A Monkey Tale
Tell me if you think this is rude. I get to the first tee and meet my playing partner. It’s just him and me playing golf for 18 holes. We are perfect strangers. He shakes my hand, but doesn’t give his name. So, I did the same. I figure, why not? We spend the next four hours enjoying the golf course and practicing golf etiquette. After our round, I ask him if he always avoids names. He says yes. He says, “My head is full, if I let something new in, then something has to come out. Chances are I will never meet you or any perfect stranger again, so why clutter my mind? It’s not as though it will change the way we interact on the golf course.” I never met him again and never forgot this encounter. Granted, he was an extremist, but the message was clear. We can only keep so many things or people in our heads. Dr. Robin Dunbar agrees, and since his life’s work is the study of primates, I call this A Monkey Tale. Let me explain.
If you haven’t heard of anthropologist Dr. Robin Dunbar, here’s your chance. He came up with a theory that applies directly to you and your financial advisor. He proposes humans, just like monkeys, have limits to the number of comfortable stable relationships they can maintain. The number he uses is 150. If this is true, it means financial advisors are also subject to this mental barrier. If they have 50 friends, relatives, co-workers, etc., it only leaves room for 100 clients.
This made me curious, so naturally I called a number of my advisor colleagues. I wanted to know how many clients they felt they could reasonably service. After many calls to many advisors, guess what. The consensus was 100. Dr. Dunbar was right.
What can we postulate from Dunbar’s number?
1) If you are paying an advisor and you are not one of their approximately 100 top clients, you are not part of their circle of stable relationships.
2) The 100 number may be off by as much as 100, but it doesn’t negate the fact that advisors are limited to the number of clients they can service.
3) Because advisors are limited to the number of clients they can service, many reach a point where they are at capacity. They can’t possibly service more clients. They have a limit on their time. Thus what they are really selling is their expertise, and since this expertise is relationship intensive, it is not scalable.
4) Examples of other non-scalable professionals include doctor, lawyer and accountant. They all sell their expertise at an hourly rate. This is markedly different from perceptions since investment advisors are often confused with investment managers. They are distinctly different. Although investment advisors know their client by name, investment managers often have no idea who they are. Investment managers sell their expertise outside the boundaries of time and are therefore, scalable. A mutual fund manager is a good example of an investment manager. The manager of the fund typically has no idea who the individual investors in the fund are, and thus focuses on performance. If the funds do well, the mutual fund manager attracts more clients and more income without any more time expenditure. This is scalable and completely different from what an investment advisor does.
5) Because the investment advisory business is not scalable, it means firms can’t just hire and train more advisors in order to expand. Each of the advisors within the firm is constrained by the Dunbar number. Although it may appear that a firm is large, with thousands of advisors and separation of duties, the economies of scale are in fact not present. It is why we see even the largest firms dividing their advisors into smaller teams.
6) Expert advisors gravitate to affluent clients. Expert advisors typically don’t deal with smaller clients because it is not profitable.
What does this mean to you? It means you need to know where you fit. Here is where you fit. The largest commission-driven firms, the ones you’ve probably heard about—traditionally known as wire houses—have the same business model. They make almost all their profits from their wealthy clients. Specifically, this means clients with accounts in excess of $250,000. Do you have more than $250,000 to invest? If you don’t, they really don’t want you. At least they don’t want you to speak with one of their advisors, because they deem you unprofitable. You are too small to deal with an advisor who knows your name. Here’s proof. If an advisor at one of these household-name firms opens an account for a new client, and the account is under $250,000, the firms won’t pay them. The advisor makes zero, nothing, nada. These firms simply don’t want their advisors dealing with small clients. One of these firms even had the audacity to eliminate, from the advisor’s purview, every client with less than $100,000 to invest. One day the clients had an advisor. The next day they had a call center. You can’t knock the firm’s business model, however. They know where they make their profits, and it isn’t with small investors.
What does this mean to you? Here’s my opinion. If you have less than approximately $250,000 to invest, you should avoid working with an advisor. You should be a do-it-yourselfer and learn as much as possible. Here’s how I come up with this. It gets tricky. See if you can follow.
1) Most successful advisors at large commission-driven, household-name firms are not experts. Some are and some aren’t, but most aren’t. Most are high cost and provide conflicting advice. However, because these firms have so many advisors, they do have some experts. If you can find one, and if they charge you on a competitive fee-only basis, just like a Registered Investment Advisor, you are fortunate. However, the pool of expert advisors in this category is zero if you have less than approximately $250,000 available to invest. Please note, the number is very low even if you have millions of dollars. It is imperative, therefore, to educate yourself! Learn as much as possible.
2) Let’s be fair, however. Most successful advisors at competitors to these large commission-driven, household-name firms are also not experts. They go by hundreds of names, and I divide them into two camps.
a. The first is the commission-driven independent advisor. My advice is to avoid them. Because large commission-driven, household-name firms won’t compensate their advisors to swim in this small client pool, it is the most dangerous of waters. These types of advisors are product-oriented sharks that prey on the innocent. Swim in these waters at your own peril.
b. The second is the fee-based independent advisor. As a small client, I would also avoid these types of advisors. Here’s why. Groucho Marx, the famous comedian, once said, “I refuse to join any club that would have me as a member.” I think the same holds true for small clients. You should say, “Any advisor that would have me as a client, I wouldn’t want to hire.” Why do I say this? The answer is clear. Successful advisors need large clients, or they wouldn’t be successful. If you are a small client and the advisor is willing to work with you, then he/she is probably not successful. He/she might be, but why risk it? Educate yourself and then you can tell. Let me point out a technological development in this area that is allowing an automated solution for small clients. It isn’t perfect and it isn’t personal, but the industry is getting closer to delivering an adequate solution. Some people call this robo-advisory or automated solutions and they may offer a temporary solution for you.
As a small investor, and now you know what small is, this tale is liberating because it offers no alternative or magic formula. There is no cavalry riding in to save the day. It is up to you as do-it-yourself investors to sharpen your skills. It is liberating because it will save you lots of time looking for experts who aren’t there or, better said, aren’t there yet. It also eliminates excuses. Either you develop skills or you are out of luck. When the day arrives and you want to hire an expert, you now know you must make it worth their while or they won’t give you the time of day. What you still don’t know is how to identify an expert. But you will. Until you do, you must hone your skills. Lastly, the alternative of working with anything other than an expert is more costly than going it alone. Don’t do it. Learn the lessons from these tales, interpret them for your situation and apply them.