"If you fail to prepare, then prepare to fail" - Benjamin Franklin
Have you ever gone on a trip somewhere far away? Obviouly you pack your bags cautiously...you think about how the days will carry out (more or less), so you visualize what clothing and accessories you will most likely need...somewhat of a real life Montecarlo simulation! What about when you buy a new car or electronic device? You do your homework right? You visit many different stores and read articles on the internet to find the best possible deal within your means.
And yet when it comes to investing our hard earned money, we usually jump to conclusions and/or follow the herd. Which is basically just as bad as not planning at all.
1. Why most people fail to plan their financial future
If you are lucky to earn more money than you need each month, there was probably a time when you could have used some advice about how best to spend, save and protect it. (so the first thing is: do NOT try to trade or invest if you don't have the capital to spare!..and NOBODY tells you this).
But if you looked around for a big national firm that swore to do the right thing, you would not have found it. Doing it right means putting your interests first, making money only through reasonable fees and not commissions earned from pushing complex life insurance policies, and talking to you in depth about your entire financial life and your goals and dreams.
That brings up two questions: Why is it so hard for any start-up or established company to provide the right kind of financial planning to large numbers of people? And what is so wrong with all of us that we are unwilling to pay for the good stuff when it is being offered?
a) First of all, admitting that you need help can be hard. There is shame in having gotten money wrong so far, or shame that you can’t figure it out or shame that it’s taken so long to start.
b) The industry, with all its various conflicts and bad actors, has also made it very difficult for the common folk to understand exactly what he's being offered or sold. Complex language, stacks of paper (which are mostly a limitation of responsibility in case of losses), and hundreds of "slightly" different "products" add layers of complexity to something that needs to be straightforward. And each layer of complexity usually costs the investor a few pennies more.
Yet nowadays it's possible to be a complete DIY (Do It Yourself) investor and/or trader with minimal guidance from a fiduciary or independent financial consultant, saving money and stripping off layers upon layers of complexity. Yet most people just fail to search for help. Why is that? Among the reasons most listed:
- People think good advice will cost more than they can afford
- people think that the information received won't be precise enough;
- people think that that looking for advice will take time they don’t have;
But the top reason? People say it’s hard to know which advice to trust!
2. Magic Words: Delayed Gratification
Tom Hiddelton teaches Cookie Monster about
People don’t like to take advice in general, explains psychologist Art Markman, author of Smart Change, but financial advice is harder to stomach than most. “Financial advice is almost always about doing something differently in the short term in order to preserve money for the long term,” he explains. That’s tough for humans who are “really wired” to do the opposite.
What Dr.Markman speaks about, is a well known human bias: the desire for immediate gratification, and myopia. It's the reason why Governments borrow much more than they can possibly repay. It's the reason why smokers continue to smoke despite the scientific evidence showing that smoking will kill them eventually. It's the reason why the exploitation of the World's natural resources isn't much of a going concern...we have trouble seeing past our most immediate needs. Instead, sound financial behaviours have everything to do with delayed gratification:
a) saving more than you spend (discipline)
b) thinking about defence first (insurance policies, fixes indexed annuities, Market Linked CD's)
c) offence (asset allocation solutions such as Alpha Architect's RAA, and active trading).
Ask yourself: Why do you go to the dentist? Or the car mechanic? “You go to the dentist because he knows about teeth,” says Markman. “And you bring your car to the mechanic because they can make sure it stays running well. You do that in part because you don’t want to have to be an expert in teeth or cars.” So the question that follows is, do you want to spend the time necessary to become an expert in personal finances? “If the answer is no, you’d rather spend your time worrying about something else, it’s time to engage services that will help you.”
3. Finding a financial advisor or coach
As far as I can tell, not much has changed with the so-called “full-service” brokerage firms since my brief experience in 2004 and 2005: anything that won’t generate a commission or an annual fee of 1 to 2 percent of assets is ignored.
So most of these folks predominantly provide investment management. Fine. However, there’s no way to know if they’re providing good financial management. The financial adviser may say that his recommendations result in fabulous returns for his clients. But there’s no way he can back up his claims. He’s not going to let you see his clients’ accounts, and he shouldn’t; that would be a violation of privacy. You pretty much have to take his word for it.
Of course, after you’ve hired an adviser, you’ll get quarterly statements and can monitor his performance. Unfortunately, the problem here often lies with the client and the current lack of financial literacy. Many people don’t know enough to properly evaluate an adviser’s performance – what is an appropriate benchmark and how to adjust the comparisons for the amount of risk taken. Or clients just like the adviser enough to trust him, because he’s nice and jovial and sends chocolate during the holidays.
4. How to evaluate a financial planner/adviser
Here are some questions to ask an adviser you’re considering:
a) How are you paid?
The commissions paid for selling financial products vary widely, so there’s always the temptation to provide advice that garners a higher payout. Fee-only advisers who charge by the hour or by the project have the fewest conflicts of interest, since the amount they are paid is not directly related to the advice they provide. Those who charge an annual fee based on the size of the portfolio have a few more conflicts of interest, but it’s much less conflicted than those who earn their keep through commissions, payments from mutual fund companies or payments from insurance companies. With fee-only advisers, you still have the problem of not knowing how their past investment recommendations fared. But the research done by Alpha Architect leads me to believe that most of them recommend low-cost, diversified index-based investments, which pulls back the curtain a bit.
b) Are you a fiduciary?
A fiduciary has a much higher legal hurdle than an adviser who only has to meet a “suitability” standard, such as the brokers who work for the big-name firms – Morgan Stanley, Merrill Lynch, UBS, and so on. In fact, brokers have a primary loyalty to the firm, not to the clients. On this note, when I was a broker, back in the day, and attempted to help a wealthy client, my boss was not happy. My suggestions had everything to do with reduced turnover, patience, waiting until the macro and technical pictures spoke the same language...with the end result of having the client make more and spend much much less with us. Happy client, irritated boss...
c) What services will you provide?
Will you receive just investment advice, or will you receive a complete evaluation of your entire financial situation (debt, insurance, estate planning, etc.)?
d) What are the risks?
Any adviser who doesn’t thoroughly explain the risks involved with the investment strategy they recommend isn’t doing his job.
e) Why should I listen to you?
We’ve already established that you can’t verify their claims of investing awesomeness. In the USA, you can visit BrokerCheck to see if they’ve had any disputes with clients, and whether they were resolved. Also, an industry standard certification like Certified Financial Planner (CFP), Chartered Financial Analyst (CFA), Certified Public Accountant (CPA), or other legitimate designation (Certified Warren Buffett Invest-a-like doesn’t count) won’t guarantee competence or ethical behavior, but it does show that the person had to know enough to pass very rigorous exams. Also, these designations come with their own ethical standards and ways to report who has been found wanting.
f) How can you make such crazy promises?
f you hear anything too good to be true – such as high guaranteed returns – then the adviser is hoisting a malodorous red flag.
Not everyone needs the services of a financial adviser. But if you don’t have the time, inclination, or self-discipline to create and stick to a plan, asking for help could be one of the best things you ever do. Just make sure you get a good one.
I would say this: only trust advisers or educators that HAVE SKIN IN THE GAME, for their own reasons and objectives. You need to have skin in the game to be able to have empathy for the client and respect for his money.
References:
1) http://www.oecd.org/finance/financial-education/37087833.pdf
2) http://blogs.worldbank.org/psd/why-do-we-feel-poor-people-need-financial-education
3) http://www.frbsf.org/community-development/files/hogarth_jeanne.pdf
4) http://blog.alphaarchitect.com/2014/12/02/the-robust-asset-allocation-raa-solution/
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