A Fairy Tale





Wouldn’t it be fantastic if there was a magic mirror that could lead us to the perfect advisor, even if it was ourselves?  This magic-mirror world would certainly be a more abundant place.  Alas, it is a fairy tale.  Finding the right advisor is difficult and ranks high on any list of the most important decisions a person will make.  It’s a binary decision.  You either do-it-yourself or you don’t.  Those are the choices.  Most importantly, remember even if you hire someone else—you are still responsible.  You cannot abdicate responsibility.

What makes the decision so difficult is that most people aren’t experts in the field.  They need to identify an expert and don’t have the tools to do it well.  The expert-selection task is difficult regardless of what expertise one seeks.  However, it is even more difficult when it comes to the financial services industry.  I believe one of the main reasons for this difficulty is the lack of an industry designation that consumers can rely on as a mark of true expertise.  The advice industry has many ways for advisors to seem expert, but in my opinion most are just slick marketing and self-aggrandizement propaganda.  Granted, some credentials are harder to achieve, unfortunately no credential bestows true expertise.  True expertise is self-taught and learned in the trenches.  Like my graduate school finance professor would say, most designations are earned with as little effort as “a book, a beer and a weekend.”  I will concede, this is an exaggeration, but when it comes to managing your money you need expertise, not “almost” expertise.  Almost does not cut it.

We learned that in 1968, when my Cuban immigrant father decided that he needed to hire an investment advisor, he was surprised to find that there was no advisor-equivalent designation or degree that had the academic and case study rigor of the MD degree.  It was a surprise because it was his natural inclination to seek expertise.  Instead, our system has a Wizard of Oz mentality in which the powerful wizard can miraculously give your advisor courage, wisdom or strength they already possessed but just didn’t know they had.  A firm can take a top copier machine salesperson and in six weeks transform them into an expert investment advisor.  Others, take a kid out of college with a finance degree, teach them their dogma, certify them as a planner and soon allow them to dispense advice.  What a joke.  A few correspondence classes later, they are bestowed a wizardly medal and dubbed expert.  Don’t be fooled.  True expertise is learned in the trenches after many years, many mistakes, many dead ends and a true passion for the profession.  40-plus years later this hasn’t changed and it still isn’t even close to changing.  So if we were to measure an advisor’s expertise and training to that of a physician, they would fall far short.  In fact financial expertise falls far short of almost any professional designation that we recognize.

Of course, there are some true financial experts who are capable of rendering competent advice.  However, I need to clear up or define one thing before we proceed.  What exactly is competent advice?  We know what it isn’t.  But what a competent advisor looks like, that is hard to recognize.  However, I wouldn’t go looking for someone who will make you wealthy quickly.  Acquiring wealth quickly is your job.  In my opinion, the best advisors will help you acquire wealth slowly, educate you and help you keep the wealth you have acquired.  They will also keep you levelheaded during times of market extremes.  Unfortunately, unless you can compensate an expert for the hours they must devote to you, you are not likely to find one or be able to hire one.  In the interim, you must equip yourself and do it yourself.  You need to know what you are doing because in my opinion you are much better off managing your own money than working with anything other than an expert.

Is there a shortcut?  A number of vendors are trying to standardize the expert process through technology.  I commend them for it, and entry-level investors should take a serious look at these alternatives.  They are all low cost and based on modern portfolio management theory.  But they have two fatal flaws.  The first is they ask you to complete a questionnaire to determine your portfolio’s asset allocation.  Seems like a good idea, but the same questionnaire, completed by the same person, a few months apart, produces different results.  Similarly, different firms have different questionnaires, and so they provide different results.  This essentially becomes what I call “the battle of the algorithms.”  Go to a few of the sites and take them for a spin around the block.  You will see just how varied your results will be.  This isn’t the worst flaw, however.  The key flaw is technology-driven advisors have no response to your own irrational behavior.  Whenever we experience bear markets, these technology-driven advisors will see either an exodus of capital or a “revised” asset allocation from their clients as they change their risk profile on the new questionnaire.  People have variable risk profiles, and I don’t see this changing.  Technology, combined with modern portfolio theory, while helpful, is not the solution.

I am not saying to stay away.  I am saying that this shouldn’t be your final destination.  Your final destination is an expert advisor as your advisor, one that knows you personally and spends time with you, and you can only get there if you make it worth their while.  Why do I say this? I am a firm believer in the Dunbar number, a number that approximates the personal relationships that a person, any person, can have with other people.  The number is around 150.  This means that if I have four personal relationships with my children, one with my wife, twenty-five with my relatives and fifty with friends and co-workers, it only leaves room for approximately seventy clients.  If we do the math and assume each of my clients has $100,000 under my management at an annual rate of 1%, this translates to $70,000/year in income without including expenses.  No expert advisor could stay in business at these levels.  Furthermore, fee-based expert advisors are the same as other professionals such as a CPA, doctor or lawyer in that what they sell is their expertise over time.  This is a critical thing to understand, especially the over-time component.  Because a personal relationship requires time, fee-based expert advisors cannot scale effectively.  They are not hired asset managers such as a mutual fund or technology-driven provider where they can do the same thing for thousands of clients without knowing their names.

This means fee-based expert advisors have a limit as to what they can earn based on time and the Dunbar number.  Those experts that make substantially more than their expert peers, and they exist in every profession, are not better at expert advice.  In fact, they are probably worse because in order to make more money, they have made the move to being better at managing their business and have hired and trained others or have developed a semi-scalable product.  Therefore, they are really in the business of providing expert advice but it doesn’t mean they are providing it to you in a personal fashion.  Personal relationships are limited.

Almost all expert advisors I know view their function as a facilitator.  Quite frankly, because they are experts, they have such high minimum dollar requirements before accepting a new client, that most new clients are already wealthy.  This effectively means that expert advisors are really in the business of wealth preservation.  They are in the business of making sure that wealthy people stay wealthy.  They espouse diversification and the appropriate asset allocation.  They rebalance when necessary and make sure their clients have the right mixture of insurance, tax planning, charitable inclinations and estate planning requirements.  Unfortunately, the vast majority of people can’t access expert advisors, which means most must learn to manage their own money.

The inability to access expert advisors poses a problem for the average investor.  I preach and believe with total conviction that you are in charge of your destiny.  However, financial firms have a monetary interest convincing you otherwise.  Unfortunately, if you tell a lie long enough it becomes someone’s reality.  The average investor actually thinks they have a partner.  They mistakenly think this due to the constant bombardment from well-designed advertisements and slogans.  We’ve all heard things such as “you’re in good hands” or “the right relationship is everything” or “one client at a time” or “the company you keep” or some other nonsense meant to win our trust and loyalty.  My two favorites were the AIG slogan “the strength to be there” and the Washington Mutual slogan “the friend of the family,” right before both companies needed government bailouts to prevent them from going belly-up.  The point is that you come to believe you have a partner, and even worse that you have a competent partner.  In most cases you don’t.  Your best partner is yourself, armed with knowledge.

The problem is an individual looks to hire an expert advisor, when they don’t know what one looks like.  Furthermore, most expert advisors are out of an individual’s wealth cycle or price range, and those that remain are probably not expert advisors.  It reminds me of the Groucho Marx quote, “I refuse to join any club that would have me as a member.”  There’s tremendous wisdom in his saying and translates to, “Most advisors that would have me as a client, I wouldn’t want to have as my advisor.”  There’s no good solution to this problem other than financial literacy, which is of course why I write these tales.  You must learn about money.  It will make you a better judge of who’s good and who’s not.  There is no alternative.

I consider myself an expert and think I can recognize other experts.  However, when I pose a theoretical question to colleagues asking them to explain how they would advise a loved one in the ways of expert recognition, they are as stumped as I am.  We’ve all read personal finance columns that tell us their version of how to hire an advisor.  They give you a checklist of questions, and if you follow their advice, theoretically you are set.  If it was that simple, everyone would be healthy, wealthy and wise.  But we’re not.  To reiterate, neither I nor any of my colleagues can come up with a bulletproof method to hire an expert advisor.  However, there is unanimity in eight areas of what one should not do.  The following is my checklist, and I thank those that helped me create it.  I hope it helps.

1)      Only work with advisors who have a full-time passion for the business.  If your advisor has business interests not related to managing money, they will never excel.  If they have outside business interests, they are telling you through their actions that the best use of their time is not providing you with investment advice.  The time your advisor may spend devoted to running a restaurant, a moving company, a mortgage company or whatever other endeavor they designate potentially more profitable or enjoyable is time they are not getting better at their profession.  Avoid the half-steppers and only deal with focused advisors.

2)      Don’t hire an advisor that hasn’t personally advised clients through at least one full stock market cycle.  This means one full bull-and-bear cycle of the stock market.  I say this because as a young advisor I was not immune to the same fear and greed my clients exhibited.  I made rookie mistakes.  No one is immune to error, but expert advisors keep them to a minimum and avoid the big ones.  We know many people fail because of his or her financial programming or behavior.  The advisor’s primary function in this area is to remove the fear and greed component out of the investment equation.  Therefore, it seems logical to only deal with those advisors who have at least experienced this in the past and have corrected their own tendencies.  In order to correct these tendencies, every expert advisor has developed an investment approach.  So the next item on the checklist is . . .

3)      Don’t hire an advisor without a valid easy-to-explain investment methodology.  In most cases the actual methodology is unimportant as long as the advisor knows exactly how he/she will behave in a given stress situation.  Get a sense of how the advisors think.  For example, ask them what they would do if interest rates went up or down dramatically.  Ask them what they would do if the stock market dropped 25% from the day you started your relationship.  If you come up with questions, they should have answers, and the answers need to make sense to you.  Market cycles repeat, and the expert advisor recognizes that although they can’t predict the future, they know what it will generally look like and more importantly how they and their clients will behave.  Look for clues.  For example, if an advisor tells you that he would avoid investing your money in the stock market during periods in which the market goes down 25%, find another advisor because they’re either lying to you or to themselves.

4)      Don’t hire an advisor who provides conflicted advice.  These are advisors I call commission-compensated or sales-driven advisors.  No good can come from a situation in which the advisor doesn’t have your best interest at heart.  Although some are good, there is no way for you to tell, and unfortunately you must paint them all with a broad brush.  For example, it’s particularly difficult to deal with a salesperson during times of market turbulence.  Believe me when I say you are more likely to be overly fearful of losing money during turbulent times.  You have a variable risk profile whether you choose to admit it or not.  You will be turning to your advisor, and since the advisor is more than likely compensated on a transactional basis, they will sell you what you want, not what you need.  When advisors sense fear, they sell fear.  When they sense greed, they sell greed.  The result is not good.  You typically end up buying high, selling low and achieving unsatisfactory results.  The fee-based advisor has no such conflict of interest, is held to a fiduciary standard and in my opinion provides a higher probability of success.  This is probably the reason why the fee-based compensation model has gained such popularity over the last two decades.  Please note this does not mean you will succeed if you hire a fee-based advisor.  You just have a better chance at success.  You must still find and hire the right one.

5)      Don’t hire advisors with a narrow focus.  If they specialize in a particular area and their area is out of favor, your portfolio suffers.  They may be very good at their specialty, but you want to work with an advisor who specializes in personal finance and not one particular area.  For example, it does you no good to work with the world’s preeminent technology stock picker if you don’t want to allocate 100% of your money to technology stocks.

6)      Don’t hire advisors who try to be all things to all people.  They will be below average at all things.  For example, have you ever gone to a restaurant that advertises Italian, Mexican and Asian cuisine?  If you have, you know neither their Italian, Mexican or Asian food is any good.  I strongly believe individuals should assemble an advisory team.  Our country’s founding fathers believed in the separation of duties, and I believe people should do the same thing with their finances.  People should hire an independent accountant, lawyer, insurance agent, mortgage banker, financial advisor and investment manager.  This keeps everyone honest and encourages a beneficial interchange of ideas because you can get feedback from various perspectives.  Some of the most important insights I’ve gained have come from dealing with other professionals while serving our mutual client.

7)      Don’t hire advisors who will invest less than 40% of your money in the stock market.  If they are overly conservative, they will shortchange you in terms of rate of return.  I don’t manage one client that has as their target allocation less than 40% stocks.  Conservative advisors or perma-bears seldom do well.  They are forever afraid, produce low long-term results and charge way too much money for this service.  Stay away.  If you want your money managed conservatively, you can do it much cheaper than with an advisor.  There are many low-cost bond mutual funds and exchange-traded funds available for do-it-yourselfers.

8)      Don’t hire advisors who can’t see you within two weeks of your initial appointment request.  Advisors must be available.  They don’t need to be on-call like a physician since they don’t deal in life-or-death matters, but they do have to be available.  If their appointment calendar is so booked that they can’t meet you in the near future, forget about them.  If they are too busy to speak with you when you are a virgin prospect, you can be certain the treatment will only get worse once you become a client.  Advisors are there to work for you.

I apologize that this tale may not give you the answers you expected.  If I knew the answers, I would share them or tell you where to look.  So take this as an incomplete checklist based on 30 years of studying markets and advisor/client behavior.

Lastly, let’s not lose sight of one last thing in this fairy tale.  We learned that you are responsible for your actions.  I purposely selected the subtitle to this fairy tale because, as in the original Snow White fairy tale, the queen expects to hear that she is the fairest of them all when she voices the familiar question.  When you look in that mirror, always remember that though you bear the responsibility, there is someone out there who can probably do a better job advising you than you can.  You may not be able to afford or hire them at this time, but you are better off doing it yourself than dealing with an incompetent.  Therefore, your responsibility is to learn as much as you can for the day you can find them and afford them.  It’s your job to find Snow White.  Until then, you are your own advisor, so polish your mirror.

Upvote (0)
Comment   |  3 years, 7 months ago