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Clients Are Financially Savvy, and Other Myths

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Okay, I lied. Again. But I will get to the “good” flat fees (versus AUM fees) the first chance I get. However, the comments to my last blog (What Do Advisors Really Do Anyway?, July 15) are crying out for a response, and I just don’t seem to have the will to resist.

Before I get into that, let me say up front that while I don’t believe that I’ve met either Derek Tinnin or Elliott Weir (who commented on my last blog) I’m assuming that they are smart guys, and good, client-centered advisors. Which leaves me even more puzzled as to why the key points of their comments make absolutely no sense to me. Either they are cooking on another planet or I am, and perhaps after I tell you why, maybe they or some other reader(s) can enlighten me. 

Let’s start with Elliott Weir’s shorter comment, which reads in part: “Bob, in a way you disproved your own thesis. Of the three values you cited (protecting clients from themselves, protecting them from bad products/services, and preventing them from making big mistakes), none of them has any connection to the size of the investment account.” 

As I said, I’m baffled by this statement. In fact, I’m so baffled that I’m having a hard time formulating a cogent response. To my mind, the connection between these three “key services” that financial advisors provide and the size of client portfolios is obvious, but I guess not. You see, if a client makes any investment “mistakes” (which most lay investors are inclined to make, but more on that later), the size of their portfolios will decline, which means the compounding of their investments will be reduced as well, rendering their long-term portfolios smaller, and their retirements less well funded. 

To my mind, it is this simple, but essential, fact that makes fees based on assets under management by far the most client-centered form of advisor compensation: it squarely aligns the clients’ primary interest—to grow their portfolios as much as possible, within an acceptable level of risk—with their advisor’s financial interest in earning more fee income, also by growing the investment portfolio.

As I’ve written before, this is how the wealthiest people in the world pay for their financial advice: it just makes sense. 

For his part, Derek Tinnin also takes issue with this concept, as well as the notion that most lay investors, left to their own devices, will make the serious investment mistakes I listed.

First, Derek addresses my comment that I wish the other professionals in my life were compensated based on performance, as is my financial advisor: “Bob, are you aware that it’s illegal for your accountant to charge based on performance (how much tax they save you)? Why is that? Conflict of interest or “bad behavior” by the accountant, perhaps? The same thing with your doctor: Do you really want to pay them based on your life expectancy or other metrics that once again introduce very questionable conflicts?… …doctors, lawyers, and accountants get paid on the quality of their work…” 

Again, apparently we’re on different planets: I recently had “minor” heart surgery, and I can say with certainty that my surgeon got paid exactly the same whether the operation was a success or not. In fact, should it turn out to be only “partly successful,” he’ll get paid 100% more when he does the procedure again. The same is true for accountants and lawyers on the respective services they provide, for which they mostly bill on an hourly basis, regardless of the outcome to their client(s).

In fact, the reason why it’s “illegal” for accountants to get paid based on how much they reduce my taxes (of which I am aware, but wish it were otherwise), is because, in addition to their clients, CPAs also have fiduciary duties to the “public” and to the government. Talk about conflicts of interest. 

But what really has me scratching my head is Derek’s concern about “very questionable conflicts” inherent in professional performance fees. What conflicts? Where’s the conflict if an accountant enables a client to pay the least amount of, legally permissible, taxes? (Cheating on taxes would be a risk that’s not in the clients’ best interest.) Or doctors getting paid for increasing one’s life expectancy? Or criminal lawyers, for keeping their clients out of jail? Or my mechanic, for getting more mileage out of my truck? Maybe he’s using a different definition of “conflict,” but usually these situations are described as an “identity of interest.” 

Finally, Derek also takes issue with the notion that retail investors can be their own worst enemies: “The numbers I see show exceptional behavior by the average investor…Are you telling me that a client who walks into my office with a few million dollars is someone likely to exhibit bad behavior?…The so-called “behavior gap’ is built on bad data.” 

Now, tell me: Is it just me? My first response to Derek: If your clients are such great investors, why do they need you? And second, apparently on Derek’s planet, they haven’t yet invented “Behavioral Economics.” But here on Earth, academics who study how retail investors actually behave have amassed about 30 years of research that pretty conclusively shows most of us are financial idiots, and will die broke without professional help.

For a compendium of this research, I’d suggest picking up the book Investor Behavior: The Psychology of Financial Planning and Investing by H. Kent Baker and Victor Ricciardi (John Wiley & Sons, 2014). 

So, yes, Derek: I am telling you that unless your millionaire client works in the financial services industry (and even then, it’s 50/50), he/she is very likely to exhibit bad investing behavior.

And in my 30 years of talking with financial advisors, you are first one I’ve come across who seems to feel his/her clients would be financially just fine without him/her. 


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