For a generation large financial institutions have promoted the idea that wealth accumulation is to be desired and is necessary for an individual's happiness and social status in society. Beginning in the 1990's we have witnessed a sustained marketing campaign to convince investors that by using one of their financial advisors we will generate outsized returns. These advisors are usually the first investment "professionals" that the new retail investor meets.
Largely absent in discussions in the financial media are the risks that arise from investing with advisors from large financial institutions. This may be because many of the experts engaged by these media sources are closely tied to large financial institutions. Below I have outlined three areas which I believe retail investors should explore prior to investing with a financial advisor at a large institution. These are the education and experience level of the financial advisor, financial advisor compensation, and objectivity of the financial advisor.
Education and Experience Level of Financial Advisors
The lack of education and experience required to be a financial advisor today is disconcerting. If one looks up financial advisor job postings at major financial institutions today, the education level is often high school graduation with sales experience or a 3 week CSC course. Since many of these individuals do not have an undergraduate grounding in finance or economics and more importantly, no investing experience, they also have no context in which to place differing investments and the associated risks. Firms recognize this, and standardized investment advice is therefore formed centrally in large financial institutions. The system ensures that financial advisors have an interest primarily in making sales to clients, rather than actively determining the actual nature and risk of the investments they are selling (a function that is performed elsewhere). One must ask then, who is really looking out for the client? Is it the financial advisor who meets the client and has been trained to trust the firm's template and make sales? Or the firm's portfolio manager or risk analyst that has never even met the client? I'm not sure it is either in many cases. As a retail investor, you want to be paying for advice from someone more informed and knowledgeable than you are; otherwise, what are you paying for?
Compensation of Financial Advisors
Many financial advisors' at large firms today are remunerated based on commissions for the investment products that they sell. This compensation structure works against good financial planning by immediately requiring the planner to sell in order to make any income. This introduces the bias to sell investment products with the highest commission attached whether or not the retail investor requires them and works against the ideal of an adviser who puts the client's interests first. It almost by definition precludes a trust relationship between a new retail investor and the advisor.
Lack of Objectivity in Financial Planning
In addition to the compensation structure noted above, for a planner at a large firm, it is often impossible to be objective with the potential products offered to retail investors. Most planners only offer a limited number of asset classes for investment. These usually consist mainly of the firm's own or licensed mutual funds and fixed income products. Investments that do not earn the firm or the advisor commissions or fees are often not discussed or unavailable. These exclusions would often include precious metals, food commodities and treasury bills that exist outside of a fund. For example, gold and silver have increased in value by over 200% and 300% over the past decade, but few advisors have had the incentive to offer these options over their firm's own fee and commission producing investments. Moreover, in times of higher economic risk, an investment advisor with limited options and skewed incentives will similarly be biased away from capital preservation instruments such as cash and short term GICs and toward higher risk equity investments. The result is that investors miss out on potentially appropriate asset classes and this has the effect of diminishing potential portfolio investment return.
A Potential Way Forward
Currently a financial advisor must give clients advice that fits with the client's needs; however they are not a legal fiduciary. It is time to professionalize the investment advisory industry and make financial advisors fiduciaries under the law in Canada. This would allow the incentives of both financial advisors and their retail clients to be more aligned and give investors clear legal recourse in the event a financial advisors conduct fell below the legal standard.
Per the Canadian Institute of Chartered Accountants "Rules of Professional Conduct", a fiduciary:
- Must not place himself or herself in a position where his or her interests conflict with that of the client;
- Must not profit from his or her position at the expense of the client;
- Must use information obtained in confidence from a client only for the benefit of the client and must not use it for personal advantage;
- Cannot act at the same time both for and against the same client and must make available to a client all of the information that is relevant to the client's affairs, unless these requirements are modified with the client's agreement.
I believe adhering to the above principles would be good way to begin establishing a standard of conduct. Further, mandatory university education and practical experience requirements should be put in place to ensure a consistent level of investment expertise. Commission-based compensation on products should be replaced by upfront fees allowing for greater transparency and minimization of conflicts of interest. While we leave the financial planning industry outside the professional sphere, we give an open invitation to those who would seek to profit at the expense of those investors least able to afford it. The financial advice industry deals with a key part of people's lives and deserves to be elevated to its proper place as a profession for the sake of transparency.
In the Meantime
Beyond pressing for the remedy noted above, the retail investor should look to educate themselves through investment media sources outside the mainstream media (i.e. CNBC, BNN,CNN, MSNBC, NBC, CBS et al) as these sources can supply neither the depth of coverage nor range of opinions needed to base informed investment decisions. They should seek to form a basic understanding of macro/micro-economics, finance principles, different asset classes, technical and fundamental analysis, investor psychology and market history. I would look to learn from individuals who have decades of direct experience in financial markets and those with nothing to gain from you or your money. Thus far, I have found there are no easy or absolute answers in investing; no maxims that can absolve one from the responsibility of critical thought and analysis. However, I believe that those with a genuine curiosity in investing and markets will have the stamina to challenge the ideas they are presented, whereas those looking "to get rich" will be more inclined to accept fantasy and convention in place of reasoned argument. The first will pay with some of their time, whereas the latter will likely pay a much heavier price.
