Whatever Happened to Common Sense Regulations?

The truth is that there never has been any such thing as common sense regulations when it comes to Registered Investment Advisers (RIA's). Do not get me wrong. I am on the side of disclosure and regulation, because every time you turn around, there is another Ponzi scheme happening. Sadly however, the good guys are stuck complying while the bad guys are out there stealing people's money.

The Securities and Exchange Commission has instituted a new Form for RIA's called a Form CRS which stands for customer or client relationship summary. This is to be kept to two pages by RIA's like my firms.

The Form ADV 2A is also required and that is 22 pages long. The corresponding Form ADV 2B that goes with it is another 14 pages long. My firm's Investment Advisory Agreement is 12 pages.

Of course, because I am a CFP®, I am now subject to even more disclosure to clients. I felt the need to create a new CFP® disclosure document that is 5 pages.

Oh, I almost forgot, if I refer a client to Morningstar to let them manage the client account, then I have to provide their disclosures. This is another 24 pages. But wait. There is more. Morningstar requires a Request for Proposal for each client which varies, but generally you can count on another 20 plus pages.

So, if I take out my trusty HP-12C calculator and add all this up, I come to the laughingly low figure of 85 pages of disclosures.

Oops! I forgot. We have to fill out the paperwork from the qualified custodian, Charles Schwab & Co. Inc. or Fidelity Investments. That will get us up to over 100 pages easily.

Don't you think 85 pages of disclosures is a little too much? Are you going to read all of that from cover to cover, each and every word of it?

See what I mean when I say there is no such thing as common sense these days when it comes to regulations. The good guys are being penalized for the bad guys' bad behavior.

We need to get the requirements down to a simple two or four page requirement and refer the client to our web site if they want more details. That's just my lone opinion from someone out here in the wilderness.

Coach John vs. Coach David

People always view the world from their own perspective and sometimes it is hard to get them to think critically and see the other side of the coin. There is a lack of critical thinking in the financial services industry today and we need to right the ship. 

Today, there is rapid change going on right now and unfortunately, there is no shortage of opinions about winners and losers. Sometimes, it is best to express an opinion through the use of an analogy.

Let us look at two imaginary baseball coaches. Coach John is a very successful college baseball coach. His goal in life has been to further his career. He started out coaching kids, quickly jumped to high school baseball and ended up as a college baseball coach. Coach John's style is to recruit the best and win at all costs. When he was coaching kids, he was brutal. He didn't want bad players as he quickly ran them off. At the high school level, he was figuring out how to get the best baseball players to move to his district by convincing their families to move, so their kid could play for him. His high school baseball team soon after won multiple state championships and it didn't take long before major colleges started calling. Coach John took his skills to a major college and recruited the best high school players to come to his college. He only recruited the best. Of course, since he was successful at recruiting, his college teams were also successful. Coach John's goal all along was to be a successful baseball coach and he achieved that goal.

Coach David on the other hand was also a coach of young kids, high school players and college players too, but with a major difference. When he coached young kids, instead of dispensing with the players who were not star athletes, he encouraged them and taught them the game of baseball. He took the time to teach every player on his team the game of baseball. He taught them how to throw a baseball. He taught them how to stand in the batters box. He taught them how to hit and how to bunt. He taught them how to catch a ground ball. He taught them how to catch a fly ball. He taught them how to run the bases and he taught them how to be a team player. Coach David carried this same coaching philosophy on to his high school and finally college coaching career where he too was a success.

Coach John was all about Coach John. He looked at the world from his viewpoint that he wanted to be a successful coach and that what was most important to him. Coach David on the other hand, looked at each individual player on his teams and his goal was to teach these players the game of baseball, how to handle disappointment and challenges in life and be a team player, so that they would go on in life with the skill set they needed to succeed.

Which coach would you rather have played for?

In the financial industry today, we have a lot of people who act like Coach John. They are all about their own egos, building the biggest business, becoming a thought leader, speaking at industry conferences, making the most money they can and stepping on and over anyone in their way. The do not mind calling out the compensation models of other advisors from their "ivory towers". They look at the world from their "pure as the wind driven snow" perspective. They think everyone else is overcharging investors while they have the "best" method of compensation. A lot of times, these Coach John people in our industry have somehow convinced enough people in the industry to be a "thought leader". This gives them the audience and the platform to continue to preach and talk down to other financial industry professionals. At the same time, they do not even realize the effect they are having on the young "players" just coming into the profession.

The Coach David people in our industry are critical thinkers. They see a rapidly changing industry. They see a huge unfilled market of young investors that would not get to open an account with Coach John. You see, Coach John only wants people who pay him according to his "pristine" business model. Kind of like the baseball Coach John who only wanted the best players to reach his personal goals and was not concerned with teaching anyone anything. After all, if you only recruit the best players (people with money), then why do you need to teach them anything? They are already great players (successful people).

The Coach Davids see fee commoditization. They see zero commissions on trading from the major custodians of RIA firms. They see the threats to mutual fund and ETF companies from direct indexing and the move to fractional shares. They see this huge unmet need of younger investors, so these Coach Davids choose to educate and encourage these young investors (players.) Coach David would never show these young investors the door. He believes in giving them the skill set they need to be successful in life.

Coach John also has a problem with the Coach Davids of the world. He routinely calls them out as overcharging clients, ripping off these young investors and criticizing their compensation models. In reality though, the Coach Davids of the world are the ones who are encouraging the young black woman to get into our industry. He is the one who is encouraging the Indian-American to get into our industry. He is the one encouraging the young black man to get into our industry. He is the one encouraging more women to join our industry. Coach David is the one taking the time to teach young investors the best ways to plan for their future and charging a fair fee based on his valued teaching and coaching skills. Coach David is the one encouraging diversity at every opportunity and who is a mentor to young advisors who want to join our industry.

Coach John is all about Coach John. He doesn't encourage anyone unless it fulfills his pocketbook. He routinely beats up on other financial service industry professionals as ripping people off. Coach John is not a thought leader. Far from it. He is narcissistic. I feel sorry for Coach John's clients. Little do they know that he doesn't really care about their future. He only cares about making money from them, if they meet his "recruiting" criteria.

Personally, I do not think we need any more Coach Johns in our industry. I would rather see more Coach Davids. We need advisors like Coach David who not only encourage young investors, but also young advisors to get into our industry and help them determine how best to run their businesses. Coach David's value is immeasurable when it comes down to it, because he is having such an impact not only on young investors by teaching them financial planning strategies, but also helping young advisors from diverse backgrounds to join our industry and be the best advisors they can be.

I would rather be a Coach David any day. What type of coach are you?

https://www.firstcoastplanning.com and https://www.marianfs.com

How is it possible for an RIA not to work in your best interests?

I have always been a big fan of Socrates and the Socratic method of arriving at decisions. Socrates would always ask questions of people to try and get them to justify their positions. In all cases, Socrates would act less informed and question his pupil repeatedly to teach them that they were actually ill informed and the position that they have taken was without merit. Most times these people took the advice of someone else and did not really have a position of their own. With this in mind, let us ask some questions to see if we can arrive at the answer of how it is possible for an RIA (registered investment adviser) not to work in your best interests.

I have to wonder about some of these big registered investment adviser firms out there who are getting other registered investment advisers to outsource their investment management to their mega firm. There are several of these big independent firms that manage billions of dollars of other investment advisers' clients. The thing that goes against the grain for me is all of the extra fees involved.

I was looking at the Form ADV 2A and 2A Appendix of a large $14 billion dollar firm which is growing like a weed and attracting a lot of registered investment adviser money. In effect, it is the feeder fund concept that several registered investment advisers got into hot water about in regard to Bernie Madoff. They referred their clients to Bernie Madoff and did not do their due diligence. That is another story altogether. Today, I wanted to forget about the feeder fund aspect for a moment and just focus on the fees.

This big $14 billion dollar registered investment adviser firm has several different programs available, such as mutual fund asset allocation, ETF asset allocation, strategic ETF asset allocation and so on. Their fees are as high as 1% on some of these accounts for smaller investors with less than $250,000. Then, you have to add whatever the adviser who referred the client to them charges on top of that figure which is usually in the 1% - 1.5% or more range. Do not forget the actual expenses of the investments themselves. According to the Investment Company Institute's latest FactBook, the average equity mutual fund has an expense ratio of 0.99%.

So, if the big mega firm charges 1%, perhaps the adviser goes easy on you and only charges 1%, then you are in the mutual fund portfolio that charges another approximate 1% in expenses. It doesn't take a smart fellow to figure out that this is about 3% a year. I've actually seen worse than 3% believe it or not.

It is great for the adviser who refers his client to this big fourteen billion dollar outsourcing firm. The adviser no longer has to mess with a bunch of back office headaches and can probably cut his overhead. Further, it probably frees up more of the adviser's time. They do not have to worry about how they are going to invest their client's money any more. They hired someone to take that off their plate. Did you notice how beneficial it was for the adviser?

Conversely though, how beneficial is it for the client? Could another adviser not offer a similar mutual fund asset allocation portfolio that they manage for 1 - 1.5% instead of outsourcing to the big mega firm? It would seem to me that the client would reap the benefits of a 1% savings if this was the case.

What about if the adviser managed a portfolio of ETF's on behalf of the client? ETF's have lower expenses and may actually save the client another 0.50 to 0.75% in expenses if the adviser managed these ETF's on behalf of the client, instead of outsourcing it to a mutual fund portfolio at the big 14 billion dollar mega firm.

But, there is a problem by going with a local adviser who picks the investments his or herself. What happens to the client's money if the adviser is injured or disabled? This obviously presents a problem. Sometimes this is the advisers justification for going to the big mega adviser. This does make some sense, however I beg to question if there are other big mega advisers who perhaps charge a more reasonable fee for outsourcing money management to them? The answer is yes. I can think of one in particular that charges a maximum of 0.41% for their money management expertise and that fee grades down from there depending on the total assets managed. They are a big mega money manager who does an excellent job. So, with this alternative, you may be able to get a client's portfolio of ETF's to be roughly around 1.5% to 1.75% all in. This alternative would save the client of the other big fourteen billion dollar mega firm about 1.25 to 1.5% a year, would it not?

So when the title of this blog asks how can an RIA not work in your best interests, then I have provided an answer. When an RIA knows full well that he can find a comparable mega firm for significantly less per year, but chooses to still use the higher priced mega firm, then this is a undisclosed conflict of interest. Unless of course, they explain that there are other mega firms who may charge lower fees in their disclosure documents and you as a client know this and agree to this in writing.

Also, if an adviser can manage the money themselves for their clients instead of outsourcing it, then they will save the clients money in fees. Granted a backup plan is necessary if something were to happen to the adviser, but this can be planned like anything else. A local adviser should have a repeatable process of investing that most any other adviser can look at and implement. (We do.) If not, then you probably do not want to do business with that adviser. Especially if they are just shooting from the hip.

So, the bottom line is when you are advised to go with a big fourteen billion dollar mega firm, you might want to shop around for other mega firms if this is the direction you want to go in. You could save yourself a lot in fees and get a comparable service, if not better.

If you want a big mega firm managing your money for a reasonable fee, then let me know. I can help. Of course, you will receive full disclosure in advance. This offer is only available for clients in states that we are licensed in or maintain an exemption from licensing. Contact me at rick@marianfs.com for full details.