STANDUP to the Financial Services Industry: Protecting Yourself From Well-Intended But Oblivious Advisors

INTRODUCTION

This book represents a belated epiphany for me. For nearly a generation, I thought the problems that ailed the investment industry revolved around transparency, advisor bias caused by compensation models and the lack of focus on consumer interests. Those are all still challenges, but I believe there is now a single solution that solves all of them at once.

Why are most people’s investment returns so consistently disappointing? It turns out that a large percentage of the advisor population has misguided beliefs about how investments work. They give advice based on beliefs that simply aren’t likely to yield favourable results. That’s really just another way of saying advisors are human. But while we all suffer from some misguided beliefs, advisors’ beliefs are more critical—after all, they are the ones managing our life savings.

Too often in personal finance, ideas take hold and are taken as true simply because so many people repeat them. Many of the things advisors say are presumptively true yet demonstrably false—or at least ambiguous. The problem lies not only in the message, but also in how that message is delivered.

For many years, I have joined with consumer advocates, indus-try journalists and a handful of like-minded peers in an effort to get the investment industry to be more professional. I know from personal experience that most advisors make recommendations that are well-intended. There is little doubt that the vast majority of financial advisors in Canada sincerely mean well and genuinely care about the welfare of the clients they serve. In spite of this, however, the evidence shows that much of what they believe is demonstrably wrong. In other words, people who give advice for a living routinely give bad advice while honestly believing that the advice they are giving is, in fact, good. That’s a huge problem.

This book examines some of the behavioural and systemic reasons why advisors are giving poor advice, and it offers you tools to help ensure the advice you receive is in your best interest. It aims to give you the resources you need to hold advisors accountable for the advice they offer.

As a nation, Canadians are generally regarded as accepting, non-confrontational people. As a result, the mandate for this book is a particularly tricky one. Getting people to confront a deeply rooted industry mindset involves three distinct and sequential challenges to how the industry operates:

Summoning the courage to ask the necessarily tough questions in the first place

Figuring out which questions to ask once the courage has been summoned

Determining the validity of the answers that are provided when you get them

It’s unlikely that the problem can be overcome if the advisors who are trying to do things properly are restricted from speaking freely about what is wrong. It may be that part of the problem is that the industry actively shuts down frank assessments of deficiencies, thereby allowing the status quo to persist longer than it otherwise might. Until now, the reputation of the industry has trumped the respect for truth.

No one wants to look into a mirror and realize they have unwittingly been unprofessional. Many advisors have convinced themselves that the way they work is appropriate and best for their clients. Of course, believing something is true doesn’t make it true—and repeating unproven activities and attitudes doesn’t make them any more appropriate.

This reminds me of a parable. An ancient king once had a dream in which all his teeth fell out. The following day, he sent for a court dream interpreter to explain it to him. After listening to the king recount his dream, the dream interpreter said, The dream means that all your relatives will die and you’ll be alone. The king fired the employee on the spot and called for a second dream interpreter. The second listened to the recounting of the dream and then said, Good news, your majesty! The dream means you will live many more years—longer than all your relatives, in fact. For this, the second interpreter received a substantial reward. The irony, of course, is that the two dream interpreters said essentially the same thing. The difference was in how they delivered their messages: style and tone, not substance. Until now, I have been like the first dream interpreter. Going forward, I aim to be more like the second.

In my previous book, The Professional Financial Advisor IV (TPFA IV for short), I used the acronym STANDUP (Scientific Testing and Necessary Disintermediation Underpin Professionalism) to summarize the need for greater emphasis on evidence, integrity and transparency in the advice business. Simply put, giving STANDUP advice and acting in a STANDUP manner mean verifying evidence and eliminating bias in order to give clients a truly professional experience. This is a worthy cause that I am proud to be associated with. I refer to STANDUP advisors throughout this book as the self-aware and knowledgeable advisors I will help you find. They exist and are excellent. You might want to refer to TPFA IV as a resource when speaking with your advisors about many of the ideas discussed here.

My message is simple: hold your advisors accountable for their recommendations. There is a saying that the sincerest apology is changed behaviour. Mistakes must be corrected! Those who refuse to correct them shouldn’t be forgiven for their refusal.

There’s a strong consensus that most investors genuinely like their advisors and trust that they are looking out for them. Ironically, that implicit trust is an impediment to progress because few people think there are any problems that need to be solved. Advisors will need to tease out their own biases and make a serious effort to identify their own shortcomings. In the meantime, your action now will protect your investments while also starting to address the financial advising industry’s systemic and entrenched problems.

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GETTING FINANCIAL ADVICE:

It’s Important, but Is It Any Good?

It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.

mark twain (apocryphal—note that it’s especially ironic, seeing as Twain never actually said it)

Getting financial advice is important. Dozens of books preach about the importance of good financial advice, and an entire industry provides it. But is the advice any good? This book argues that the advice investors are getting is quite likely to be wrong even though the advisor who is giving it wants to do well by the client.

Many books talk about how the industry uses complex strategies to layer on fees and then gets hapless people to buy in by using compelling advertising campaigns. This might well be the first book that shows advisors to be simply the friendly face of an industry inclined to get clients to think in specific, revenue-­maximizing ways—even when there is no basis for that line of thinking. Advisors might be better seen as unwitting accomplice intermediaries between some sophisticated corporations and trusting Canadian consumers. Many advisors are, in fact, small players in a larger arena that most people (notably the advisors themselves) are oblivious to. This book’s objective is to be direct and honest about facts—what is—and to propose actionable recommendations to overcome them—what ought to be.

As I explained in my book The Professional Financial Advisor IV (TPFA IV), most advisors hold themselves out to be professionals the way doctors, dentists, lawyers and accountants do, yet for most, their primary function is to sell products. Overwhelmingly, these advisors are not sneaky manipulators of client assets (although I’m sure there are a handful of those) but trusting, consensus-­seeking human beings who are just trying to earn a living by taking care of their clients. They truly believe in the products they are selling. Financial advisors are merely human.

So why do some advisors provide bad advice? And how can you know if you’re receiving good or bad advice? Answering these questions requires delving into human psychology. Advisors, like all of us, come to their jobs with unwitting biases and beliefs that shape the advice they give. Understanding some of these biases and beliefs helps us assess their advice.

Confirmation Bias and Misguided Beliefs

Dan Kahan is a professor at Yale Law School. For years, he has been interested in understanding how an individual’s beliefs affect their recollection of events. In order to test this, he had two groups of students watch a video of a protest. One group was told that the protest was against legalized abortion and the other group was told that it was against the ban on openly gay and lesbian soldiers from serving in the military. After collecting information about the students’ political beliefs, Kahan found that the students’ reactions to the video were highly correlated with their pre-existing views. Many people see what they want and expect to see. Stated differently, many people are unwittingly biased in favour of their pre-existing views and less open to new ideas than they are willing to admit.

This concept, now known as cultural cognition, is a form of confirmation bias, which explains why we tend to ignore or reject information that goes against our most deeply held beliefs. With the rise of Facebook, Google and Twitter, it is getting easier and easier for us to experience confirmation bias. That’s because social media systems are optimized for societal engagement and not truth or intellectual diversity. In social media, your actions curate your feed, and, before you know it, you only see and read opinions you agree with. This is true for pretty much everyone, but it’s particularly disconcerting as it applies to financial advisors.

Even when someone prefaces a comment by acknowledging that he is stating an unpopular opinion, people react negatively. It’s instinctive and tribal. We need to be careful how we receive and interpret information, because if we’re not careful, we (for now, I’m talking about all humans) can create a false view of reality. You might think that your beliefs come as a result of deep analysis and critical thinking, but that probably isn’t the case. People believe what they want to be believe.

In Annie Duke’s book Thinking in Bets: Making Smarter Decisions When You Don’t Have All the Facts, she describes how belief formation actually works:

We hear something.

We believe it to be true.

Later, if we have the time or inclination, we think about it and vet it, determining whether it is, in fact, true or false.

Of course, this won’t work when we already have a belief about a topic, but for new information, it is spot on. In Daniel Kahneman’s book Thinking, Fast and Slow, the Nobel laureate shows repeatedly that people don’t like thinking, but they love certainty. Thinking takes mental energy and time, so why do it? Just consider how much of your day is spent on autopilot versus in analytical thought. Autopilot is efficient, and there is usually nothing wrong with this, but what if sometimes there is?

How can you identify and resist misguided advice based on ideas that are believed to be true but are, in fact, untrue? To begin, you need to understand that the vast majority of advisors are well-intended people who really do want to help produce good outcomes for their clients. The problem seems to be that their well-intended efforts are often unwittingly counterproductive because they believe things they shouldn’t. For people in general and advisors in particular, it might be advisable to consider viewpoints through the lens of strong opinions, weakly held. It may be best to keep your identity small and not be too wedded to your ideas and beliefs as an advisor.

Petty tribalism can lead to highly entrenched perceptions. When you identify with an idea, you make it harder to argue about the idea, because you instinctually feel like any disagreement is an ad hominem attack against you and not the idea.

Do your research to create opinions, and then change those opinions if you receive new information that suggests your original world view was incorrect. Some have suggested that we should think of our beliefs like clothing, not tattoos. You want to be able to easily change and adapt them, not have them become a permanent part of your identity. Alas, it may be that advisors have beliefs that are more like tattoos than clothing.

This brings us to something that has become all too prevalent today—people believing what they want to believe, facts be damned! Some people call this a tendency toward alternative truths, while others are pejorative when they refer to evidence as fake news. It’s hard for a layperson to know who to believe. There is a wide body of research on what has come to be known in academic circles as motivated reasoning. All of these euphemisms are really just variations of confirmation bias. For instance, while confirmation bias is our tendency to notice and accept that which fits within our preconceived notions and beliefs, motivated reasoning is the complementary tendency to scrutinize ideas more critically when we disagree with them than when we agree. Upton Sinclair offered perhaps its most popular expression in I, Candidate for Governor: And How I Got Licked: It is difficult to get a man to understand something when his salary depends upon his not understanding it.

Since the start of the millennium, I’ve been urging advisors to be more transparent, professional, client-centric and evidence-­based in how they do business. Since these attributes are all self-evidently positive and accretive in nature, I have been surprised by how few advisors were loath to STANDUP and do the right thing. Then, in late 2016, a paper entitled The Misguided Beliefs of Financial Advisors was released by a team of American academics. It hit me like a thunderbolt. The abstract of the paper reads as follows:

A common view of retail finance is that conflicts of interest contribute to the high cost of advice. Using detailed data on financial advisors and their clients, however, we show that most advisors invest their personal portfolios just like they advise their clients. They trade frequently, prefer expensive, actively managed funds, chase returns, and under-diversify. Differences in advisors’ beliefs affect not only their own investment choices, but also cause substantial variation in the quality and cost of their advice. Advisors do not hold expensive portfolios only to convince clients to do the same—their own performance would actually improve if they held exact copies of their clients’ portfolios, and they trade similarly even after they leave the industry. These results suggest that many advisors offer well-meaning, but misguided, recommendations rather than self-serving ones. Policies aimed at resolving conflicts of interest between advisors and clients do not address this problem.

The moment I read the paper, I realized that consumer advocates and would-be change agents such as myself had been barking up the wrong tree for over 20 years! The real problem is that financial advisors suffer from confirmation bias, overconfidence and other behavioural quirks like everyone else. Human nature impedes their ability to do their job properly. No amount of disclosure, training or regulation is going to change entrenched advisor attitudes and beliefs that are demonstrably wrong if nothing is done to challenge them. What we need is an investor-led revolution that forces advisors to be accountable for making recommendations that repeatedly fall short of the mark. The evidence that the paper provides makes it clear that there are severe deficiencies in the advice-giving process. What, exactly, is the utility of advice that is misguided in the first place?

Meanwhile, the problems that are exposed in the paper are insidious, but nonintuitive. It seems that advisors will only change if their clients force them to. Inviting them to do the right thing or even changing regulations to force them to do it will not cause them to change their beliefs... and misguided beliefs are the real problem. We all need to challenge presumptive and entrenched value propositions in order to receive evidence-based advice. We specifically need to do this in spite of advisors who often don’t really believe the evidence.

This is going to be a challenge. Basically, I’m asking Canadians to call out their advisors for doing the wrong things—even though the advisors were doing those things for what they honestly believed to be the right reasons. To make matters even more challenging, most people who read this book will, by definition, likely know