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Thursday, February 3, 2011

Three reasons investors leave their investment advisor (published in April of 2010 in the SB News Press)

Investors often make decisions about who they will entrust with their investments based on less than scientific (or even illogical) reasoning.  Over the twenty years I have been in the investment management business, I have identified three main reasons clients come to me from other advisors.  These three reasons are:

·         Lack of trust
·         Lack of communication
·         Lack of performance

In this week’s column, I will address each of these three and will discuss some ways investors can work through their relationship with their advisor to hopefully make a more informed decision as to whether or not to remain with them or chart a new course.  The three are certainly related and impact one another, as we will see.

Lack of trust is the single most likely reason that an investor will fire an investment advisor.  Every poll I have ever seen on investor satisfaction, and especially with wealthier investors, lists trust as the number one issue.  We can all understand this, especially in today’s environment of Ponzi schemes, Bernie Madoff, corporate fraud, et al. 

So how can we address the issue of trust in a meaningful way?  How can we judge if an advisor is trustworthy—if they truly have the investor’s best interests at heart?  For most, developing a reasonable level of trust with an advisor starts with the firm that the advisor works for, and the general consensus is that larger is better.  In general, I agree that larger firms tend to be safer, in terms of the risk of collapse or the risk of fraud, including the advisor running off with the investor’s money.  Larger firms tend to have insurance, including SIPC insurance (Security Investors Protection Corporation), the investment world’s equivalent to FDIC insurance for banks.  But this insurance only covers investors up to $500,000 including a maximum of $100,000 in cash, should a firm go bankrupt (SIPC does not insure against market losses).  (To make sure you are dealing with an SIPC member organization, look for a sign in the window or language on their website or investor materials that specifically states; “Member SPIC,” or call the SIPC at 202.371.8300, or visit their website at:

Most larger firms carry additional insurance on the assets of their clients from third-party insurance companies.  For example, I use Fidelity Investments to house my client portfolios.  Fidelity has roughly $2 trillion in assets under custody, and has unlimited insurance on investor accounts (again, in the event that they were to go bankrupt and not to insure against market losses, etc.)  Many independent advisors, like me, work with larger firms like Fidelity, so that the portfolios we manage are every bit as secure as those managed by the largest firms in the business.  It is a good idea to ask your advisor, or a prospective new advisor, what insurance coverage your portfolio has or will have. 

One thing to note, and that I have experienced throughout my career, that deals directly with trust is the motivation of the advisor.  Unfortunately, at most large firms, the business model is structured around raising as much in new assets as possible, using the lowest overhead possible.  What this can mean is that the typical advisor at these firms is juggling a large number of client relationships, making it very difficult to spend the necessary time with each client to really get to know them and their financial needs.  More concerning is that their primary focus may be on bringing in new relationships, rather than properly servicing existing relationships.  In fact, the compensation models at most large firms drive this bad behavior because they offer additional compensation (usually monthly, quarterly, or annual bonuses) to advisors for new assets gathered.  Advisor behavior is usually driven by compensation, so if the advisor is financially incentivized to spend most or all of their time pursuing new business, that’s exactly what they will do.

Understanding each client’s specific financial needs and their emotional connection to the risks involved in investing their assets is key to building trust between the advisor and investor.  If the advisor is not spending the necessary time to fully understand the client’s needs and wishes, it will be very difficult for the investor to gain a comfortable level of trust.

A final issue that should help to build trust with an advisor is their level of education, experience and credentials.  I have worked hard over my twenty year career to secure the top credentials in the business, but not all advisors focus on education or credentials, and instead, see the business as more of a sales-oriented career.  I would advise all investors to inquire about their advisor’s background, and to request a written biography that details education, experience and credentials.

One final note on trust… FINRA (Financial Industry Regulatory Authority) provides an easy to use database where you can check the background of anyone licensed through FINRA as well as licensed firms.  They also provide a lot of useful educational information:

Lack of communication is something I hear time and again when discussing other advisors with prospective clients.  I would say that lack of communication—advisors failing to return phone calls or emails, not providing acceptable explanations for what the investment strategy is and the tactics to be used to implement that strategy, communicating when major changes occur in the financial markets, and the like—is the most frequent reason that I receive calls from dissatisfied investors.  The problem in many situations when advisors are not communicating relates to what I detailed above, which is that the advisor is spending most if not all of their time prospecting for new business.  If they are out of the office on appointments several days a week or more, how can they return phone calls?  A more concerning question would be; how are they managing investment portfolios if they are on appointments all the time?  Investors should be wary if their advisor is consistently out of the office when they call, or if they do not receive return phone calls in a timely manner. 

Another possible reason why advisors are not communicating is that they simply don’t have a good answer.  Unfortunately the vast majority of advisors, and particularly those looking for new clients, tend to be young and inexperienced.  This makes sense if you think about it because those that have been around longer tend to have more clients and in theory anyway should be focusing on those existing clients and not on raising new assets as much.  All advisors are trying to build their businesses over time, and there will always be attrition—deaths, divorces, taxes, relocations, etc., but those newer to the business usually are primarily focused on new business.  These green advisors typically don’t really have an investment strategy, other than the one their firm provides for them, because they simply do not know enough about the financial markets, and have not had enough practical, on-the-job experience to know what to do.  So, if they are not communicating, it could be because they don’t have the answers that the investor seeks. 

Regardless of the reasons behind the lack of communication, this is a huge red flag and investors should probe more deeply to find out why their advisor is not communicating in a satisfactory manner.  It may be time to make a change.

Finally, a word on performance… while the ultimate goal of investing is obviously to make money, it is very difficult to judge an advisor solely on performance.  The reasons are many.  First, to accurately judge any advisor on their performance, (to make the analysis statistically significant), one would need a very large number of observations (quarterly returns).  Since there are only four quarters in a year, once can see that, by the time that the advisor had been investing for clients long enough to achieve statistical significance, he or she would likely be retiring. 

Also, historical returns are not a good measure of future potential returns, and the reality is that most advisors have good periods and bad periods (very few consistently outperform year-after-year, in all market environments), so judging what they may do in the future based on how they performed in the most recent historical period rarely works.  Studies show time after time that those that perform worst in the previous period tend to do well in the next period, so if an advisor does poorly and the investor fires them, and invests with the one that just did really well, the one that was fired tends to do well in the next period while the one that did well tends to underperform. 

I don’t want to suggest that performance is not important, (it is!), but investors need to understand what they are looking at and also that performance must be reviewed, analyzed and understood in the context of the market and economic environment and the risk being taken to achieve the results. 

Of the three reasons for investor frustration listed above, I would say that performance, especially short-term performance, should be the least likely to drive investors to fire an advisor.  In general, the more investors know about their advisors and the firms they work for, the higher the level of trust will be.  At the end of the day, if investors do not trust their advisors, no amount of positive performance will be enough to compensate for the discomfort felt and possible negative consequences.

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