Worst Practices in the Investment Advice Insustry
By now you probably realize that I’m not a big fan of the financial advice industry. Great advisers are out there, but it’s getting harder to find them. The problem with the traditional model of advice lies in the way advisers are compensated.
Until the last few years, most advisers earned most of their money from commissions on the products they sold. Today, more advisers earn their money from fees rather than commissions. It was widely believed that this change would improve the quality of advice, because brokers would no longer have a financial incentive to recommend products based solely on commissions. In practice, it hasn’t worked out this way.
Here are the 5 worst practices in the advice industry, based on my own observations and conversations with clients.
1. Training programs for new advisers that emphasize sales and marketing rather than sound investment principles. When I taught investing concepts to training classes back in the 1990s, I was required by management to spend at least 50% of my allotted time on sales and marketing techniques. This made perfect sense from a business perspective, because the number one goal was always to bring in new business. The problem is that marketing was over-emphasized, and this left little time for teaching sound investment principles like risk management and proper asset allocation. Marketing should be taught, but not at the expense of real skill-building.
2. Sales quotas prevent new advisers from building solid relationships with clients. Sales quotas don’t exist, “officially.” But every brokerage firm uses them. The training classes that I was responsible for had to spend the majority of their working day on the phone, cold calling for new accounts. It’s a stressful and demoralizing process that only a few rookie brokers survive. And who do you think survives? The ones who are able to churn out the highest number of calls each day – not the ones who have done the best job of mastering the finer points of investing. This is a warped reward system.
3. The 80/20 rule is based on the idea that 80% of an adviser’s compensation comes from the the top 20% of his customers. It’s a principle that applies to almost all sales-driven enterprises. But in the advice business, it’s especially harmful to the client. It means that most clients don’t get the time, attention, and care that they deserve and pay for.
4. Proprietary products are investments that are manufactured and marketed by the firm that the broker works for. Think of them as “private label” investments. They include things like in-house mutual funds, structured notes, and private placements. The problem with these products is that they carry added incentives for the broker to push, which creates a conflict of interest.
5. Sales contests are a time-honored tradition in many industries, but in the advice industry they are harmful to the client. We’re not talking about selling more cars, or computers, or toasters here – we’re talking about clients’ life savings and financial well-being. I think it’s completely inappropriate for a company to offer an extra monetary reward for bringing in new accounts or squeezing more revenue from existing accounts. I know of no instances where brokers were offered an extra financial incentive for how well their clients did in the market.
All of these practices are linked to the warped system of rewards and incentives in the advice industry. As a realist, I recognize that there must be a way to encourage sales in any business enterprise. But I would like to see an element of performance added to the mix, so that the client can benefit from the success of his adviser.