A Hierarchy of Advisor Value

I talk often with lots of advisors of all sorts and from a wide variety of firms. They are profoundly disillusioned an astonishingly high amount of the time. When the markets are strong, they are disappointed that they didn’t capture enough of the upside. When the markets are weak, they are apoplectic that they didn’t avoid the downturn. When markets are sideways, they’re just plain frustrated. When they try to anticipate these movements they usually fail and when they don’t – a very rare event indeed – their next moves inevitably don’t keep up the good work. They hate seeming to start from scratch every day and living from transaction to transaction, dependent upon the machinations of markets for survival.

This profound disillusionment is well-earned, of course, and is predicated upon three primary problem areas: execution; expectation; and erroneous priorities. The basis for each of these problems can be established in surprisingly short order.

In terms of execution, the trade ideas they offer rarely turn out well and the performance provided by money managers, when they go that route, almost never meet expectations such that it’s not unfair to say that much of the money management business has been an abject failure pretty much across-the-board, even for the mega-rich. Poor investor behavior makes that dreadful performance even worse — we trade too often, at the wrong times and into the wrong instruments. We chase returns via managers, sectors and trades that have been hot only to be disappointed when mean reversion inevitably sets in. Our inflated expectations make matters worse still because investors expect outperformance as a matter of course and investment managers tell them to expect it, implicitly and explicitly. That’s what makes the sale after all.

Erroneous priorities include a failure to manage to personal needs, goals and risk tolerances as well as “plans” that change with every market movement. It shouldn’t surprise anyone that clients with huge appetites and tolerance for risk when markets are rallying frequently want to go to cash at the first sign of trouble. At the advisor level, the priority problem is even more fundamental and encompasses each of these problem areas. Much of what tries to pass as “financial advice” is actually glorified (or even not-so-glorified) stock-picking. In my experience, most advisors and their clients wrongly think that the advisor’s primary function is to pick good investment vehicles.

Advisors are well aware of the failures of the money management business, of course, as well as the limitations of a transactional business model. That’s a big reason why their disillusionment is so existential. They have been let down again and again by the idea that they have (finally!) come up with a formula for success only for reality to crush those promises. Even worse, and consistent with that conundrum, a 2012 study from the National Bureau of Economic Research concluded that financial advisors reinforce behavioral biases and misconceptions – the problems outlined above – in ways that serve the advisors’ interests rather than those of their clients.

Still, many of these advisors keep hoping against hope. They routinely tell me that if they proposed a data-driven, evidence-based approach with their clients that actually had a reasonable chance for success, their clients wouldn’t perceive a need their services. Not so coincidentally, that’s a big reason why so many advisors are terrified by the proposed Department of Labor fiduciary rule with respect to retirement accounts. And that’s why the Dilbert cartoon reproduced below about index funds (one possible data-driven approach but hardly the only one) is so wickedly funny.

Hierarchy 1

Proper advisor priorities begin with a recognition of what is important and what is achievable. That’s why I have created this hierarchy of advisor value, which was developed for a presentation I have been giving to groups of advisors. Hierarchy of Advisor Value (wide)(ATM)

Managing to this hierarchy won’t make the markets any less infuriating, but doing so will make the financial advice business much more fulfilling and gratifying. It can even make that business more lucrative, at least over the longer-term. Simply put, it will require carefully and truly putting the client’s interests first, even when the client doesn’t see it that way.  Continue reading

Financial Planning and Hiking on Half Dome

res0914annuityanalyticshikepicsMy latest column in Research magazine is now available on line. A small taste follows.

The truth is much more prosaic. Retirement planning—indeed, all financial planning—is very tough and is difficult at every level. It takes significant personal sacrifice and being psychologically strong when our emotions are screaming at us to do otherwise. Thinking about a future that is years or even decades away is exceedingly challenging for most of us, for whom lunch is a long-range plan. But good retirement planning isn’t “perfectly inaccessible.”

I hope you’ll read it all.

Financial Planning and Hiking on Half Dome

Beware Squirrely Risk Assessment

res0814coverMy latest Research magazine column is now available online. Here’s a taste:

In the financial services business, we spend a lot of time dealing with complex products and strategies. And there’s good reason for that. But the heart of good retirement planning—good financial planning—is simple (if hard to do). It’s informed common sense. It begins with starting early and saving aggressively. Then when the markets get ugly, as inevitably happens, it requires that we manage our internal radar to good effect.

This requires courage, the ability to do the hard, right thing even when we’re afraid. The best retirement income strategy in the world is utterly meaningless unless and until one has the resources to put it into place and make it work.

Beware Squirrely Risk Assessment

Retirement Planning Is Not for the Passive

Not for the PassiveMy latest column, from the April edition of Research magazine, is now available on-line. The opening lines will give you an idea of what it’s about.

The most bitterly fought ideological skirmish in the investment world is that waged between advocates of active and passive investment management. But whatever view one takes on that controversial subject, active financial planning for and of retirement is an absolute necessity.

I hope you’ll read it.

Retirement Planning Is Not for the Passive

The Demographic Wave

The following animation (from Calculated Risk, using Census Bureau data), which updates every second, shows the wave of demographic changes from 1900-2060.


The additional numbers of older Americans (and thus retirees and, by implication, the need for better retirement saving and planning) going forward — as the Baby Boomer generation retires — should be obvious.

The U.S. Retirement Crisis: Essential Reading and Resources

CFALauren Foster of the CFA Institute asked Wade Pfau, Michael Kitces, David Blanchett and I to suggest some resources for advisors dealing with retirement.  What we suggested and a lot of other good stuff are available here.  I think it’s well worth your reading.

The U.S. Retirement Crisis: Essential Reading and Resources

Math Suckage and Dave Ramsey

Dave RamseyDave Ramsey has added further evidence to the pile already in place attesting to how bad we are generally at math and probability.  Sadly, he’s no better than the mass of us.

Let me hasten to emphasize up-front that Dave has done some fabulous work by helping many, many people to get out of debt, stay out of debt, budget effectively, live frugally and save aggressively.  But when it comes to investing and to doing math, he is simply out of his depth.  Let’s start with the backstory. Continue reading

The One Percent Doctrine

One Percent DoctrineA number of years ago, during George W. Bush’s second term and by sheer happenstance, I ended up playing a round of golf with a Navy SEAL Commander (half the SEALs train here in San Diego).  Obviously, much of his job was classified and he was very circumspect in what he shared.  However, when I asked where or how I could become better informed about foreign policy, he recommended Ron Suskind’s book, The One Percent Doctrine.

The “one percent doctrine” (also called the “Cheney doctrine”) was established shortly after 9.11 in response to worries that Pakistani scientists were offering nuclear weapons expertise to Al Qaeda. Here’s the money quote from Vice President Dick Cheney: “If there’s a 1 percent chance that Pakistani scientists are helping al-Qaeda build or develop a nuclear weapon, we have to treat it as a certainty in terms of our response. It’s not about our analysis … It’s about our response.”

Thus in Cheney’s view and per subsequent policy, the war on terror required and empowered the Bush administration to act without the same level of evidence or analysis as might otherwise be necessary.  Continue reading

The Tyranny of Compounding Costs

PBS aired an important documentary Tuesday evening examining retirement planning in America and entitled The Retirement Gamble.  One particularly noteworthy comment came from Vanguard founder Jack Bogle on the “tyranny of compounding costs.”  In contrast to the “miracle of compound interest” (often attributed to Albert Einstein, probably falsely, but that doesn’t lessen the import of the concept), which shows how quickly interest can accrue when it is compounded, the tyranny of compounding costs addresses how dramatically returns are diminished on account of excess fees.  Note the chart below from The Journal of Financial Planning.Fees2 As always, fees matter — a lot.