Can investors trust their money managers?

A recent article in the Wall Street Journal, “Taking Control,” by Jennifer Levitz highlights how investors feel they can no longer trust money managers. Multi-billion dollar Ponzi schemes by the likes of Bernie Madoff, prominent financial companies being accused of cheating clients, and terrible recent performance have all conspired to make investors feel shell-shocked.

This is quiet understandable. After being re-assured that regulators were looking out for their interests and by money managers who have conflicts of interest, no wonder people feel scared.

The article goes on to spell out some of the things investors can do to take back control, so they don’t feel as scared.

1) Do your homework when picking a financial advisor. Every investment advisor must provide a Form ADV Part II to prospective clients. This form spells out an adviser’s structure, methodology, criminal record, compensation, etc. If you advisor won’t disclose this basic information, then don’t consider them. I gladly provide this form to all my prospective clients.

2) Ask tough questions to identify potential conflicts of interest. Some advisers are salespeople in disguise. They are compensated by commissions and they only have to judge a potential investment as “suitable” for clients. A tougher standard, which all registered investment advisers must meet, is a “fiduciary” standard. A fiduciary must put the client’s interests first. A commission-based broker only has to ensure an investment is “suitable,” which has a lot of wiggle room. Make sure your advisor holds themselves out to the fiduciary standard. I do.

3) Find out how an advisor is compensated. If they are compensated by commission, then your interests and theirs are not aligned. Their commissioned-based structure may not be obvious to you, so ask a lot of questions. If an advisor gives you a financial plan for $500, and they recommend you put $100,000 with a mutual fund they get a 5% commission ($5,000) for recommending, they have 10 times the reason to get you to buy their fund than to provide you with an objective financial plan. If they work for a flat fee and don’t receive kick-backs for recommending investments, then their interests and yours are aligned. If they work for a fee based on assets under management, then their interests are aligned with yours except when you ask them how much of your money they should manage. Find out how your advisor is compensated and you’ll find out if their interests are aligned with yours. I’m compensated by a fee based on assets under management, so my interests are aligned with clients, and I disclose my conflict of interest when they ask me how much money they should stick with me.

4) Ask tough questions about risk factors. Most advisers try to paper over risk factors. They stick clients with a hundred page prospectus (feeling certain no one except accountants and engineers will read it), or they try to understate risk considerations. Make sure your advisor can clearly articulate the risk factors of their particular approach. I have a brutally honest web page that explains the risk factors of equity investing (which is what I do), and I tend to over-emphasize risk to my clients. My first client letter, in the summer of 2005, said the market was over-valued and that clients should lower their return expectations. Fortune favors the prepared mind.

5) Don’t expect a free lunch. When someone gives you a free steak dinner, you have to question their motivation and objectivity. When someone says something is “cash-like,” doubt their statement. Cash is cash-like; structured products, bonds, even CDs all carry risks that are distinctly not cash-like. I invest in equities, and they are not cash-like. Don’t be fooled by someone trying to pitch a product that anything other than cash is truly cash-like.

6) Does a manger invest his own money the same way he’s recommending you invest your money? Does he or she eat their own cooking? If your advisor doesn’t or won’t invest where he is recommending you invest, be very worried. If they earn $100,000 a year selling variable annuities and have $20,000 of their own money in a variable annuities, be very worried (they make so much more from selling annuities that they’ll never care about the mere $20,000 they might lose). If an advisor believes in what they do, then they’ll have all, or almost all, of their money invested there. I have over 90% of my money invested in the same securities I recommend for clients. My other 10% is in a bank account in case an emergency happens.

7) Does your adviser’s firm have interests aligned with yours? Firms make more money when they advise more people. But, the more people they advise, the less time they have for you. Such is the conflict of interest of money management. Added to this, large firms cannot move as quickly as small firms to exploit market opportunities, nor can they deploy their money in smaller situations like small firms can. The benefit of large firms is the possibility of lower costs. With Vanguard, that’s the case. Most firms that are 100x my size still charge more than I do, when all costs are considered. Many large firms charge their clients to help them market to new clients, that’s what 12b-1 fees are at mutual funds. What a rip-off. My firm is small and nimble, allowing me to provide excellent, personalized customer service to a limited number of unique clients.

Yes, Virginia, some money managers can be trusted, but you have to do your homework to find that out. Get full disclosure, ask about advisor conflicts of interest, find out how they’re compensated, get clear information about risk, don’t expect a free lunch, ask lots of questions and expect understandable answers. It’s hard work, but very much worth the effort.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

“The typical small investor has no idea what his or her performance has been”

This distressing quote comes from an article I read in the September edition of Financial Advisor magazine.

A study by Markus Glaser and Martin Weber of the University of Mannheim came to this conclusion after surveying 215 retail investors to find out what they thought about their investment results versus how they had actually done.

Their study showed that investors with bad results thought they were doing just fine, and that there was almost no relationship between how investors actually performed and how they believed they had done. They also discovered most investors weren’t as successful as they thought.

Although the authors focused on cognitive biases that caused this result, my mind turned, instead, to other questions.

If investors don’t know how they’re doing, is that their fault, or the fault of their advisors?

If investors think they are doing okay when they’re not, how would they know they should switch advisors?

If investors work with advisors who aren’t serving their best interests, do they know they can get better results by working with an advisor with fiduciary responsibility?

It’s troubling that so few have saved enough for retirement. It’s more troubling to realize they may not know this. To me, it’s most troubling that the people who should be helping investors reach their goals are frequently using an investor’s ignorance to keep them in the dark.

After all, who gets an education in the math of investing such that they understand investing results? Who gets an education in the costs of investing and the compensation schemes of financial service providers? How can people make good decisions if their financial advisors benefit at their expense?

Many investors are getting bad advice because they work with salespeople who are likeable. Such salespeople are trained to be likeable because financial service firms know most people can’t judge performance and tend to choose based on gut feel.

I believe this is the real cause of the problem Glaser and Weber discovered. The solution is to work with professionals. Professionals are experts in their field based on extensive education, training and experience. They tend to have ethical guidelines and join associations that enforce those ethical standards.

If you want a great doctor, pick a doctor with great education, training and experience. If you want a great accountant or lawyer, look for the same thing.

If you want to pick a great investment advisor, look for education, training and experience–not likeability.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Looking for information about picking a financial planner or investment advisor?

I’d like to recommend a good web resource for those seeking information about picking a financial planner or investment advisor: Paladin Registry.

Paladin is an information services company that provides resources and referrals for individual and institutional investors. They provide both articles and seminars for free. They also provide, for free, referrals to high quality financial professionals and firms. If you are looking for help picking an advisor or planner, this is a great place to start.

The reason why is Paladin clearly understands how most investors can get hoodwinked by salespeople who call themselves professionals. The purpose of forming Paladin was to link investors with professionals in the field who are compensated by fees instead of being compensated for selling products.

Watch one of their seminars or read one of their articles and you’ll see what I’m talking about. They are trying to inform investors about what to look for in advisors and planners. And, they’re not pulling punches in describing the way the financial services field operates. You really can get some great information and guidance on how to pick a professional who can help you.

If you do use their service to locate a professional, they don’t link you to just one professional. Instead, they generally provide 3 contacts who can help you. That way, you have alternatives to choose among.

Some full disclosure is in order here. I belong to the Paladin Registry, which means I pay to be a member and they refer qualified investors to me (as well as two other advisors). 90% of the advisors and planners who apply to the registry are turned away because they don’t meet Paladin’s high standards. I prefer to be in such good company, and gladly pay to be a member of this elite organization.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Growth vs. Value; “and another thing…”

Another thing that bugs me about the growth versus value distinction is the bad advice that a lot of so-called investment advisers and financial planners give out.

First off, around 85% of financial planners and investment advisers are commissioned-based salespeople. Asking them for advice is like asking a Ford salesman whether you should buy a Ford. You’re not going to get objective advice.

I have no problem with salespeople making a living, but I do have a problem if they don’t disclose how they’re compensated. Here’s a tip: ask any “advisor” how they are compensated and you’ll get a clear picture of whose interests they are serving.

Another problem I have with the advice given out by so-called investment advisers and financial planners is the line that “you need both growth and value investments.” The rationale goes like this: you need to diversify so you will do well regardless of whether growth or value investing is working.

My problem with this “advice” is that mixing most growth and value investments together gives you market returns. And, market returns should not cost you a 5% upfront load plus an annual active management fee of around 1% a year plus an investment advisor fee of 1% a year. Instead, you should just buy an index fund that charges 0.2% a year for market returns.

Want to know why they recommend both growth and value investments instead of an index fund? Because the index fund doesn’t pay a big fat commission for selling their product, and the growth and value mutual funds probably do.

Accepting such advice will help the salesperson make their quota, but it won’t help you reach your goals. Either buy market returns at lowest cost, or find an active manager who can beat the market after all fees.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.