The Business of Giving Financial Advice is Complicated

There is some parallel to the business of giving financial advice. There is little in the way of barrier to entry and we know there are some dishonest people in the industry. Josh Brown took a machete to this post from a firm called Betterment which tries to democratize financial advice with low (or maybe no?) minimums using indexing strategy. The post from Betterment made a lot of sweeping negative generalizations about advisors and brokers–Betterment appeared to use the terms interchangeably which is not correct if preciseness matters.

Like any industry there are competent practitioners and there are incompetent practitioners. Where portfolio management is concerned an incompetent advisor may not be outed until something bad happens in the market, the tide goes out and as Warren Buffet has said we see who’s naked. An example of this type of incompetence might be having had 50% in financials in 2007 by virtue owning a bunch of funds that were grossly overweight the sector.

Another form of portfolio incompetence would be stock selection that turns out to be peculiarly poor and is combined with inadequate diversification such that clients get blown up. These are just two examples.

On the financial planning front it may not take a bear market to damage clients. Simply embarking on the wrong course with a financial plan can be ruinous. Planning is not what I do but things like incorrect tax decisions, an incorrect spending program or insurance issues can obviously hurt people.

As far as what is not incompetent; if an advisor tells you ahead of time “we are going to hold on no matter what and rebalance” then going down 39% in a down 38% world is not incompetence. The prospective client needs to listen to that and decide “is that right for me.” An advisor who sets an expectation and comes pretty close to that expectation is probably pretty good at their job.

There is another layer to the complexity I had in mind when I titled this post which is the advisor’s own financial situation. There was an article recently (sorry no link I did not know I’d be writing about this) about a large number of advisors whose own financial houses are not in order. They have too much debt and don’t save money. You might remember this from the NY Times a few months ago about an advisor who got caught up in the trade up/house as ATM trap and went on to lose his house.

This can be very complicated. Why is the advisor in debt and incapable of saving money? Someone with a sick child in this sort of situation is certainly different than the guy with a Ferrari and a boat. I would also expect that it is possible for someone to be very capable of giving excellent advice but be unable to see their own flaws, biases and tendencies (I can save later type of thing). How much does it matter if an advisor has negative equity and owes $12,000 on a credit card if he prevented all of his clients from panic selling a fast decline? Conversely, being debt free does not guarantee competence.

Personally it would be difficult for me to talk the talk without walking the walk. I wouldn’t know how to handle a situation where I was asked how much I had saved and how much debt I had if as an RIA in my mid-40s I had none of the former and lots of the latter.

As a matter of personal belief I as an RIA would not want to be distracted by my own finances. How much time spent on personal trading is too much? Is the advisor going to freak out about declines in his own account at exactly the wrong time? The client base of an RIA is a crucial asset–financially life-sustaining, our financial future rests with my doing the right thing for our clients. In that context it is crucial that the interests of the client base be put before personal trading and financial worries.This is more easily achieved by minimizing the chances of having these distractions.

My take on how to manage this has been to have no debt, save a lot, have low allocation to equities and not trade that allocation a lot. I typically have 25% allocated to equities but it is a little less now as I am hoping to shift into a particular ETF should it list.

My approach reflects my biases and the manner in which other RIAs address these issues reflects their own biases. Where we are talking about biases and quirks things get complex. Personal motivations are also complex. Some want to work for a very short time and figure an exit strategy. As I enjoy my job I view this as a potentially evergreen annuity–it won’t stay green if I don’t do the right thing.

If you have an advisor it probably makes sense to take some time to understand where he is coming from (to our firm’s clients, the above is where I am coming from). RIA are going face more scrutiny along these lines from clients, prospective clients and even the media.

This was kind of a heavy post but just like everyone else, advisors have fears and greeds that when mismanaged can be very detrimental to all concerned. If you (as an advisor or client) can easily define your greed and fear then I think you have a good shot at getting to where need to to be financially.

About Roger Nusbaum 169 Articles

Roger Nusbaum is an Arizona-based financial advisor who builds and manages client portfolios using a mix of individual stocks and ETFs. Roger writes a popular blog, which focuses on risk management, foreign stocks, exchange traded funds, options etc.

Roger has been recognized by many in the investment management industry for his expertise in portfolio management. Roger has been regularly interviewed by the financial press, trade journals, and television news shows. He has also had numerous technical articles published and has been quoted in a number of professional trade journals, newspapers, and consumer finance magazines. He appears frequently on CNBC Asia as a market commentator.

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