Tuesday, April 21, 2009

Advising the Investment Advisers

Consultant John Bowen offers this sobering assessment of client attitude toward financial advisers: "... in the current market downturn... research shows that four out of five affluent clients are thinking of switching to a new financial adviser."

Since Bowen's firm advises advisers on how to become more successful, let's examine how he proposes to solve this problem. Link here.

Mostly, Bowen tells advisers to offer customized investment plans to their clients. This implies, reasonably enough, that if your clients want to be treated as special, you should treat them as special.

This involves discovery meetings, getting-to-know-you meetings, and follow-up conversations. It also requires relationship development, trust building, extensive communication, and just plain getting along.

Surely, if your client does not trust you to be offering advice that is in his best interest, he will simply not listen to you.

All of this is on point.

Yet, a large number of advisers already present customized investment plans to their clients. It is not reasonable to think that 80% of clients are thinking of changing advisers because because they do not feel sufficiently special.

In my view the custom approach also fails for being too client-centered. The best approach is market-centered.

Bowen reflects the problem more than the solution. Many advisers are so worried about losing their clients that they are spending too much energy stroking wounded client egos. And they are offering too many bromides, and not enough guidance.

They need to step back from their clients' anguish and address the most basic questions: What happened? What might happen now?

Understanding the client is a good thing. Feeling for the client is a good thing. Understanding the market is a better thing.

Today, an adviser should have an opinion about whether the recent rally is the eye of the hurricane or an all-clear signal.

An investment adviser should have an opinion and an outlook about the state and direction of the market and about the condition of the macro-economy.

And he should demonstrate his understanding of the new market reality by showing appropriate emotion, and by avoiding now-discredited conventional investing wisdom.

No adviser should ever utter the words: buy and hold. If he does, people will rightfully get angry.

And advisers should consign the notion of a diversified portfolio to oblivion.

Famed investor Jim Rogers offered this view of portfolio diversification in Business Week: "Diversification is something stock brokers came up with so they wouldn't be sued [for making bad investment choices for their clients.] Henry Ford never diversified. Bill Gates didn't diversify. The way to get rich is to put your eggs in one basket and to watch that basket very carefully. You can go broke diversifying. Ask anyone who's diversified in the last three years." Link here.

But how do you know which basket to put your eggs in? Do you have to be a professional investor like Jim Rogers to know it?

Not at all. Echoing advice that another famed investor, Peter Lynch, has often touted, Rogers told us to invest in what we know: "If you're an auto mechanic, you know much more about your field than anyone on Wall Street ever will. You'll know when new products and new processes are coming out. These people can get extremely rich just by staying with what they know. If could be products that go into cars, like tire companies, or glass companies, rather than [only] auto companies."

Rogers should have added that while your personal knowledge is a great place to start, you should still do your due diligence. Questions about the company balance sheet, its profitability, and its creditworthiness should also be added to the list.

If your daughter loves to shop in a store, you should give some thought to investing in it. But don't go all-in on the basis of an eight year old's whims.

Of course, Rogers is assuming that we can all trust our own judgment and that we want to go out and make money.

John Bowen veers more toward ego massage when he assumes that people just want to preserve capital. This feels like the kind of thing you tell someone to console them after they have suffered a grievous loss. It's like saying: you may be broke, but you still have your health!

It is a nice thing to say, but it reveals a passive and fearful attitude.

If a client has been traumatized by investment losses, the best way to overcome the trauma is for him to go out and try to make some money.

When your instincts are telling you to hunker down, the better to avoid future trauma, the best approach is to attack the problem aggressively.

Surely, Jim Rogers does not have to be in the markets. He could easily sit back and collect interest.

And yet, he continues to invest. He knows that there is always a way to make money. The challenge is finding it.

1 comment:

Adam said...

Dr Schneiderman's analysis of what investment advisors should be offering to their current and prospective clients is dead on.

What I call the interior decorating theory of investment advice postulates that every client is different and that each client should be offered a unique solution to their investment goals.

Aside from being impossible to execute, the infinite customization of investment solutions ~ the business thesis followed by most advisors ~ is based on a lie: that there is more than one optimal portfolio.

There is only one optimum of anything, as there is only one summit on a mountain, and only one of any unique article.

By constructing fully customized portfolios for each client, the financial advisor is acting like an interior decorator: designing the financial life of each client as an interior decorator would design their home, to reflect their personality and specialness.

This is a sub-optimal way of designing an investment portfolio.

Clients of financial advisors fit into rather clear categories... let's call them silos. Clients can be divided into age brackets, asset owning brackets, debt-level brackets, family-size brackets.

If an investment advisor has ten clients, some of these will have similar traits and thus the cohort can thus be segmented into silos according to those traits.

While such an idea might not appeal to most people's need to feel special, such a strategy ~ described above ~ will in fact result in the design of portfolios better suited to their real-world needs.

Ultimately, what investors crave are either capital gains or income, both produced in a steady stream with a minimum of volatility. Thus we are left with two silos and two portfolios (neither of which will be free of volatility).

Neither of these will be the uniquely optimal portfolio dictated by the current market regime, but they do permit investment advisors to stop acting like interior decorators selecting window treatments and start acting like market professionals.

If your current or prospective investment advisor claims to be designing a portfolio uniquely sensitive to your personal needs, grab your hat and head for the door.