How to tell if your financial adviser is a Warren Buffet or Bernie Madoff clone
I've been getting quite a few cold calls lately from financial advisers looking for business. The standard sales pitch is: 'Can we meet to discuss your investments? We have some ideas that you might be interested in.'
The cold callers won't tell you over the phone what the ideas are that you might be interested in. You will have to agree to a meeting to find that out. And if you do agree to a meeting, all you are likely to get is a well-oiled presentation about why this particular adviser is ready to help you 'put your money to work' or 'grow your wealth' or something like that.
So, how should you cope with financial advice and financial advisers? The first answer to this question is that you need to recognise that the job you think the adviser is doing and the job he is actually doing are two different things.
To explain this, I want to talk about my tennis coach, Matt. Now, Matt's job is ostensibly to improve my tennis game. In some sense, this is an impossible task. I am well past my physical prime and I'm not getting any fitter. To have any serious impact on my ability to hit a small furry ball around the court, Matt would have to make me work extremely hard to overcome my physical limitations.
But he doesn't. And that's because he knows that his real job is not to improve my tennis. No, his real job is to make sure I keep coming back for more lessons. Otherwise, he doesn't get paid.
So, too, with the financial advisory business. You might think that your financial adviser's job is to give you good financial advice and help you grow your wealth. But it's not really. Just as Matt's job is really to sell tennis lessons, your financial adviser's job is really to earn advisory fees and commissions.
Now, before every financial adviser and tennis coach in Hong Kong writes me a nasty letter, let me be clear. I am not saying this dichotomy means that I'll get bad coaching or bad advice. Obviously, if Matt improves my tennis, or at least creates the impression that my tennis is improving, it makes it a lot easier for him to sell tennis lessons to me.
And if your financial adviser is able to give you good advice or at least creates the appearance of giving good advice, then that makes it a lot easier for him to earn advisory fees and commissions. But a financial adviser who advises his clients not to make any investments is not going to earn a lot of commission.
So how can you be sure that you have the right guy managing your money for you? How do you know whether you've hired Warren Buffett or Bernie Madoff? Financial advisers all look pretty much the same, and they all say the same sort of things: 'asset allocation', 'short-term, long-term strategies' and 'risk appetite'. So how can you tell if your financial adviser is giving you good advice?
Simple answer: you can't. This is mostly because the world of finance is really, really complicated. But it is also because, as the events of the past 18 months have shown, no one really knows what is going to happen next.
So this is my second piece of advice on how to deal with financial advice: be sceptical. Assume that any advice you get is worth a grain of salt. Make no investment decisions on the basis of financial advice. Base your investment decisions on your own understanding of the investment product. And if you can't understand it - don't buy it.
If your adviser offers you a product and says something like, 'this product offers you the benefits of an equity upside, and a commercial-paper-based interest rate, along with a relatively small risk', don't say 'yes' or 'no'.
Say: 'Exactly what equity upside do you mean? Which stocks? How much upside? What's the difference between the equity upside of this instrument and the equity upside of buying the equities directly? And is there a corresponding downside?'
And if you get comprehensible answers to these, then you ask: 'What commercial paper? Actually what is commercial paper, anyway? What interest rate? Is the interest fixed or floating? What is the credit rating of the issuer?' and so on.
And if you get through that, then ask the most important question: 'And what exactly are the risks?'
The purpose of asking these sorts of questions is not to find out if you are smarter than your financial adviser, or even to make him squirm uncomfortably if he doesn't know the answer - and you'll be surprised how often this happens. The purpose of asking questions is to make sure you completely understand what you are buying. And if you don't understand the answers, keep on asking until it's clear. And, as I said, if you don't get to the point where you understand the product, then don't buy it.
The upside of this approach is that you will know what risks you are assuming and you will be able to make well-considered decisions about investment. The downside is that if things go wrong, there will be no point in protesting in front of your adviser's office; you will only have yourself to blame.
Having said that, though, I must admit I don't always follow my own advice. I haven't asked my tennis coach if he thinks I'll ever really be a good tennis player. I think I know what he would say, but I don't really want to hear it.
Contact Alan Alanson at firstname.lastname@example.org