Donald Moine
06/01/2005
In the face of mounting investor losses, private wealth managers and financial advisors have quietly shifted away from selling investment advice. Instead, many ask questions such as: “What is the most important thing about money to you?” or “What do you want your money to do for you?” They sound more like therapists than financially savvy investment advisors.
I have watched this trend develop since the early 1980s. At the time, I served as a consultant to Wall Street firms, training their sales staffs in how to build trust and address investors’ values and goals. My clients wanted to establish a values-based relationship with investors, rather than one based on performance. Their hope was that this strategy would expand their appeal to investors and stave off client flight in the face of inevitably poor investment returns.
Many financial advisors and consultants in this life-planning, values-based movement focus on philosophical and psychological issues related to money. For some investors, these services are truly valuable, and there are many well-intentioned life planners. They can prevent their clients from trying to time the market or from overreacting to losses by exiting the market altogether. But on its way to becoming mainstream, this movement was hijacked by brokers who simply wanted to avoid the responsibility for growing their clients’ portfolios.
Part of this problem rests with the limited arsenal that most financial advisors have. The prevailing wisdom recommends a highly diversified portfolio that rarely, if ever, changes. Financial advisors assemble a model portfolio that they adjust to the needs of individual clients. Unfortunately, this tailoring and customization are often fairly cosmetic.
A typical diversified portfolio—60 percent stocks, 30 percent bonds, 10 percent cash—may provide a gross return of 7 percent a year. After taxes, inflation and fees—which are much higher than the official expense ratio cited by fund managers and brokers—the real rate of return can average out to less than 1 percent a year.
Most planners lack the training in sophisticated investing techniques that have developed since the advent of diversification. Hedge fund managers have clearly demonstrated that there are ways to profit from uncertainty, market declines and volatility. Many private wealth advisors, however, are unaware of or untrained in using these techniques.
Moreover, even if they were inclined to move beyond diversification, many financial advisors have their hands tied by aggressive compliance officers. In other cases, they are constrained to selling in-house products. Independent advisors suffer a similar fate. Many began their careers with large investment houses where they are brainwashed into an unfaltering belief in diversification.
Fiduciary Flaw
To exacerbate the problem, most advisors have no fiduciary
duty or other incentive to deliver performance on their clients’ investments,
which frees them to act in their employer’s interest rather than their clients’.
In fact, the large brokerage firms have fought hard to maintain their exemption
from fiduciary duty. But registered investment advisors are fiduciaries, and
must attempt to do what is in their clients’ best interests. Nonetheless, not
even fiduciaries are required to deliver performance. As long as they diversify
assets, they are relatively safe.
The SEC is considering changing regulations
to require all financial advisors to act as fiduciaries. But whatever the SEC
decides, wealthy investors must be on guard against financial planners who
misuse life planning and values-based techniques to sell commission-loaded
financial products.
Do not dismiss all life planners. Legitimate financial
advisors in the life-planning movement charge either an hourly fee or a low fee
(less than 1 percent a year) based on the assets they manage. They primarily use
low-cost index funds or exchange-traded funds—and they never talk about beating
the market. They can now buy indices at a discount and can protect
multimillion-dollar concentrated portfolios at little or no cost. They can also
steer you toward returns of 6 percent tax free, year after year, in AAA-rated
insured investments.
Of course, there is another solution: Find an advisor
who really can deliver performance. Though they are rare, they certainly
exist.
Donald Moine is principal of Wilson Advisory Services, a private wealth
management firm, and a columnist for MorningstarAdvisor.com.