Beating Wall Street at Its Own Game (Part 3) – Advisory Services

Wednesday, April 14, 2010

Riding through a small town last weekend, I spotted a ramshackle trailer with a sign reading, “Income Tax Services.” Seems as though everyone wants to be a financial expert.

And nowhere is this growth as visible as in today’s investment advisory business. This is the age-old approach of having an investment expert provide guidance to a non-expert with money.

The expert’s title really doesn’t matter: broker, trust officer, private banker, investment counselor, investment advisor, registered investment advisor (RIA), financial advisor or financial planner. What does matter is the quality of the advice given.

In this article, I am focusing on the investment management advice, not the ancillary services like insurance, wills and arranging for dog walkers. (Yes, you can get these if you are in the ultra-high-net-worth/ultra-wealthy/super-rich category.) Those other services are nice, but what really counts is what the advisor does with your money.

Is “independent” all it’s cracked up to be?

First, a word about “independent” advisors, a categorization that is used to differentiate and elevate those who are not beholden to a big firm and who collect – mostly – fees instead of commissions.

The implication is that “independent” means “objective” because a commission-based advisor will provide skewed advice. Well, if you talk to an insurance company representative, you certainly can expect to hear about the wisdom of buying insurance. But, if you’re talking to an advisor at a full-service firm, where many services and products are available and the advisor’s income includes fees, you’re back to the quality issue.

And there is a potential drawback: “Independent” often means “small shop,” without the resources and support of a major firm.

Therefore, “independent” is not a key criterion to getting the best. So, we can focus on the quality of the advice.

Where quality suffers: Comfortable advice

As I mentioned yesterday, we need to have strong defensive moves to avoid being sold by Wall Street. One of those moves is to know that your comfort level can be a warning signal. Remember that the easy road to build an investment advisory business or sell an investment product is to take actions that match investors’ feelings. Are they a bit gun shy (like now), wanting to reduce risk? Or are they willing to buy just about anything that offers the opportunity for a big gain? If what you’re hearing matches most investors’ feelings and makes you comfortable, likely you’re getting one of those easy sales pitches.

The adviser that panders to investors’ desires for today is likely selling poor performance and disappointment for tomorrow.

Using your comfort factor to judge quality

So, as an informed client, you know that successful investing means taking the right steps for the future, not doing the things that would have been rewarding yesterday. And you know that those steps can seem contrary to your own views. Tomorrow’s winning investments often lack popularity today. Seeing them enter your portfolio can be uncomfortable, but that feeling can be the very sign of quality.

For example, as Manager of Pension Trusts at International Paper in 1976, I saw Capital Guardian (think American Funds) add GEICO to the portfolio. GEICO was a mess back then, and the stock had dropped from $60 to around $2 with bankruptcy being discussed. (I do not recall the exact price at which Capital Guardian bought.) Naturally, my initial reaction was “Yuck!” Then, knowing Capital Guardian’s analytical depth, I figured there were probably good developments coming. And the price was certainly cheap. Good news did follow, and the stock rose appreciably.

You don’t want this…

I recently read a complimentary article about an advisor that has her clients holding only 30% in US stocks. Even that small allocation is not fully invested. Some portion is in one of those Wall Street concoctions that offers “participation” in the stock market along with a promise of no losses (meaning, if the market rises, the return will be watered down by the cost of the insurance guarantee). Terrible! That is just playing to investors’ concerns based on past risks with no attempt to get them to focus on future prospects. And that semi-stock product is just a gimmick. She has made some easy sales – our goal is not to be one of them.

So… When you depend on someone else for investment advice, make sure the person isn’t just pandering to your desires and worries. Valuable advice in investing often means actions that run counter to what you are hearing, reading and feeling. But that initial discomfort can be well worth it. And that is what you’re paying for – the tough decisions today that produce the good returns tomorrow. Then you can be comfortable.

Next: Part 4 – Products

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John Tobey on Seeking Alpha

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April 2010