Thursday, January 08, 2009

Why Your Financial Advisor Failed You

Bloomberg is reporting that a lot of people are unhappy with the performance of their financial advisors.

Financial advisor is the 21st century euphuism for what we called a stock broker in the 1980s & 1990s. Watch the first 10 minutes of Wall Street with Charlie Sheen and Michael Douglas. That’s what a stock broker is and does. A stock broker/financial advisor is someone who sells equity stocks and other investment vehicles in order to earn commissions.

I spent a few years as a stock broker in the mid 90s. I was modestly successful, but the business wasn't the gentleman’s business I had hoped it would be. Instead, its an industry dominated by boiler rooms like DH Blair, FN Wolf or South Richmond Securities and slightly more refined stock brokers who elevated themselves to more reputable companies Prudential, Merrill Lynch, etc.

With that sort of understanding, let me offer an example of how unqualified your financial advisor is to be handling your retirement and you children's college savings. The kid from Geek Squad who comes to your house to set up you flat screen or fix your laptop is more qualified as an electrician than your financial advisor is an investment advisor. I worked for 3 years as a series 7 licensed stock broker. I worked for a boiler room firm for a short time and then moved on to a more reputable firm that we've all heard of and earned a decent living before deciding that calculus, physics and computer science were more desirable ways to spend my days and less likely to burn a hole in my stomach like selling was.

The goal of the stock broker was not to make money for his clients, but to make money for himself and the firm. Making money for your clients was ancillary. I knew hundreds of stock brokers. Some had BAs from a variety of schools, most didn't and very few possessed MBAs. Plenty of guys did the job and did it well without any sort of college education. They succeeded because the goal was not to make people money, but to sell them stock and generate commissions. They were good salesmen. They would have succeeded in selling just about anything, but selling stock was more lucrative and prestigious than selling cars or magazine subscriptions. But, they would have been no less successful.

Selling stock is easy to do in a bull market. In a bear market, you need some luck. I got to Wall St in late 1993, right before things tanked in the spring of 1994. I sold a lot stock on the back of a sales pitch which asked prospective clients why they hadn't heard from their current stock broker when the market was tanking. The stock I was selling at that time is irrelevant. It was going up that week, that month and that is all my current customers cared about. Its all my prospective customers would care about. Customers are funny, you could make them money for 2 years straight with lucky pick after lucky pick, but if you lose their money once your neck was on the line. One bad stock pick could ruin your book of clients. Especially if some ambitious hot shot like myself happened to find their name and phone number in an alumni directory, a professional society register, in the white pages or on some list of dubious origin.

For most stock brokers the day begins with the walk and train ride to work. The ambitious ones "read" the Wall Street Journal. The more savvy guys "read" the Investors Business Daily. We all shrugged at the guy reading the Financial Times. Near our office, we stopped at one of the carts and picked up a 1000 calorie cranberry muffin because it sounded healthy or perhaps we chose the bagel with a quarter inch slab of cream cheese to go with our coffee. Then we went upstairs to cushy offices. Maybe we sold a lot of stock last year and they decided to call us vice-president or even senior vice-president which entitled us to a window office. If you were really a good hustler, you were an executive vice-president or perhaps you got some nice logo on your business card which said something like Chairman's Council which impressed your customer, but all it really meant was that you sold a boat load of stock and made a ton of money. You were probably a million dollar producer, which means you produced a million dollars in commissions. It meant you won a nice trip with the rest of hot shot sales guys to a golf resort in Florida or Arizona and took home some nice corporate swag, you know, like the Enron or Bernie Madhoff stuff people sell on ebay all the time.

So, you've got upstairs, you attempted to put your stamp of authority on the rest of the guys with whom you’re competing with for that Chairman’s Council logo and made your way to the office. You lose your suit coat and put on your headset that is wired to the phone. You are literally going to make 300 phone calls today, minimum. Remember the first few minutes of Wall St? A headset is essential to not ending up with the world’s worst stiff neck and cauliflower ear. You'll hit up that list of alumni directories for fresh fish to sling your stock to. You'll also sort though your book of clients and see who has been in the current stock du jour the longest, if they are up a good bit, its time to hit them up to take a profit or perhaps talk them into terminating a relationship with one of their other stock brokers who might be under performing. Those were always the best days, nothing like raking in fifty or one hundred thousand dollars in new money. Sure, you throw them a bone and only charged them commission on the buy side of the account transfer which saves them a 2-3 grand. That’s it, you do that all day long. Perhaps it was a good day, you made a few sales, brought in a few grand in commissions. Commissions are split with the firm. That split is determined by how much in total commissions you generated for the month. On the low end the stock broker takes 45%. On the high side, the Chairman’s Council guys take about 55%.

Determining what to sell ... Well, as a young broker, someone who has finished their indentured servitude or apprenticeship to a full broker you sell what the firm tells you sell for the most part. That’s where you really find out who the true hot shot sales guys are. The guys who can make blue chip companies sound interesting and sell enough to make a true living, they are the guys who could make a million bucks selling you the clothes your wearing. Other guys who barely scrape by have to get a little lucky. They are never going to make a living selling blue chips. Plenty of them fail and go sell insurance or work back office operations. I would guess the attrition rate is a solid 85% or more. Those guys have to catch lightning in a bottle. If they get lucky, deviate from the script and start selling something risky, something they heard someone else selling. If that works out, they have a sporting chance of sticking around, for a little while, assuming that stock doesn't tank like the dog it always was.

This posting is 10 paragraphs long and I haven't talked about the financial analysis that your stock broker performs. That’s because he doesn't. I say he, because there are very few women in this business. The ones that make it are tigers (who will grow in to cougars), but for the most part, it’s a boys club. If your buying some kind of high flying investment funds or equities from your broker, odds are he got a tip from someplace or perhaps his dartboard is on. The best days for a stock broker are the days when one of the talking heads on one of the financial networks touts a stock that he has been building a position in for his clients. That’s the golden palace of the Himalayas. The stock in question is bound to jump. The stock broker is going to look like a soothsayer to his customers. Now, your sitting at home watching the talking heads tout this stock or that stock. You can run and buy it, but the real money has already been made. Faster than your little fingers can click the mouse or dial your stock broker. You’re now just a block near the bottom of the pyramid. Your stock broker isn't much smarter than you, sitting there watching the talking heads on the boob tube, except that he knows that train has already left the station. Its ok to get on the train in Chicago, but you gotta hope that the train will still get to LA, while everyone who got on in New York already has their profit all but locked in. In essence, stock brokers and stock tips are like teens and sex, the info is traded on the ball fields and street corners. It’s diluted, it’s less likely to be accurate. Sure, there are some stock brokers who are capable of doing true financial analysis, but its hard to do without the right education, experience and most importantly information.

Information, as Gordon Geko taught us is the most valuable thing. It’s what allows experienced professionals who are in a position to take of advantage of the information to come to the right conclusion. Stock analysts, you know the James Spader character in the movie, only seem to be eclipsed in their poor performance as prognosticators, by meteorologists. Bottom line, neither you nor your financial advisor are often in a position where information, experience and opportunity come together to make that perfect storm, to buy that stock as it’s on the verge of starting its run to doubling.

So, there it is, this is probably why your financial advisor failed you. And just because your financial advisor lost you money in 2008, doesn't mean he failed you. There are plenty of Harvard and Wharton MBAs running multi-billion dollar funds who were down 30% or more. Everything is relative. My advice, it's your money, it's your future. Spend the time, do your homework, make your own picks. Pick solid blue chip style companies that are going to succede in the long haul. Be in it for the long haul. Doubles don't happen often. Remember the stock brokerage commercial where the guy said he was going to "get rich quick and retire by 35"? Get rich quick more often means broke and starting over 6 months later.


moderator said...

Good post. Jim Cramer comes to mind when I think of pure sales guys that don't do any better than throwing darts at a board.

tim said...
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steven conville said...

Great advice thanks..
Steven Conville