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Last week, Scott Bell wrote a wonderful and heartfelt post about what it’s like being a financial advisor.

I’ll tell you to sell something because a trend is broken or a target is reached, or you need money and I picked that one… the one that went up still. And I’ll hear about it whenever something else is down.

We’re supposed to have read that great article on page 5 of the business section in the LA Times about GE. And when I say I didn’t, I can actually feel the shock and disgust oozing through the phone. The disappointment…

We’re supposed to know about every single product being advertised and whether the new one is better than the one we have. We’re supposed to be compared to every portfolio at your friends’ next cocktail party…

I don’t have a magic bullet or crystal ball, but somehow I’m still supposed to know. Even though you know I don’t know, you still have it in your head that I do (or else why are you paying me). And this irrational double talk in your head only shows its face when your greed or fear kick into overdrive. You know, the time you are least logical for us to talk about your money.

It really is a gruesome job, being a broker — the kind of people who hire you tend to have ridiculous expectations when it comes to what you can do with their money. (Anything less than 10% annualized is a disappointment, as a rule.) They all want to outperform the market, they all want high return with low risk and they are quite happy contradicting themselves on a regular basis.

And on the other side of things, it’s not much easier being a client. A reader sent me a note today that they got from their broker. It advises a big restructuring of their portfolio: a bunch of funds should be sold and a bunch of similar funds should be bought. The asset allocation ends up pretty much the same, but the vehicles change. And in the course of an eight-page letter, the reason for doing this mass purge is dealt with swiftly indeed:

The funds we are recommending that you sell have in the most part demonstrated performance that has not been in line with our expectations and we feel you would benefit from switching into more prosperous and more diversified holdings…

The property sector has experienced a turbulent time since the financial crisis and in most part has not fully recovered and we feel there are better opportunities in this sector for you to benefit from.

On the basis of this advice, the broker is recommending a six-figure decision representing an enormous proportion of his client’s net worth — and the advice, boiled down, comes down to a pretty tautological “we’re recommending this course of action because we think you will benefit from it”.

The deeper thing going on here is what might charitably be called a momentum trade, or what might less charitably be called a sell-low strategy. First you pick your sector, then you pick funds in that sector. If the funds do well, that’s great; if they do badly, then you sell those funds and instead you buy funds which did do well over the time period in question. Then, next year, presumably, you rinse and repeat.

If you’re a remotely normal person, you’re not qualified to pick stocks and neither do you have the self-confidence to even try. So instead you outsource your stock-picking and buy mutual funds. But this just shunts the problem down the road: if you’re not qualified to pick stocks, what qualifies you to pick mutual funds? After all, there are just as many funds to choose from as there are stocks. So you punt again and outsource your fund-picking to a financial advisor. And all the while you know you’re still not much better off: however many stocks and mutual funds there are, the number of financial advisors is greater still. If you can’t pick a stock or pick a mutual fund, what makes you think you can pick a financial advisor?

The relationship between you and your advisor, then, is a bit rocky from the beginning: you’re paying the advisor to pay mutual fund managers to invest your money in stocks which might well underperform. There’s a lot of fear and greed in there, neither of which make for particularly clear-headed conversations or decisions. And then to make matters worse, your advisor is likely to treat you like he treats most of his other clients. That means that he’ll recommend you do something or other on a regular basis, since most clients think a broker who doesn’t do anything is wasting their money. (In fact, a broker who does do something is probably wasting their money; a broker who doesn’t do anything is saving them money. But most clients don’t think that way.)

All of which is why my standard advice to everyone is to simply buy index funds and rebalance every so often, if and when you get around to it. Because it’s silly having an advisor if you don’t take their advice — but at the same time there’s no particular reason to believe that your broker’s advice is particularly good, or that something like a “sell the funds which have underperformed of late” strategy is actually a sensible one, or is liable to work well over the long term.

And it’s hard to have that kind of meta-conversation with your broker, too, because brokers don’t get paid nearly as much as they used to and are often not particularly smart or sophisticated. (I hasten to add that smart and sophisticated brokers aren’t necessarily better at being brokers; they just might be a bit better at giving a good answer to questions like “does it make sense to sell funds which have gone down in value, and if so, when should you do so”.)

If you look at the 14-figure sums being managed by financial advisors, it’s easy to see how incompetence and rampant emotion and waste and fraud and messiness can easily result in billions of dollars flowing from dumb investors to the smart Wall Street crowd every year. And it’s equally easy to blame Wall Street generally, and brokers in particular, for that waste. But irrational and emotional individual investors deserve their own fair share of the blame. Financial advisors are dealt a nasty hand, much of the time. So before we blame them for things which seem wrong, we should probably ask ourselves what exactly we’re hiring them to do in the first place and whether our expectations are remotely reasonable.

Comments
13 comments so far

Good post, Felix. I’ve done well with my own money, and my brother has done even better piggy-backing on the ideas that I discuss with him, but I would be very uncomfortable offering specific advice to anybody outside my family. The more distant the relationship, the closer my advice gets to the same standard that you offer, “Simply buy index funds and rebalance every so often, if and when you get around to it.”

Yet even that approach requires sufficient sophistication to NOT sell low. How many index-fund investors were selling in the first quarter of 2009 because they had given up on the stock market? You cannot escape the dilemma that the person with the final say must either understand investing or trust somebody who does.

Finally, I don’t think you gave enough attention to this line, “Anything less than 10% annualized is a disappointment, as a rule.” While my 3- and 5-year portfolio returns are over 9%, I could not have achieved anything close to that if I were aiming for 10%. Instead, my target is a hoped-for 6% return with a strong likelihood that everything I own will be worth more in ten years than it is today. Anything better than that 6% is simple luck.

Reminds me of that John Milton quote, “Luck is the residue of design.” If your investment plan is built on 10% stock returns and the expectation that you will pace or beat the market every quarter, you will reap the luck that approach deserves.

Posted by TFF | Report as abusive

an excellent post, sometimes the only thing harder than investing is advising others on how to invest.

bravo, you nailed it

Posted by ReformedBroker | Report as abusive

Great post. Buried in the subtext of what you wrote is the lack of financial literacy by the “remotely normal person.” Quite a bit of the advisor’s job is often education.

I have to mention though that I cringe at your interchanging use of broker and advisor.

Posted by david3 | Report as abusive

Has anything changed since Michael Edesess wrote his book The Big Investment Lie? His blog http://www.thebiginvestmentlie.com/ hasn’t been updated in over a year; maybe there’s nothing new to add to his general opinion that fees and taxes nullify any possible advantage to using a financial advisor. One can peruse the archived notes there.

I’m quoting second-hand from a transcript of an interview with Edesess from the Tavis Smiley Show archives:

“Edesess main arguments can be summed up as follows: investment advisors and investment manages don’t have a crystal ball and they cannot predict the future. Furthermore, they do not give you good value for your money as the benefits they provide are not worth their cost. On average they don’t earn more money for you than you could probably earn on your own without their “expertise.” And they certainly don’t know how to beat the market no matter what technology and research they may have available at their finger tips.

Most of the hype that is proliferated is based on a Big Lie that only serves to fill the pockets of these individuals with their high fees. In fact, as Edesess points out, many investors don’t even realize that they are using high-cost services that typically cost 2 to 3 percent of an investor’s assets annually. The arguments used by these investment managers and advisors is that people want professional advice and they feel more assured when they receive it. However, as Edesess states: “But the business would be gradually reduced to a much smaller, much less lucrative business if it made a practice of telling the whole truth and advising clients accordingly.”

Posted by MartyNH | Report as abusive

“Buried in the subtext of what you wrote is the lack of financial literacy by the “remotely normal person.” Quite a bit of the advisor’s job is often education.”

There are probably ways of achieving this education that wouldn’t cost ~2% of our household savings annually, no?

A middle-class couple in their 50s might be sitting on a half-million dollars of financial assets. I wonder if they could find a better use for that $10k annual fee?

Posted by TFF | Report as abusive

“I have to mention though that I cringe at your interchanging use of broker and advisor”

I cringed as well. This is a significant problem in the public understanding of financial services, the confusion between brokers and advisors or even CFPs who are held to fiduciary stanrard of care.

Also, there seemt to some underlying assumptions here that warrant further examination: first, that the primary “service” advisors offer is individual security selection, and second, that a “normal person” has the free time and inclination to attend to these matters on their own.

Posted by Blicero | Report as abusive

Great post Felix & thank you for the kind words.

I can completely understand the investors plight too. Who do you trust, where do you go, when do you know? When brokers can seamlessly switch from their broker role to adviser role, turning fiduciary duty on & off, it becomes impossible to know.

In general, I think the answers to most of our issues rest in listening to common sense. If someone is touting market beating returns, you should heed caution. If your advisor works in a giant investment bank that makes money on trading, investment banking, and selling products– you should probably heed caution. If your advisor can never (or will never) answer a real question you have clearly about YOUR money, heed caution.

And If someone says you can’t do what we advisors do, that’s just flatly wrong. The truth is, most clients could do what we do, but they know 1) they won’t or 2) they don’t want to or 3) they just really don’t have any knowledge or interest in obtaining the knowledge or 4) people are just too emotional about their own money.

You lost 10%. No big deal? What if 10% is $100k of your money, now you’re probably a bit more emotional. The larger the numbers, the bigger the mind games. That’s what a professional is supposed to help you with, helping you avoid your breaking points. I’d say as an industry this is where we are lacking– instead of selling, start telling the truth about reality.

So, do advisers add value? Yep. It’s often based on reason & knowledge. Do a lot of advisors not add any value?…yep. Which is why I think the industry layoffs that are coming will probably be particularly meaningful.

Happily, this disconnected reality is being tested in the marketplace right now, as people seek new advice from new places– independent places. But what is the value for that?

I don’t think the 1.5% fee (or 5% commissions) that I see all too often for an advisor to go onto morningstar.com 5 minutes before your meeting & print up some 5 star mutual funds to tell you to buy is sustainable. Not with the technology shift that’s happening.

Instead a good advisor should be like a coach or teacher, guiding you & telling you about the possible benefits and pitfalls of your choices and actions, helping you stay rational and manage your expectations objectively.

So, what’s that worth? 1%? Sometimes, probably yes. .5%? Sometimes, probably yes. A one time consulting fee? Sometimes, probably yes.

Endless flexibility & real solutions are coming, and becoming more ubiquitous as we speak. But it will take time…

Eight pages & no clear answers on why the changes are being made & what the tangible cost/benefit is for the client sadly happens a lot. But until we stop accepting the status quo and start asking hard questions, the dance will go on. And we’ll keep acting crazy, thinking we’ll get different results still doing the same thing.

Posted by iheartWallSt | Report as abusive

There’s probably an easier explanation for the broker wanting to sell one group of funds and buy another group – commissions. Brokers get paid for selling you products. Period. You should not depend on a salesperson for investment advice.

Posted by JYC3 | Report as abusive

What undid brokers in the 70s/80s was incompetence at picking securities (individual stocks and bonds) once standardized performance reporting was introduced. So what did the broker/dealers do?, they had their brokers sell funds instead of individual securities and take away the performance culpability risk. But now we are in the same position again, except the SEC or FINRA have been slow to figured out that you need to standardize performance reporting for fund pickers (brokers and consultants) like the AIMR did to stock pickers years ago. That needs to happen now to weed out the incompetent.

Posted by dis737 | Report as abusive

I think that the key to having a good client/advisor relationship is good communcation, just like it is with anything else. Threfore, I would argue, a lot of the problems both clients and advisors have is because they do not effectively communicate with each other about what they want to get out of the relationship.

When my wife and I first hired an financial advisor nine years ago, we interviewed ten different candidates, explained very clearly what we wanted to get out of the relationship, and have been very happy with our advisor we chose ever since. He knows how we think, we know how he thinks, and we have a successful and productive relationship.

Posted by mfw13 | Report as abusive

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