Higher Calling - To Protect
This is Part 2 of “Higher Calling - To Serve and Protect” blogs. Click here to read Part 1, "Higher Calling - To Serve".
Having been in the investment business now for almost 20 years, I see how the design and marketing of investment advice and products shifts with market winds. “Shiftiness” alone should be a red flag for potential investors as product marketers often prey on emotions stirred by some recent market event, or exploit recent (statistically irrelevant and, most certainly, not predictive) past performance. Yet, unless you are immersed in this industry and focused on what is being marketed at different times, it is all too easy to make regrettable investment decisions in response to the latest idea or market shift.
A critical role that our industry can play is to PROTECT clients from value-destroying actions and ill-thought out investments.
Here are some common actions and investments that tend to destroy value over time. Before making emotional decisions or responding to a sales pitch, it may be wise to pause and seek unbiased counsel from a fee-only fiduciary (see our blog “Does Your Adviser Work For You?”) who can provide objective guidance and give you some “protection.”
Protection from Randomness and Reactions
Foundations, pensions, and institutions are required, as fiduciaries, to have an Investment Policy Statement (IPS) that serves as a roadmap on how investments should be managed. The IPS generally addresses how much risk should/can be taken, what expected returns might be, target allocations, tax management, timelines, goals, etc. One role of the IPS is to give purposeful direction (eliminate randomness), but another key role is help investors stick to their plan and not be whipsawed by the markets (eliminate reactive actions).Study after study show how investors destroy value by reacting to (or guessing about) market movements. Every investor should have their own IPS to guide them. Rarely do we find a “do it yourselfer” with a solid plan. A valuable service advisers can provide is a solid, tailored investment plan that addresses each client’s specific needs and provides a compass for direction when market winds are blowing. Having and sticking to a well-developed IPS may be one of the best sources of protection an adviser can provide.
Protection from Investment Biases
There are numerous studies showing how biases impact our investment decision-making. We all have them. Our industry must help surface and better educate clients about them. The more you become aware of your biases, the better you can manage them.
Here are some common bias-based mistakes that we see:
Recency Bias. This is when we put more weight on recent data than longer-term data. When markets move downward or volatility increases, it is common to extrapolate the recent into the future. We forget that markets do go up and down (see our blog “Are You Getting Queasy With These Markets?”). It is always good to step back and look across time before making any decisions. Reacting to the most recent data is generally not a good investment strategy.
Home Country Bias. We tend to invest in things we know. Yet, we are limited in what we know and therefore take on too much risk and miss out on the bigger investment world. With this, we often see too much US exposure. The world is bigger than the S&P 500.
Endowment Effect. This is when we put more value into something than it really has because we already own it and are comfortable with it. The problem with that comfort is that an investment doesn’t care about you! Investment decisions need to be objective not relational.
Behavioral Finance researchers have documented many other biases. See our blog "You Might Have a Behavioral Bias if..." for some of these. Biases can add excess risk to a portfolio. A good plan should address these, and a good adviser should be trained to identify biases and protect clients from them.
Protection from Inappropriate “Investment Products”
While some of the products I will mention may have valid roles, in my experience most were bought based on fears (that is, recency bias) and without much financial analysis around these very complex and often misunderstood products. In almost all cases, investors really had no idea what they “bought.” The recent apparent losses in UBS’s “Iron Condor” risk management solution is just one example of where clients may not have achieved the outcome they hoped.It is important to note that rarely would these products be recommended by full-time fiduciaries – advisers committed (legally) to putting client interests first – and why it may be prudent to seek their unbiased counsel before signing on the bottom line.
Products that make me cringe have many similarities. They are generally:
Very complex, hard to understand and accompanied by 100+ page disclosure documents
Often high cost with significant embedded fees and commissions, and also not very transparent about all the costs, fees, and commissions
Put significant restrictions, constraints, and limitations on you the investor (e.g. lock ups, penalties)
Broker sold for commissions, not fiduciary (client's best interest first) recommended
Finally, while these are often designed to meet particular purposes, there is often a lower costing, simpler, and less restrictive way to achieve these goals.
Some products I put in this category include:
Whole/Universal/Permanent Life Insurance Policies
Structured Notes
(High Priced) Annuities
I go into more detail on each of these products in my blog “Investment Products That Make Me Cringe.” Each of these should be considered in light of an overall estate plan as well as against other options. This is again another place where a good fiduciary adviser can be helpful.
Conclusion
The investment and wealth management industry has an opportunity to respond to a higher calling by protecting clients from emotional decision-making and poor investments. Sometimes this is not easy and means having hard conversations with a client, but it is a great way to serve and add value.Serving and Protecting: a great way to add ongoing value to clients!
