Rebuilding Trust in Financial Markets and Advisors
June 7th, 2009
While on a New York media tour for our new company, Peoples Financial Advisor, I heard one question more frequently than any other: “What are you doing to rebuild people’s trust?” At the time, financial reporters were losing their jobs because trust was in very short supply.
Trust is the foundation of all business, including the advertising dollars that support media. Without human trust, a modern economy cannot exist and capital markets cannot function. Money itself is an invention of human trust. Whether it’s in the form of clay tablets, coins or plastic credit cards, money is nothing more than a “promise to pay” and belief in the promise. So I don’t think the problem is public trust. The economy is still functioning and as far as I can tell everyone is still using money. We are by nature an optimistic people. We want to trust our government, financial institutions and advisors.
But we’ve just learned that we’re never more vulnerable than when we trust. Misplaced trust created the economic bubble. The loss of almost twenty trillion dollars or 40% of personal wealth is a measure of our financial vulnerability when we, the public, misplace our trust. I personally think the new found skepticism is healthy. I believe the personal losses in our real estate and financial portfolios were the “price” of a valuable lesson for all of us.
So what am I doing to rebuild trust? From 16 years of counselling and building non-profit organizations I learned that the way to win trust from others is to focus on being trustworthy. I want Wall Street to spend fifty billion dollars a year on becoming trustworthy instead of advertising to win trust. I want the media to acknowledge it has the same conflict as the cigarette industry. I want the financial media to post warnings that it cannot survive if it doesn’t arouse emotions and sell copy and “this advice may be hazardous to your financial health.” I want regulatory reform to require an authentic fiduciary standard of care for anyone offering financial or investment advice to the public.
As for individual investors, what were our expectations before the collapse? Were they reasonable? Did I expect for-profit financial institutions and advisors who sell products to put my interests ahead of profits and compensation? Did I believe that I or my advisor could beat the market by looking into the future to pick winners and avoid losses? What lesson will we learn from our losses? Will we blame advisors, the media, politicians, financial institutions or capital markets? Will we learn not to trust anyone or anything? Will we return to the days of putting our money in the mattress and not asking anyone for advice or help? If so, we may be setting ourselves up for more disappointment.
It’s true, we are never more vulnerable than when we trust, especially when it comes to money and love. But it’s also true that if we never trust we will never experience financial freedom or rewarding relationships. Perhaps some of us just need to rebuild our trust in ourselves. Everyone has the ability to learn. Everyone has the ability to make better financial decisions. Trust me on this.
Someone once said broken trust is like a glass vase. You can glue it back together, but it will never be the same. I agree to a point. If people learn from their losses, their trust will be reinforced with wisdom.
How to Avoid Being “Madoffed”
May 28th, 2009
The simplest and best way to protect your investments from advisor fraud, is don’t give the advisor opportunity. In other words, don’t give him custody of your assets. Don’t give your advisor power to buy and sell securities without your permission. Give him a limited power of attorney to execute trades with your signed permission only. Don’t authorize your advisor to pay himself (deduct his fee) out of your account. Ask for an invoice and pay the fee with your credit card or a check. The more control you give the advisor over your money, the greater the risk of being defrauded.
If keeping control creates too much work for you, then at the bare minimum require the advisor to use an independent financial institution to hold your investments. Such an institution is called a custodian because it provides custodial services for advisors and their clients. An independent custodian gives you an extra layer of protection because it, not the advisor, generates the reports and values your assets. You should be very nervous if the only report you receive is the one prepared by your advisor or a custodian controlled by our advisor.
If the independent custodian is not a well-known name like Schwab, TDAmeritrade or Fidelity, you will have to do some additional background checking. Get the firm’s name and contact information. Call and ask for evidence that custodial services are provided to other advisors. Request copies of reports from an independent auditor. Visit the physical office. I’ve read that Bernie Madoff’s custodian had a small office in a remote location, with just a couple employees and no independent auditor. Do a Google search and check the yellow pages. Verify to your satisfaction that the custodian is truly independent and trustworthy.
Finally, I believe you can greatly reduce the risk of being defrauded by abandoning the strategy of active management altogether. There is no evidence that an active money manager can beat the market. Read the all time best seller ”A Random Walk Down Wall Street” by Professor Burton Malkiel or ”Winning the Loser’s Game” by Charles Ellis. I can’t prove it, but I suspect that most, if not all the Ponzi schemes and acts of fraud were committed by advisors who believed they could beat the market, even after subtracting their expenses. An advisor who sells his ability to predict the future (ie. pick winners and losers) has created almost impossible expectations (and pressure) for himself and his investment performance.
