Using Investment Advisors


If you use an Investment Advisor (IA), you should read this. If you do not, you may consider using an IA in the future when you accumulate more wealth. In which case, you should read this. If you are thinking of becoming an IA, you should read this.

I was an IA and I worked in the Wealth Management industry. This is also known as Investment Advice or Financial Planning. Investment Advisors were called Stock Brokers previously. I worked for one of the big North American banks. I will tell you the truth about this industry that most people do not know and that you should know if you plan to use it.

As described in How to Beat the Hedge Funds and Warren Buffett, I significantly outperformed in 2008 and 2009 in percentage terms. Hence, I thought I should be an IA. To become one, you need to go through a criminal background check and take some courses and exams. If you pass, then you get licensed to sell stocks. Then the firm puts you through a training program.

As a caveat, all of the following is my opinion. There might be different opinions from other Investment Advisors, as they might have different experiences or they might have biases if they still derive their living from that industry.

The relationship between IAs and clients is dysfunctional. IAs could be providing more value but they do not because they are afraid of clients. They are afraid because clients mistreat IAs. Clients mistreat IAs because they do not trust IAs.

One of the main reasons I wanted to be an IA was to give investment advice. As it turned out, I was not able to give investment advice, not the kind of advice that I wanted to give.

In my opinion, the secrets to success for an IA are (in order of importance):

  1. Buy a book from a retiring IA (A book is an IA’s list of clients)
  2. Know high net worth (HNW) individuals
  3. Get referrals to HNW individuals
  4. Able to market
  5. Able to sell yourself
    • Able to get people to like you and trust you quickly
    • It is good if you know something about investing, but not nearly as important
  6. Able to sell investments

Please note that “Able to pick stocks” is not one of the secrets to success.

The first thing new IAs need to do is to get clients. Actually, the most important thing is to “gather assets”. Most retiring IAs sell their books only to other IAs that they know well and have worked with. Therefore, buying a book is not an option for a new IA.

Since I did not know many HNW individuals, I needed to market and sell myself. I originally thought that this should be easy to do because I did so well at picking stocks in my personal portfolio. On a percentage basis, I beat most hedge funds in the world. I told my manager that I will tell prospective clients about my outperformance. To my surprise, he rejected the idea. He told me that if I told people that I doubled my portfolio and after they become my clients and do not see their portfolios doubling, some of them will sue me. Minimally, they will get pissed off. I was baffled. I said to my manager that I did not plan on telling clients that I will make any specific returns for them. My manager said it does not matter. Clients can hear it differently or claim that you said that even if they know that you did not. I cannot promise that I will double portfolios every year. I did not want to get sued, so that marketing idea was flushed down the toilet. Unbeknownst to me at the time, this will become my death knell as an IA.

Therefore, there can be many good stock pickers who became new IAs, but clients are not getting their advice because of the fear of clients.

The firm helps out with marketing by providing templates for mail-out cards, letters and phone scripts. The content usually involved marketing pitches, such as “Do you have enough to retire? Do you know what you are holding? Talk to me for a free review.” If I used these templates, I felt like I would be using old, soiled, hand-me-down clothes from multiple generations of IAs. Who wants to wear someone else’s underwear? I wanted mine to be new, different and fresh so that I can stand out from the thousands of IAs. To my surprise, this will be excruciating difficult.

Due to compliance and extremely onerous regulations, every little change that I made to the template needed to be approved by, not one, not two, but three different people: my manager, an outside firm and the firm’s compliance officer. Most of the time, it will take one or more weeks to get back what I submitted and most of the time, they disapproved it and changed not only what I wrote, but they also changed my punctuation, font and color. Font? Color? Who cares? Why would this hold up the approval process? Why are they so anal?

I would later find out that my manager listened in to my phone calls. I got off the phone one day and a few minutes later, my manager walked over to my cubicle and told me that I shouldn’t say what I said on the phone.

I’ve already worked for several companies to this point and I’ve never seen micro-management down to this level.

Eventually, it took over 3 months to get my customized marketing material finally approved. As it turned out, it was not very customized after the many rejections and changes.  It was similar to the generic templates that many other IAs used. So, I essentially lost close to 3 months to gather sufficient assets to stay in the business.

Later on, I will come to realize that the reason compliance is so onerous is to protect the bank from getting sued by clients. The bank didn’t want IAs to give a sales pitch, such as “I can help improve your portfolio”, and get sued when the IA fails to do so. Clients are frivolous, love to sue and are ready at any time to hit the speed dial to the litigation lawyer. I can see now that there is no way that the firm’s compliance manager would have approved a marketing pitch from me that talked about the performance of my personal portfolio. One of the veteran IAs told me that the corporation would love to do away with Wealth Management and just keep the Discount Brokerage business, because there is so little profit in the former due to all of the lawsuits.

Because clients have sued IAs quite often, usually when their portfolio goes down, IAs are deathly scared of putting clients into anything risky. This is why IAs try to put clients into the safest and most boring investments imaginable. Two of these are mutual funds and fixed income. Putting clients into mutual funds is a joke. Mutual funds usually underperform. Even if a fund comes close to the index, the return is net of fees, which means the client will get less return than just buying ETFs. Some IAs will put their clients into ETFs. However, anyone can put themselves into ETFs or mutual funds. They don’t need an IA to do that.

Every firm has a research department that provides a few portfolios of recommended stocks. However, they can have up to 20 or 30 stocks each, which in my opinion is over-diversified and therefore cannot outperform the index.  If clients want stocks or if IAs want to put clients into stocks, they are recommended to use the firm’s list. Since the firm is acutely aware of client lawsuits, these portfolios comprise of the safest and least volatile stocks with little to no alpha potential.

Therefore, if you use an IA and if the IA puts 100% of your portfolio into equities, your chances of outperforming the market is still slim.

Since the mutual funds and the recommended portfolio of stocks usually mimic or underperform the index, especially after fees, I felt that the best choice for clients were ETFs that mimic the index. Other than fixed income, IAs can charge one to two percent fees, but it is hard to justify the fees if the IAs put clients into ETFs.  The perception is that an IA is doing no work for the fees.  So they rarely put clients into ETFs, even though this is best investment for most clients.

The best thing for clients to do is buy ETFs themselves, pay very little fees and not use IAs.  They would make the most returns that way. IAs do not put their clients into ETFs, because IAs need to put food on their tables.

If you are an investor, remember the first thing they teach you in business: No risk, no reward.

I wrote the following in Allocate 100% to Stocks!:

The worst investment in the world, in my opinion, is fixed income.  To me, an investment is not an investment unless it has these two attributes:

* Risk

* Reward

Some people like fixed income because the risk is lower.  However, the yield on some fixed income investments are so low that it is below inflation. This means that they have a negative real return.  There is no risk, but there is no reward either.  This is not an investment.

Besides, every chart in the world shows that stocks outperform fixed income in the long run. If one was not myopic and had some logic to know that the market has a high probability to eventually recover after every bear market, because it always had historically, then one would never prefer fixed income over stocks.

One rationale that the industry uses for fixed income is that the investor may not have enough time to recover from a loss. In the U.S. it took less than 6 years for stocks to recover from 2007 to 2013 and 7 years to recover from 2000 to 2007. These are two of the worst bear markets in 74 years. Most people, including retirees, have more than 6 to 7 years to live.

However, there are IAs, including IAs with very big books that are up to $1 billion, who put their clients in mainly fixed income because they have been sued in the past or are afraid of getting sued. The ones who have been sued are especially afraid. Hence, IAs provide little value to clients because they are afraid of them. There is very little skill needed to pick fixed income securities. Due to the very low yields on fixed income, the client gets close to nothing after paying fees to the IA. The party who makes the most money is the IA. The better way to go is to buy ETFs that track fixed income, but I would think that very few IAs would put clients into ETFs as it is hard to justify charging a fee for doing this and IAs need to eat.

There is another reason for putting clients into fixed income. Management and trainers will teach IAs on how to grow the book. In order to grow the book, the IA needs a business model that can easily scale. Researching, analyzing and picking stocks takes a lot of work and time. This is not scalable. An IA cannot grow or scale his business by spending his days picking stocks. He needs to spend his time on marketing. One of the ways for an IA to scale his/her business is to put clients into low-work, low-maintenance assets. Fixed income is one of the lowest. It is easier to pick. Also, the IA does not have to monitor the holdings as frequently and the client will not be checking in as often because the value doesn’t fluctuate as much. So, you might be impressed that your IA is a big shot in his firm because he manages a billion dollars of assets. However, this means that you’re likely getting very little return, if any, on your money.

Therefore, if you use an IA, your chances of outperforming the stock market is slim to none because your IA will put a significant portion of your portfolio into fixed income.

There are thousands of Investment Advisors. The firm knows the critical success factors for an IA. The firm does not want IAs to be researching, analyzing and picking stocks because they know that there is not enough time. Marketing and regular meetings with clients take up the bulk of the time. They know that the ones who succeed are the ones who can gather assets. This ability is not dependent on stock picking skills. Consequently, there are some very successful IAs who can gather assets but cannot pick stocks or even have business education. However, I do not blame the firms. The clients are getting what they want, which is someone they know or like. If the clients know or like the IA, then they will distrust him less.  Clients care less about stock-picking skills.

The far majority of my classmates failed to gather sufficient assets and had to leave the business. I was one of them as I did not have any significant selling attribute about me that made me stand out. One of the IAs from my class who had sufficient assets and survived was a former Financial Planner, who already had a book of clients. In the bank branches, there are Financial Planners. These people are not licensed to sell stock. Therefore, they sell mainly mutual funds. These Financial Planners get the benefit of receiving referrals from the tellers. Anytime, a customer asks about investments, the tellers refer them to the branch’s financial planner. Referrals are very important in getting assets. Therefore, Financial Planners have a higher chance of success at being an IA, because they have already accumulated a book of clients that they can bring with them when they transition to Wealth Management. If you are thinking of becoming an IA and the top 3 “secrets to success” are not options for you, then I recommend that you start as a Financial Planner.

Note to potential clients of IAs who were Financial Planners:  Starting salaries of Financial Planners are low.  Consequently, Financial Planners tend to be less educated or may not be educated in business at all.  There may be exceptions, but people who started their careers as Financial Planners cannot pick stocks.

There is one significant value of IAs. They keep the clients invested and tell them to not panic and jump out every time there is a correction. Unless you are able to jump out at the beginning of a bear market, then jumping out is one of the worst things you can do to your portfolio. Most of the time, this results in selling low and buying high. I don’t know if the IAs know this but I would assume that most do. However, the main motivation for IAs to tell the clients to stay strapped in, is to keep the client’s assets, from which they make their fees. The unintended or intended consequence of this is that this can provide significantly more value to the clients than the fees that they pay to the IAs.

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