Investors as Frogs

As you all know, frogs are cold-blooded creatures. Within a very wide range they are insensitive to temperature changes. Like small fish, they often freeze in ponds during the winter only to thaw out, not much the worse for wear, in the spring. It is said that if you put a frog into a large pot and then very slowly heat the pot, the frog will swim around quite happily until he abruptly dies! (I don’t want to get tons of hate mail. Please believe me, I have never tried this!)

Many investors act like our frog. They swim around quite happily, oblivious to their peril until it’s too late. They delay investing, invest in the wrong markets, get awful returns, fail to set goals, or fail to monitor their progress – treating the whole matter as if it will solve itself. As time runs out for them to meet their goals, or the temperature slowly increases around them, they paddle around their little pots humming, “Don’t worry, be happy!”

Strangely enough, most investors think they are doing a very fine job for themselves. Yet, few can tell you what their rate of return has been, how that compares with the market indexes, what their investment philosophy is, what their investment costs have been, how much risk they are taking in their portfolio, or what asset allocation might be appropriate to meet their own unique financial goals. Nevertheless, most remain convinced that their investments are in not only capable, but possibly even brilliant, hands.

Not counting my dog, Schatzie, who can call the market turns at least as well as any guest on Wall Street Week, America is a land of at least 270 million fully qualified investment advisors. Each feels perfectly free to give advice, and conversely accept advice, from any other advisor she happens to sit next to on the bus.

If we believe the Dalbar and hundreds of other similar studies, most investors are getting disastrously bad results. Few are even aware of just how bad their results are and even fewer have a clue about how to repair the situation. Almost none have projected the impact of that miserable performance in terms of their future lifestyle.

A Riddle Wrapped Up in an Enigma

You might wonder why so few investors seek out professional assistance. Ironically, it seems hard to imagine a field where more people need help, or where the impact of professional help could have a more positive impact for people. There may be many answers: some investors don’t believe that professional investment advice is necessary, some suffer from financial phobias, some don’t know that professional help is available to them, and some don’t know who to trust.

Most Americans don’t fly their own airplanes, change the oil in their cars, fix their own plumbing, perform surgery on themselves or their families, file their own taxes, prosecute their own legal cases, or educate their children. They are perfectly happy to leave that to experts. Yet they feel perfectly competent to direct their entire financial future by themselves. Even worse, they put up with years of terrible results without reaching the obvious conclusion that they could use a little help.

Racing Flat Out at 5 1/2 Knots

I’ve always been a water rat – I would be completely happy floating on a cork. So, in the late 70s when Bob Hickock, a former college roommate, invited me to join his crew racing a J-24 in Biscayne Bay, I jumped at the chance. Bob was a third generation New England sailor, a real competitor who had been nationally ranked in small boats while in high school. The J-24 is a small, fast, sophisticated, single-class racing sloop which usually carries a crew of four or five. The class was recognized not only internationally, it was one of the most competitive on Miami’s Biscayne Bay.

J-24 class racing is reasonably democratic. All the boats are built from the same mold by the same manufacturer. Complicated rules dictate everything from the height of the mast to the number of sails allowed on board. In theory, at least, the boats should be equal.

In Miami, the sport was dominated by a third generation sail maker. While technically an amateur, Augie Diaz used racing to promote his business. Winning races led to more sales of sails. His crew practiced five days a week, sparing not a single effort or expense on the boat. Before a big race, Diaz could pull up in his van, check the wind, and cut a new sail just for that event.

Being a total rookie, I was the designated fore deck ape, sitting on the rail for ballast, changing the jib or jibing the spinnaker when told. We took racing seriously but had a great time doing it. The crew returned from each race exhausted, blue from cold, sunburned, windburned, bruised, cut, and beat up from contact with various moving parts of the boat and its equipment. In short, it was a perfect way to spend a weekend!

But, we never won. Racing is a sport of inches and seconds. One twentieth of a knot over several hours can be an enormous advantage. One blown tack, one fouled line, or one jammed halyard is enough to sink your chances. While there is always an element of luck, there was no way a bunch of airline pilots, attorneys, doctors, and financial planners were going to beat Augie Diaz’s professionals. The bay was their backyard and had been since they were born. They practiced every “business” day, giving them better local knowledge, equipment, discipline, tactics, and strategy. We didn’t think they were necessarily smarter, or better human beings, but we had to acknowledge that they were better sailors. In any sport or business, pros usually win.

While we wanted to win, working hard at it and taking it to heart, winning wasn’t everything for us. (Vince Lombardi is probably spinning somewhere as I write this!) Just the excitement of competing, being on the water, being out with the guys, and sailing the boat as well as we could were enough. And, the stakes weren’t very high – win or lose, we were coming home exactly as wealthy as we left.

But, for investors the stakes are very high. Your investments are your future. With the exception of your health and the choice of your mate, no other factor will determine the quality of your life as much as whether you succeed or fail at obtaining reasonable investment results.

While I would encourage all Americans to learn as much as they can about economics, finance, and investing, most will be far better served to delegate this important task to a professional. Professionals have an edge: better knowledge, equipment, discipline, tactics, and strategy. If results are what count, as measured by the probability of meeting your important financial goals, most investors can’t afford anything less.

Financial Phobias

For some, money is an emotional subject which they treat far differently than other important elements in their lives. For a variety of reasons, they are just not about to seek out a professional to help them meet their goals. I have never taken a psychology course, so I admit I am way out of my depth here. But I have watched investors for a long time, discussing their sometimes curious behavior with my peers, which has allowed me to make some non-scientific and intuitive observations on investor behavior.

Fat, Dumb, and Happy

Clearly, many investors are unaware of their peril. We might classify them as “fat, dumb, and happy.” In their minds they don’t have a problem so there is nothing to be fixed. In the real world, investors are barraged by other demands for their time and attention. Many of them will develop a nagging sense that all is not well with their investment plans, causing them to set about fixing it in a business-like manner. Hopefully, they will come to this realization before it is too late to make a meaningful impact.

The Control Freak

A few individuals realize how important their investments are to their future but simply can’t give up control of their finances. Either they have trouble delegating things in general, or money is such a personal, powerful, and emotional part of their existence that they reserve that activity for themselves alone.

The Hobbyist

Some investors enjoy the hobby of investing so much that it becomes its own reward. They join clubs, pour over the Wall Street Journal and Barons, faithfully follow Wall Street Week, make charts, build spreadsheets, subscribe to newsletters, surf the internet’s newsgroups, and never let their eyes stray far from a scrolling ticker tape. For these types, investing isn’t only the means to achieving a comfortable and secure life, it is their life.

The Gambler

Closely related to the hobbyist is the gambler. Gamblers are hooked on the excitement of the trade. Win, lose, or draw, it’s the action that counts. Mutual funds rarely satisfy their need for action, and buy and hold to them is a foreign concept. Many start with a few trades in individual stocks, then like junkies, graduate to the hard stuff: options, commodities, and futures. Even if they understood that the odds are strongly rigged against them, they are just junkies.

The Loser

Many gamblers are losers. They enjoy their role as poor souls, not happy unless they receive their daily dose of disaster. No scheme is too dumb or far-fetched for them. They know when something is too good to be true, but do it anyway. Swindlers love to see them coming. They take their losses gracefully but still come back for more. Con artists prey on losers, and boiler rooms buy and circulate lists of proven marks. The person who loses a small fortune in an ostrich farming venture will happily invest in a “private” options pool. Losing fills a perverse need.

A Closely Guarded, Well-Kept, Deep Dark Secret

While a minority of investors may indulge in private foibles, the vast majority still don’t know that professional advice is available to them. As an industry, independent investment advisors have not yet been successful in getting their message out to Americans that crave their help. Most investors don’t know that a viable alternative to the commission-crazed, churn-and-burn stockbroker even exists. Thus far, our own marketing efforts have been dismal. I sometimes feel like we are a well-kept, closely-guarded, deep dark secret.

Still, the demand for professional, impartial advice is enormous. Almost in spite of our woeful marketing efforts, since 1989, assets with Schwab’s Financial Advisor Service have grown to over $70 billion, taking into account over 390,000 accounts served by 5,600 independent Registered Investment Advisors. Fidelity and Jack White are also experiencing exponential growth in similar services, with others entering the fray close on their heels. Clearly, Americans are looking for unbiased professional advice and an intelligent alternative to Wall Street’s commission-induced conflicts of interest and voodoo-based investment schemes.

So, the genie is out of the bottle, and having tasted freedom he’s not going back. Americans are voting with their feet, migrating to the better system they demanded. Great stuff, this capitalism!


The Revolution Bears Fruit

The revolution on Wall Street is just beginning to bear fruit for the long neglected “small” investor. While the rich have always relied on professional investment advisors, today, investors of more modest means can also avail themselves of high-quality advice. Several happy advances have converged to make this all possible:


  • Financial theory has vastly improved.
  • No-load mutual funds are an excellent, low-cost, off-the-shelf building block to construct efficient portfolios.
  • Deregulation has spawned a new entrance of discount brokerages, sharply forcing down costs for a wide variety of services.
  • New “back office” technology offered by the discount brokerage houses allows efficient personalized account supervision by professional advisors for investors of modest means.

Finding an Advisor

Another problem investors face is who to trust. Unfortunately, it would be hard to imagine a field where more people offer help yet haven’t the slightest qualifications for the job. As we have observed, the advice of the average financial “professional” is worth far less than zero.

Even worse, no field of any importance is so poorly regulated. The requirements for entry into the field are close to zero. For valid reasons, not everyone is allowed to call himself a brain surgeon or practice the art. Yet almost anyone can call himself or herself a financial advisor.

An investor who sets out to find a competent financial advisor has had few reliable guidelines to assist him. The good news is that because there is such a large demand for competent, objective financial advice, the field is growing in both numbers and sophistication. While it’s going to take a little homework to separate the wheat from the chaff, by now you already know enough to do the job.


A Common Sense Checklist

Let’s look at a few requirements you might consider. The first three are “written in stone” and should not be waived under any circumstances.

Fee Only

You can eliminate many of the potential problems you might encounter by simply avoiding the commission-based salesman. In one stroke you eliminate the vast majority of conflicts of interest between yourself and your advisor. A clear separation between the advice function and the brokerage function is the best consumer protection you could have. Why set yourself up to become the victim of a commissioned-crazed broker?

Things aren’t always what they may seem. Some brokers advertise themselves as “fee based” planners and advisors. These advisors charge a fee for making recommendations, taking commissions on the products they sell. This is the worst of all possible worlds; paying fees to a commission-based salesman doesn’t guarantee objectivity or eliminate any conflicts of interest, it just lets him get paid twice.

Many brokerage houses and broker-dealers allow their salesmen to act as both Registered Representatives (RR) for the house, and Registered Investment Advisors (RIA). These dual licensed RR/RIAs are required to be “supervised” by the broker-dealer or brokerage house. In return for their “supervision”, the broker-dealer or brokerage house gets a cut of the fees and can determine where business is placed. In practice this can not only result in higher fees passed on to the investor, the potential for conflict of interest is obvious.

“Fee offset” compensation arrangements allow a dual registered RR/RIA to pick and choose both the amount and timing of his compensation. He can place some client assets in commission products and some in no-loads, depending on how he feels that day. The commissions paid for the load funds are applied as a credit against the annual fee. Often this practice is justified by the supposedly higher quality of the commission-based product. But, I guarantee you, for every great load mutual fund you can find, I can get a better one with the same objective in a no-load fund. It’s easy to see that fee offset is great for the salesman, but it’s harder for me to imagine how it can ever benefit the investor. The conflicts of interest haven’t gone away, they’ve just gotten hidden a little better under another layer of cost. To be sure that your advisor is fee only, steer clear of any that have a broker-dealer affiliation or maintain a NASD license.

Third Party Custodian

Use the services of a large discount brokerage to hold your assets. In case there is a problem with your account, the house has a problem, not you. Schwab, Fidelity, and Jack White, for instance, will be there tomorrow and have the resources to straighten out any problem you might have with assets under their care. Insist on statements directly from the custodian in addition to any that come from your advisor. Of course, read and carefully check your statements. Remember, Trust but Verify!

Limited Power of Attorney

Never allow an advisor the power to withdraw from your account. Disbursements, other than fees, should always go to you at your home or to your bank account. A limited power of attorney allows your advisor to trade on your behalf without running the risk of having your hard-earned assets disappear. In the very unlikely event that funds should be misdirected for any reason, the brokerage house has the big problem, not you! To repeat, you will still want to read and check closely each statement you get.

Professional Knowledge

As far as I am concerned, the above requirements are no-brainers. Violate them at your peril. But, while we have eliminated many bad things that might happen to your account, we still haven’t determined competence. Fee only is not a panacea, just a better way to structure the relationship between advisor and investor. Many advisors could meet all the above requirements without having a brain in their little heads. So, now the requirements necessarily get subjective.

If you have carefully read this book, you already know more about how markets work and how to turn a profit than ninety-five percent of “professionals” in the financial services industry. While this may surprise you, I can assure you that it is true. Don’t let the fancy suits, titles, and expensive office space fool you. Most of the industry still wants to do things the way our grandfathers did. And, bad advice can often be more profitable – for them – than good advice.

As a minimum, I would demand a college degree, preferably in finance, economics, business, or a related field. Don’t get too hung up on the major. Most colleges and universities haven’t been teaching Modern Portfolio Theory or related subjects for much more than five years. For instance, I recently talked to a 1988 graduate finance major from Virginia Tech who had never heard of Modern Portfolio Theory. I wouldn’t give any extra points to attorneys or CPAs either. As most of them will cheerfully admit, contrary to popular belief, they don’t have any special qualifications in finance.

Brochures and ADV

All investment advisors are required to furnish potential and existing clients with either a “brochure” or a copy of the SEC registration form (ADV Part II) outlining their education, qualifications, experience, investment methods, fees, and other pertinent information about their firm. You can learn a great deal about an advisor and his business by carefully studying this form.

Professional Associations and Continuing Education

Because the field is evolving so rapidly, and because few of us were even exposed to modern financial theories in college, independent, professional, continuing education is essential. One of the key words here is independent. I have learned from bitter experience that training by broker-dealers teaches you just what they want you to know to sell their products. Product sponsors may not exactly lie, but they sure do slant any information they pass out.

The operative philosophy seems to be that if they can fill the representatives up with BS masquerading as education, the reps will hit the ground and sell. Until they catch on to this, the reps are as much a victim as the firm’s clients. Of course, some never do catch on since it’s so easy to let them spoon feed you. But, until advisors take responsibility for their own education, the value they provide to their client will be somewhat south of zero.

In the financial planning field, two institutions stand out for their accomplishments in advancing the professionalism of the industry. Both the Chartered Life Underwriter (CLU) and Certified Financial Planner (CFP) courses give a broad general understanding of the financial planning process. The CLU course has a strong insurance industry foundation, while the CFP course favors investments. This information is invaluable in assisting the planner to properly identify the needs of the investor and place his situation in context.

Both institutions are independent of any company or sponsor, having as their only goal the advancement of professional standards within their particular industry. Both institutions are accredited by a national educational association and now offer advanced degrees in financial planning. They also benefit from the dedicated volunteer support of some of the finest professionals in their respective fields. And finally, both organizations supply exceptionally high-quality continuing educational courses as a requirement for maintaining the certification.

The CFP in particular, through their continuing education courses, have done as much as all other institutions combined, not only to spread the word about the amazing advances in modern finance but to bring these benefits to the American investor. Still, there are undoubtedly other independent high-quality continuing education sources. You should demand that an advisor have a heavy schedule of continuing education. What we learned in college just a few years ago might as well be from the stone ages, and company sponsored “education” is more often than not just glorified brainwashing.

Beyond the Buzz Words

It goes without saying that you should expect your advisor to have an in-depth knowledge of finance. If you have any doubt about qualifications, question him or her about their philosophy. You might ask them how they utilize Modern Portfolio Theory to reduce risk, how much foreign exposure they recommend, what ideas they have about emerging markets, or how they view the growth versus value debate. Continue by inquiring about their view on market timing, how much diversification they think is essential, the limitations of CAP-M, what particular asset allocation plan they recommend to meet your needs, or how they measure correlation between asset classes.

If you suspect that the advisor’s knowledge consists of only buzz words or cocktail party chatter, bail out. The important thing is that you realize that you have the right to ask questions and that you not be intimidated. Listen to what the advisor has to say about his techniques and philosophy, but don’t let the session degenerate into a “sales track.” Keep asking until you are either totally comfortable or decide to move on. After all, it’s your money and your future.

Assets Under Management

At its core, investment advice is a personal services business. It must be tailored to your individual needs and circumstances. So, even with great technology, there is a limit to the number of clients that an advisor can effectively serve. The average investment advisor has about $4 million in assets under her management. At that size either they are part-time or brand new. While you don’t necessarily want the biggest firm you can find, it’s hard to imagine a viable business with less than $15 million. On the other hand, the firm is too large when you don’t have reasonable access to the principal that makes the decisions on your accounts.

Length of Time in Business

You will find few firms that have actively managed assets for more than six or seven years. The profession didn’t really open up until Schwab began trading no-load mutual funds and offered their back office capabilities to advisors. But while the business is new, many practitioners have long experience in other areas of the financial services industry. Most advisors started their careers as either stock brokers or registered representatives, then gratefully made the transition to fee-only advisor when the opportunity presented itself. You will want to restrict your search to industry veterans. Let the new guys learn with somebody else’s money.

Minimum Account Size

Some advisors demand very large minimum size accounts. Obviously you will want to restrict your search to advisors that can economically serve your account. There may be a practical lower limit for account size. But, many advisors will accept accounts of $50,000 or even lower.


With fax, telephone, email, world wide computer networks, the Internet, and Fedex, location isn’t nearly as important as it used to be. Advisors are no longer restricted to working on Wall Street and clients don’t care where they are as long as they have access to the advisor when they need it. If you are the kind of person that just has to have frequent face-to-face meetings, you can probably find a great advisor in your hometown. On the other hand, today you may have a very close relationship with an advisor “on your wavelength” clear across the country.


It may be human nature to want recommendations from friends and/or present clients, but they aren’t much use. For many good and valid reasons, investment advisors are prohibited by law from using testimonials from clients or celebrities. For one thing, your investment needs may be a great deal different from Madonna’s. If Madonna were my client (she isn’t), she might not appreciate it if I divulged that fact to the world, or had all my potential clients call her. Madonna may be a great entertainer and talent, but she may not know any more about finance than you do. Finally, if I were to give out a list, you don’t think I would include anyone who might say something negative about me, do you?

Your friends may recommend an advisor to you. If so, you will still want to check the advisor out yourself. Mimicking your peers is an easy way out, but no substitute for a little homework. On the other hand, a bad reputation certainly should set off alarm bells.

Referral Services

Organizations like Schwab, Fidelity, and the CFP Society maintain referral services for the public. These may be a good place to start; however, not all highly-qualified members of an organization may choose to use the referral service. Many successful firms are not actively seeking new clients or accept referrals only from existing clients. Some organizations charge their members a fee to participate in the referral service, causing some advisors to refrain from using their services to avoid having to pass that extra cost on to clients.

Regulatory Agencies

In addition to the mandatory federal registration with the SEC, investment advisors are also required to register in almost all states. Most of these agencies will supply histories of regulatory problems or investor complaints upon request. Many even have toll-free 800 numbers to encourage inquiries. An isolated incident may not be significant, but multiple complaints or problems are a pretty strong wake-up call. If in doubt, check it out. A quick check with the regulators can be a good first screen to eliminate the bad actors.

What to Expect

A successful relationship should start out with realistic expectations. So, let’s list the things that investment advisors can’t do before we get into what they can do. (See Chapters 1-22, and the Introduction if you have any questions.) Investment Advisors Can’t:


  • Time the market
  • Pick individual stocks
  • Protect against loss
  • Guarantee anything
  • Refer you to anyone who can do any of the above

Given this somewhat negative list, you might be forgiven if you wonder if investment advisors can add any value to the investment process, and if so, what exactly their role ought to be. Having devoted considerable time and effort to the question of whether management can add value through market timing or stock selection, perhaps I have reached the point where I shall be hoisted upon my own petard.

The Value of Investment Advisors

Education, Counseling, and Consulting

Investment advisors deal with a lot of very successful, bright people. But, these people need guidance in our particular field. They aren’t going to walk in the door with a clear understanding of their goals, financial situation, risk tolerance, and time horizon. Nor do they probably have a fully formed investment philosophy. Most don’t have a working knowledge of Modern Portfolio Theory or know the many limitations of the Capital Asset Pricing Model. They may think market timing is a great way to prevent losses or they may want to bet the farm on a single start-up software company. They may even think that anything other than T-Bills is for deranged minds only.


So, investment advisors are part educator, part psychologist, and part consultant. One thing is for sure: There is no hope until the clients understand where they are, where they want to go, and what their options are to get there. Unless the clients have realistic expectations and believe in the program, they are doomed to pursue rainbows endlessly. Nobody expects bright, successful people to mindlessly sign on to a major investment program without all the facts and a clear understanding of the options.

As we have seen, even the most superior portfolio will encounter turbulence from time to time. The environment is often one of constant temptation and noise with the media providing many competing siren songs. Therefore, the initial education process must be constantly reinforced or else the clients will soon return to their old self-destructive ways.

Design and Implementation

Once the parameters are understood by both parties, it’s time for the advisor to design the asset allocation plan which offers the highest probability of long-term success. Generally the solution should be framed which meets all the client needs with a comfortable margin for error and with the least risk possible. The emphasis is on meeting needs rather than beating markets or some other mythical yardstick.

Cost Containment

As a fiduciary of the investor’s funds, one of the prime responsibilities of an investment advisor is to rigorously control total costs. While they provide an extremely valuable service, it certainly isn’t an infinitely valuable service. The world’s markets can only be expected to deliver so much. Every cent of investment cost must reduce that total return.

While investment advisors charge fees, much of this cost can be offset in other areas. For instance, investment advisors should negotiate discounts on transaction fees, utilize low-cost funds wherever available, provide access to funds which retail investors generally cannot purchase for themselves, and strive to reduce the tax impact of their strategies.

Independent advisors generally have far fewer expenses built into their operation than the major Wall Street firms. The typical brokerage operation involves layers and layers of staff endlessly circulating memos to each other while housed in acres and acres of high-priced office space, dining at gourmet corporate dining rooms, and vacationing at luxury resorts due to sales bonuses for sales of high-price proprietary products. So, you can’t expect economy there.

Because of the efficiency offered by modern technology, even very small accounts should be able to find high-quality advisors for fees of one percent of assets under management, while larger accounts should command discounts. Many investors will find that their total investment costs fall dramatically, although because they are fully disclosed they may be aware of them for the first time.

Management, Housekeeping, and Service

Having determined goals, set a strategy, and implemented your plan, there still remains a fair amount of grunge work. Performance reporting, portfolio rebalancing, consolidating statements, account supervision, and continuing research should all be done for you so that you can get a life. Of course, the consulting and communication process never ends; you should expect reasonable access to the principals that make the decisions on your account whenever you need it. In addition, you should anticipate frequent reviews with your advisor to keep him/her apprised of your personal and financial situation and to get strategy updates.

The nature of the fee-only compensation structure requires the advisors to deliver consistently higher levels of service than their commission-based counterpart. Fee only is pay-as-you-go. There are no strings holding dissatisfied clients so advisors’ contracts can be canceled with no penalty at any time. Advisors must keep clients for years before they are in the same position that a salesman is after his first sale. This requirement, in turn, means that advisors must only promise what they can deliver, rather than promise whatever is required to make the sale.

On the other hand, fee-only advisors who deliver the service they promise are free to go about doing the right thing for the client without the terrible pressure of having to sell something today. With conflicts of interest virtually eliminated, advisors and clients find themselves in a win-win relationship, a true partnership of shared interests.


The Bottom Line

While most investors cannot afford the advice they are giving themselves, financial advisors can provide a valuable service which investors should at least seriously explore. Like in sailing, better strategy, better tactics, better tools, better execution, and better discipline can be expected to lead to better, more reliable performance in the long term. The professional edge can yield big dividends. These dividends will be realized in terms of risk reduction, lower total costs, and a higher probability of actually attaining reasonable long-term financial goals.

Properly devised and executed, the consulting-design-implementation-supervision process will lead to substantially better performance than most Americans have been able to attain for themselves. If an advisor motivates clients to invest, steers them into the right markets and asset-allocation plans to meet their needs, communicates reasonable expectations, and over time helps the clients to exercise the discipline required to ultimately meet their goals, the fee will be earned many times over.


Coming up

Pulling It All Together