Charlie Munger is best known as Warren Buffett’s sidekick. But he is also an investment legend and renown for his intelligence. Smart investors heed his advice.
During his life Charlie studied psychology to learn the causes of bad investment decisions people make. In a compilation of his speeches on the “Psychology of Human Misjudgment,” Charlie discovered incentives drive all behavior. Ask any angel or turnaround investor and they will tell you. If you get the incentives right, you can accomplish anything.
How does this apply to picking a financial advisor? You need to do three things:
- Be wary: When an advisor can profit more from taking one action than another he will take the more profitable action. Since everyone (including your doctor) is an advisor, always consider this.
- Don’t be “sold:” To avoid being “sold” (when incentives are misaligned) learn the basic elements of your advisor’s trade.
- Double-check your beliefs. Just because everyone believes something is true doesn’t mean it is. When something happens to disprove what you previously thought to be true you might want to check again.
Let’s go into the detail.
The financial services industry is confusing. And financial “advisors” have incentives to sell certain products and services. There are three things you should be wary of.
- Your advisor works for a publicly traded company (like a big bank). Most advisors work for publicly traded firms that may say they put investors’ interests first. But the truth is that publicly traded companies MUST put the company’s interest first. It’s in the corporate charter. This means there will always be pressure on financial advisors working for these firms to find a way to maximize corporate profits.
- You advisor has an insurance license. As Munger says, incentives matter. And because insurance is the most profitable thing an “advisor” can sell, it is also the first thing they try to sell. The worst of the lot are the radio talk show hosts selling “worry-free” retirement or something like that. They peddle insurance products guaranteed not to lose money but forget to tell you they get a 10-13% commission by selling them. And ten days after they are sold they have no ongoing obligation to make sure they were right. In fact, at that point you may be locked in for ten years
- You advisor works for a dishonest firm. Not to beat a dead horse, but at least two national firms recently achieved notoriety. Wells Fargo for fraudulently opening customer accounts. And TIAA CREF for pretending to be non-profit. Advisors choose where they work.
Don’t Be Sold
Keep in mind the first bit of advice, be wary. And because its so confusing it makes it easy for an advisor to take advantage of you at just the wrong time. Financial advisors are paid fees for managing your money and may receive commissions for selling you things like Real Estate Investment Trusts, variable annuities, and other life insurance. The commissions are higher than the fees (generally 1-10 times an annual fee). After products are sold there is no on-going fiduciary duty. One, and done.
Some “financial advisors” you should avoid include:
- Advisor friend or neighbor (or friend of a friend) simply because it’s convenient. Many investors work with someone they met at church or someone they know from a friend. But remember, this is an industry where the best salesmen get the most clients.
- Advisor with a fancy title. The titles many “financial advisors” have like First Vice President, etc. are literally bestowed based on how much revenue or commissions they have made for their firm. They are often not a reflection of experience or meaningful credentials. Certified Financial Planner™ is a meaningful title. Years of experience and education level attained are meaningful.
- Listening to an expert (who is paid to tell you what to do). Experts like Dave Ramsey are richly compensated to refer you to members of their “Endorsed Local Provider” network. Also, be very wary of radio talk show hosts whenever they say “worry-free.” Here’s a hint – they want to sell you annuities.
Double Check Your Beliefs
Since 2009 the US stock market has been on fire and everyone “knows” indexing is the right path. In fact, passive strategies (like index based strategies) have beaten active strategies (where managers pick stocks) since 1980 or so. Investors often have these mistaken beliefs:
- The if aint not broke, don’t fix it fallacy: What you did to accumulate wealth may not be what you should be doing now that you have wealth. Don’t forget, while saving, volatility is helpful. When prices fall, and you are buying something, you get more. But when prices fall, and you are selling something, you might sell it before it can recover. This can mean the difference between having the retirement life you want and having to make important sacrifices.
- The low cost is the most important thing fallacy. All things equal low cost is important. But value can be found by paying extra for some things. When you have evidence, for example, that an investment manager has a long track record of winning on performance and risk, this should be compelling. Other factors like fund size, skin in the game, and resilience are important.
- The all financial advisors are the same fallacy. Financial advisors come in many shapes and sizes. Some advisors work for publicly traded firms who put their public shareholders’ interests first because they must. It’s in their corporate charter. Other advisors work for insurance companies and know all the advantages of insurance. Because they are paid better to sell insurance nearly all clients own unnecessary and expensive insurance.
Putting it All Together
Before you do business with a financial advisor ask them questions. Ask them to tell you, in writing, that they will act as a fiduciary in all aspects of the relationship. Ask them if they have an insurance license. The answer to the first question should be yes and to the second question no. We put together a more comprehensive list of questions:
Because we understand human beings are never rational, instead are predictably, nearly perfectly irrational, we developed a system to overcome this. We call it Worry-Free Portfolio Management.