The Value of Don't

As strange as it may sound, a large part of the value I provide to clients is in what I don't do. I don't, for example, recommend that client's buy opaque, illiquid private investments. I don't try to push clients into costly and complicated annuity contracts that likely won't live up to expectations. I don't buy investments for clients that are easy to buy but hard to sell. And I don't deceive or otherwise swindle clients out of their hard-earned retirement savings. What's the value of what I don't do? It could well be priceless, although you'll never see it on a statement.

What am I driving at with all of this? Well, as I've written about previously, hardly a week goes by without a story or two (or several) about advisors getting caught pulling the wool over their client's eyes, or even downright defrauding them. Last week was no exception. But while fraud and breaches of fiduciary duty are unfortunately common, one story stuck out as epitomizing the ongoing problem faced by investors.

A Virginia registered investment advisory firm was permanently closed, the founder is now facing jail time and his licenses have been revoked, for leveraging the firm's assumed expertise, competence and trustworthiness to, essentially, hoodwink clients. It seems the firm was holding "Social Security Maximization" seminars to draw in folks who were in or near retirement. Part of, or perhaps all, the investment strategy was to buy into "speculative, illiquid, and high risk" investments, according to the Department of Justice. It turns out the investments were being managed by an associate of the firm's owner who had been previously banned from the industry for fraud. The result was that clients lost over $6mil while the advisor earned over $700,000 of "ill-gotten gains".

None of this had to happen but it happens all the time. The ongoing problem is that, frankly, this investing stuff is complicated, so it's easy for unscrupulous advisors to say the right things, gloss over risks, and make clients feel comfortable enough to write a check. They create fancy presentations with "back-tested" returns for new and exciting investment strategies. They even tout the experience of their current clients to show just how wonderful retirement could be as a client of the firm. These advisors are often able to act with impunity for a while, even though they usually get caught. But by then the damage is done and everybody suffers, with the client obviously suffering most.

One of the ironies here is that the investor who buys into this kind of arrangement is often a very intelligent person who otherwise makes smart and well-thought-out decisions elsewhere in their life. But due to the complexity of investing and the ease at which advisors can sway investor opinion, the advisor is often in total control of the relationship and can steer folks into whatever crazy scheme they cook up.

Addressing this problem doesn't require more regulation. Instead, it's all about the initial questions you ask the advisor. Unfortunately, the clients who lost money likely didn't ask these questions. Or, maybe they did and just took the advisor's word for it.

The first thing you want to ask about is the money. Not yours, but theirs. What's in it for them? How do they get paid? Commission, flat fee, ongoing fees, or all three? Are there other products that offer similar returns for less cost? Ask them to back it up in writing. These are basic questions that, for a variety of reasons, investors have been trained not to ask. But if you follow the money you'll learn a lot about the advisor and the kind of advice and service you're likely to receive.

The second thing to ask about is who is actually doing the work. If the advisor is proposing a strategy, are they personally implementing it? Is it a staff person in their office? Or, is it a third party within a brokerage or advisory firm somewhere else? Maybe even a private real estate fund, private equity fund, or something like that? What do they charge? Who's watching them? If the answers lead to a third party you need to do the same due diligence on them that you hopefully did on the advisor. A lot can be determined by reviewing the firm's regulatory disclosure brochure, or ADV Part 2. If the clients in this story had done this, they likely would have smelled a rat and could have avoided lots of trouble.

It doesn't matter how nice someone is, or how trustworthy they seem. If you can at least do these two things you're more likely to uncover circumstances that potentially make you squeamish. And then you can run, not walk, away from the advisor and find someone better.

Have questions. Ask me. I can help.