Paging Dr Financial Advisor…on fiduciary duty

I was somewhat pleased to see this article on Bloomberg over the weekend.  In brief, among the proposals hitting our new US Congress is a new requirement for financial brokers (think – the guy from the big bank with a sharp suit, managing your retirement funds for around 1% per year plus some commissions) to adhere to fiduciary duty over client assets.  This is a pretty big deal, which leads to much lobbying.

Where’s the beef? Under current laws, and what amazed me when I took the required exams, financial brokers must ensure that clients’ portfolios only include suitable investments.  Suitable is really in the eye of the broker – he/she can decide, and justify accordingly.

For example, consider a financial broker managing the retirement funds of a well-paid physician:

• The broker could choose a structured product, generally mirroring the S&P 500, with lots of bells and whistles and fees associated.
  • The product is suitable, as it achieves exposure to economic growth
  • The bells and whistles might also be suitable, if the broker believes the physician wouldn’t like the risk of a big drawdown (say).
  • What is missed is the fees – the broker would very likely be paid well to sell this product; the fees might or might not be disclosed to the investor.
• Under fiduciary duty, the broker must consider the client’s needs first.  In this case, the physician’s situation (well-paid, likely high risk tolerance) means the bells and whistles aren’t necessary, and the extra fees are a bad thing.  So this structured product would need to be rejected in favour of, say, a low-fee ETF.

When is fiduciary duty a bad thing? 

• The article outlines the main issue from financial brokers – basically the line of reasoning that physicians have in the US.  The duty imposed will lead to much more cautious behaviour by the broker, as well as much more defensive paperwork to ensure compliance.  Of course that will mean higher fees.  I don’t believe this for a second, unless ‘defensive’ means ‘seeking lower fee products’.
• In my opinion, the main drawback of fiduciary duty is the over reliance on lower fees = better.  That can lead some advisors to completely ignore higher-cost, but diversifying offerings (e.g. alternative investments).  In the quest for lower fees, opportunities can be lost.  The broker (earning commissions) will more likely seek out – or be sought by – managers who provide something different for the portfolio.  Basically, if the advisor believes he/she is constrained by fiduciary duty to stick with long-only equity and bond ETFs, he/she is missing a wide world of investment opportunity.

In sum: the fiduciary duty standard better aligns the interests of the investment broker with the client.  For those of you using investment brokers or advisors, you might ask whether they adhere to this standard already – for example, the usual case with fee-only financial advisors (i.e. no commissions) is to adhere to this standard by default.  If I used an investment advisor, I’d demand the fiduciary duty standard…but would frequently ask the question “so what is new in the investment world, in terms of markets?” and be interested to hear the answer.  If you’re being paid to manage money, you should be up to scratch in a wide world of investment opportunities.

Finance 101: Part 3 – Getting started with saving/investing

Continuing forward on our exploration of personal finance.

Suppose we’ve decided to save for something – see the previous post for some ideas of how much one should be saving for various life events.  How should one put that money to work?

The investing world is full of instruments/strategies/accounts/advice for how to save money.  It’s a mess, frankly.  I think this is because the financial world is as about as important to our individual lives as medicine, but not regulated anywhere near as tightly:

• My impression is most people understand little about finance; the same goes for general health.  We’re led by rules of thumb like ‘cover your head when your feet are cold’, ‘drink 2 litres of water per day’, or ‘put your age, as a percent, of your investment portfolio in bonds versus stocks’.  These are generally gross oversimplifications, nudging us to good behaviour.
• When we really don’t know what’s going on with our health (if we have a big problem), we go to a professional.  We know our health provider is a professional, because he/she’s been certified as such by one of various government-regulated organisations.  He/she has likely passed strenuous exams, had long internships with other doctors, etc.
• Naturally, we’d like to do the same when we’re in the same financial health.  Unfortunately, there is 1 big reason why finding a financial professional is much more difficult than a health professional: no consistent certification. 
  • Anyone can dispense financial advice.  I guess that’s partly what I’m doing here.
  • When I took the US Series 7 and 63 exams – allowing me to manage others’ portfolios and/or sell securities to individuals – I was stunned how basic the knowledge requirement was for passing the exams.
  • The Chartered Financial Analyst (CFA) exams were a better challenge.  At least people who pass these exams needed to have a decent understanding of investment process, the universe of investments, and basic valuation at exam time.
  • Bottom line: ‘believe nothing that you hear, and half of what you see’ comes to mind.  Searching out a helpful financial advisor is really tough when there’s no real regulatory separation between hacks and strong performers.

What to do, then?

1. Basic education.  Like reading this blog, or writings from some of the links at right.  There will be a lot of differences of opinion, but the basic facts should be the same.  What are your options and opportunities out there; what are reasonable expectations (e.g. don’t expect 20% return on stocks each year, and don’t expect 0% interest rates on savings forever, either).
2. Get talking.  As someone who loves talking about money, I always have to remember (or get reminded) that ‘money isn’t something we talk about’.  I say: enough of that.  Ask friends and family what they’re doing about saving (e.g. ‘have you found a good rate on bank savings?’, ‘do you use a financial advisor?’).  Exception: don’t ask around for stock tips or the like, as a) it likely will make others uncomfortable, and b) I believe few really tell the truth of all their winners AND losers.  It’s like a Facebook profile: only the good stuff comes out.
3. Make an informed decision whether to use a financial advisor.  There are loads of decent resources online, as well as tons of free tools from discount brokers these days.  If you have the time and temperament to manage your savings, I recommend it.  It’s like having the time and desire to build your own car – you will have a better idea what can go wrong, and how to fix problems as they arise.  If you don’t have the time and temperament, shop around (including using personal referrals) for a financial advisor.  In my opinion, don’t expect an advisor to outpace the markets consistently; just expect them to have a strategy, and stick with it.
4. If you’re managing your own money, get reading!  I believe more reading is better, as long as it’s more educational than news-driven.  For example, I’m a big fan of finance textbooks (see some of my previous posts), but not such a fan of the latest and greatest ideas coming from CNBC or Marketwatch.

More concrete definitions/explanations of savings vehicles next time…  stay tuned.