Financial advisers: the Good, the Bad, the Ugly

Posted on May 25, 2012 at 2:06 PM PDT by

Online portfolio management company, Betterment, stirred up quite a controversy this month brashly challenging both the efficacy and ethicality of the investment advisory business in its blog post, “Financial Advisers Are Bad For Your Wealth”.

Possibly, it was their stinging criticism of the industry or their use of an image of a pig with a human face that set off the raucous debate.

Whatever the reason, their opinions didn’t go unnoticed as wealth managers across the country responded with ire. Wealth manager Josh Brown from New York City characterized the dust-up as a, “brawl between Betterment and the entire online financial advisory population” and financial planner Roger Wohlner called their comments ” immature and stupid ,” to name a few.

Behind the controversy was a study performed by the National Bureau of Economic Research (NBER). Researchers sought to determine if advisers would act in the best interest of potential clients, correcting risky and inappropriate investment behavior when contacted for help. Actors posing as vulnerable clients performed nearly 800 visits. The study resulted in the discovery that advisers often reinforced harmful investment behavior and provided advice that benefited their personal compensation in lieu of their clients well-being.

For example, when actors asked about fees, advisers played down their importance. Despite the damaging effect of fees on portfolio growth, the study revealed that adviser said things like, “this fund has a 2% fee but that is not much above the industry average.”

Actors, who claimed they were in low-cost index funds, were frequently guided into more expensive, actively-managed mutual funds despite the ineffectiveness.

In addition to financial advisers, brokers too were biased toward methodologies that increased their personal earnings, such as encouraging the actors to concentrate in hot industries which require more buying and selling despite the high-risk, and taxes and fees resulting from such churn.

In light of these findings, what then is the role of an investment adviser if any? At MarketRiders, we often help investors fire their high-priced adviser in favor of low-cost, global asset allocation using ETFs guided by an objective and proven software service.

This do-it-yourself approach, however, isn’t for everyone. Many investors lack the fortitude and stability to faithfully execute a strategy through the tumultuous machinations of the market. For those investors, a good investment adviser makes tremendous sense, but how do you know if your adviser is a good one?

The Good

The first, ultimate and irreplaceable principle that guides good advisory services is fiduciary responsibility. Not only is this the law, good advisers place the interest of their clients above their own simply because they know it is the right thing to do, even if it means passing on substantial and tempting fees.

In addition, good advisers work intimately with their clients to develop a thorough investment plan favoring low-cost indexing, tax efficiency and global diversification when possible.

Finally, good advisers help their clients stay the course, helping clients manage the psychological roller coaster ever-present when markets swing wildly during economic tumult.  There are plenty of great advisers.  But you have to look carefully for ones that aren’t paid a commission to sell you products.

The Bad

Bad advisers and brokers are those that fail to use low-cost and tax-efficient indexing as the foundation of their portfolio management. Some of these bad advisers are sincere and good people who are simply uninformed and trained by an industry entrenched in an active management ethos.

Their sincerity, however, is no ethical cover for ignorance. Research has conclusively demonstrated the failure of active money management with irritating redundancy. When it comes to an adviser’s resistance to accepting these plain facts, it behooves us to remember what Upton Sinclair said: “It is difficult to get a man to understand something when his salary depends on his not understanding it.” If your adviser fails to acknowledge the value of indexing, he may not be as good as you think.

The Ugly

The NBER study sadly revealed that some advisers are actually quite ugly and deserving of the ignominious pig image employed in the controversial article. These debauched advisers place their own interests ahead of their clients, transgressing both law and conscience.

This offense happens when advisers recommend high-price and actively managed mutual funds, products with high fees, and strategies with high risk and taxes all for the sake of their own pocketbook. When you see such recommendations in play, you can be sure the oinking isn’t far behind. Leave these ugly ones to themselves before your portfolio has an ugly result. Find a good adviser or use one of the many quality online indexing services now available for surprisingly low-cost.