There’s a reason why people choose to invest their money with an investment firm. It’s because they have neither the time, inclination, or ability to select the right investments on their own. That’s a perfectly legitimate reason to delegate that responsibility to an investment firm that does have the expertise and the ability to invest their money. And investment firms have a legitimate role in acting as stewards of their clients’ assets to ensure they’re investing them in a way their clients would if they had the ability to do it on their own. It’s a hiring process where clients search for, find, and select an investment firm that best matches their investment philosophy, preferences, and objectives.
But something has changed in that process over the last 20 years that has had a mostly negative impact on investors. In large part, investment firms, whose core business was to invest their clients’ assets appropriately, have morphed into marketing firms, whose core business is to grow assets under management. That’s not even a subtle difference. Whereas traditional investment firms were built on integrity and a commitment to do right by their clients, many of today’s investment firms are focused on their bottom line, which has been besieged by narrowing profit margins—thus the need to hunt for more assets just to keep afloat.
How We Got Here
If you go back to 20 years or more, mutual funds were fast becoming the go-to investments for average investors. They were an easy and accessible way for investors to participate in the stock and bond markets without the need for large amounts of money or the expertise to pick and choose securities. Investors could choose their funds based on the stated investment objectives of the fund managers. Fund managers were held accountable for adhering to the fund’s objectives and performing up to those objectives. Fund managers knew that if they were going to continue to attract new assets, they had to outperform their peers. It wasn’t unusual for mutual funds to replace underperforming fund managers. So, it was a healthy competition that tended to pay off for many investors.
During that time, consumerism began to permeate the investment world, just as it has in about every other aspect of life. The one thing consumers want more than solid investment returns is to get more for less. It’s what catapulted Amazon to the top while turning malls into ghost towns. That’s what has driven investors to passively managed index funds and ETFs, which have no sales charges and minuscule management fees and, oh by the way, which have largely outperformed actively managed funds over the last couple of decades. Why pay more to get less?
The migration of assets to low-cost funds triggered a cascade of fee compression across the investment industry. Not only were funds in a race to the bottom of fees charged but also investment managers who manage portfolios for individual high-net-worth investors. Investors have been leading the change in the investment industry, which, if it wants to maintain and grow its assets, has no choice but to cater to their demands.
Wolves Dressed in Sheep’s Clothing
All at once, the convergence of fee compression, higher regulatory costs, and competition from no-cost robo-advisors have squeezed out the already thin profit margins from investment firms, forcing them to boost their marketing chops, which often involves trying to make themselves look better than they really are. For instance, many investment firms engage in a practice called “window dressing,” which involves loading their portfolio up with “winners” at the end of the quarter to make it appear in their quarterly reports that they were investing in the stocks all along.
Another “marketing” ploy involves investment managers “hugging the index” by selecting stocks that closely mimic the S&P 500. The biggest fear among active managers is to be seen underperforming the index, so they abandon their strategy to ensure they perform at least as well as the index. The practice is so prevalent that many actively managed funds have come to resemble index funds, though they still charge higher management fees.
Avoiding Average by Avoiding the Marketers
So, for retail investors, it has come down to a choice of going along with the crowd and accepting the average by investing in low-cost, passively managed funds. At least their investments should perform as well as the indexes, which is better than what actively managed funds have been able to do. Or, if they seek the opportunity to outperform the indexes, they can hire their own investment manager whose only purpose is to invest their assets according to their objectives and best interests. That can still be done, just as it was twenty years ago, but it takes an understanding of what to look for when researching, identifying, and selecting an individual investment manager.
Finding the right investment advisor may even be easier than trying to pick the next top-performing mutual fund, which is virtually impossible. Starting with the fact that there are less than 60,000 investment advisors who are also fiduciaries—required by law to act in the best interests of their clients—you can winnow the field of more than 600,000 financial professionals who hold themselves out as “financial advisors.” By working with a fiduciary advisor, you can be assured your interests will come first.
That’s because they are compensated directly by their clients, not an investment firm which can present a conflict of interest. You can narrow your search by asking questions about or researching the advisor’s background, education, compliance history, and track record. Most of this information is available in an advisor’s Form ADV investment advisors must use to register with the SEC and state securities regulators. If they don’t have one, consider moving on.
In the end, the surest way to know you’re talking to a genuine advisor and not a marketer is whether they spend their time talking about themselves and their firm, or do they focus their attention on you and what you want to achieve? The right investment advisor will show you precisely how their investment strategy will put you on the path to achieving your goals.