Witten by Ethan S. Braid, CFA on 2 - 03 - 2013
The Middleman Financial Advisor – a Former Stockbroker Unveils Wall Street’s Parrots
Who is the Middleman Financial Advisor?
A parrot is known for repeating lines it hears, over and over, with surprising authority. The middleman financial advisor, much like a parrot, delivers influential sound bites to clients in the form of very well rehearsed sales lines. The middleman financial advisor brings exceptionally little value to the table for his clients relative to the fees those clients pay. Often, the client is completely unaware of this void in value. These advisors, who tend to be very successful and have prestigious titles at their respective firms, are nothing more than grossly overpaid salespersons. To the untrained eye, spotting the middleman financial advisor can be difficult. The middleman financial advisor is an expert at confusing his clients with industry jargon (that he himself sometimes doesn’t fully understand). However, once you have read my article, spotting this group of folks will be almost as easy as seeing a herd of elephants on the side of the road – you won’t miss them! Avoid all business dealings with the middleman financial advisor, regardless of how charismatic they may be. In the long run, hiring the middleman financial advisor can be a very costly mistake.
To understand why the middleman financial advisor exists, you must first learn the history of the financial services industry and how the middleman financial advisor has evolved.
Think back to December of 1982. The severe 81-82 recession was ending, the stock market was starting to move up, the inflation of the previous decade was moderating and while many didn’t know it at the time, the economy was poised for serious growth in the years ahead. The Dow Jones Industrial Average stood at 1,000.
There was no internet. Only 7 years had passed since the SEC deregulated the brokerage industry thereby ending the fixed pricing for commissions that had been in place since the Buttonwood Agreement of 1792. The door was open for discount brokerage firms, but in 1982, they were just getting started. Research reports from full service brokerage firms were considered valuable. Back then investors had limited options for investment advice.
In 1982, most investors put their money with firms like Merrill Lynch, Painewebber, E.F. Hutton or Dean Witter. Mutual funds, even though they had been around since the 1920s, were a relatively new idea to most investors. Brokerage firms knew that in order to cash in on the growing mutual fund industry, they would need to hire aggressive salespeople…
The perfect storm was in place. With little competition in their way and control of the distribution of information & product, the biggest full service brokerage firms were running the show. They began to hire salespeople in large numbers. Throughout the 1980s and 1990s, the economy boomed, interest rates dropped, inflation was tame, employment was high and the Dow Jones Industrial Average advanced from 1,000 at the end of 1982 to 10,000 by 1999. A rising tide lifts all ships, and during the boom years of the 1980s and 1990s, investors didn’t mind so much if they were being sold high-cost products by salespeople, so long as their account values kept going up. Everything seemed to be working.
As the economy boomed, the brokerage firms hired. The number one quality they screened for in their new stockbroker employees: Sales ability. One’s education had little to do with getting hired. Some stockbroker hires had advanced degrees like MBAs and J.D.s, while others may have had only a high school diploma. Further yet, some managers intentionally avoided hiring well-educated prospective stockbrokers on the basis that the more education one had, the worse they would be at selling. If the candidate was good at sales, then they were considered qualified for the job. Large numbers of stockbrokers were hired right out of college. Others were career changers coming from jobs as diverse as lawyers & school teachers, to bartenders or even car salesman. All had one underlying common thread – salesmanship.
The only barrier to entry to getting a stockbroker job back at this time (note that the same low barriers still exist today), aside from being able to sell, was passing the regulators exam. The regulators exam, called the series 7, is a test that covers topics such as securities laws, solicitation rules, and account opening procedures. The exam is not geared towards teaching one how to manage money or do financial planning. Preparation for the exam takes approximately 60 hours of study time for the 260 question test. A passing score back then was 70%. Today 72% is required. As one who previously held the series 7, I would describe the exam & study routine as equivalent to a college entry level (101), 2 credit hour class in a subject such as Speech, English or Communications. Not a high degree of difficulty is associated with getting through this exam. Some stockbrokers I know bragged of taking the exam while suffering with a hangover from the previous night’s partying and still passing the test with ease…
Back in the 1980s, 1990s and early 2000s there was very little, if any, training in investments/planning/finance offered to the financial advisors (they were called stockbrokers back then) by the firms who hired them. Instead, training typically consisted of a two week sales boot camp that took place at the firms’ headquarters in New York.
Now that you can see who was hired back in the 1980s & 1990s, what are they up to today?
Many of those hires from twenty and thirty years ago have become extremely successful, with some now commanding seven figure incomes. Today, they have impressive titles such as Chairman, Senior Vice President, Regional Vice President, etc. While they were never trained or educated in investments, they got great educations by their firms on how to sell products. Some took it upon themselves to religiously self-study their evolving profession, get credentials, and are now excellent advisors. Most never cracked a book at all outside of maybe earning an industry designation and have largely rode the wave. Note: Having worked myself, at two of the largest Wall Street Brokerage firms during the start of my career, I can attest to the fact that nearly all of the training I received was on selling and very little on advising/investing.
Many of these salespeople, who have been in the business for twenty to thirty years, currently manage large sums of money. While some manage 100s of millions, others personally manage billions. Some are solo practitioners and some have formed teams or groups. Others, who were not quite as good at selling, hung up their dreams of being a stockbroker and became managers. This group is even more intriguing in that those who failed ended up leading. If you look at the background of many of today’s managers in the financial service business you will see that they started on the front lines as salespeople. They generally floundered for a short period of time in that role and then took a management job. Interesting and also a part of the problem with the financial services industry in that failures were often promoted and advanced into positions of leadership. Due to the fact that many of these so called leaders are only in their 40s or 50s today, the culture of weak leadership and poor decision making is here to stay for many years to come.
Why should I avoid the middle manager financial advisor?
Let me be clear in saying that there is nothing wrong with salespeople. All businesses need salespeople to educate their customers and promote their products. Ethical, hard-working salespeople are one of the pillars of success for any growing company. However, wealth management is a complex world that requires a deep understanding of estate planning, taxation, certain laws & how they affect one’s wealth (both in the current and future generations), investment management, investment analysis, statistics for portfolio management, financial statement analysis, and behavioral finance. Some of this education can be picked up in formal channels such as an MBA or by obtaining an industry designation like the CFP. However, most formal education is merely a foundation upon which to build a house. The bulk of an industry professional’s education will come from extensive self-study (reading books), mentorship, and experience. Finally, a pedigreed education does not mean that one has strong analytical skills or is willing to work hard for clients.
The middleman financial advisor has certainly had “on-the job training” in some aspects of wealth management. Training for the middleman financial advisor generally takes place at sales meetings or workshops. The training is put on by sales managers or partner asset management firms’ wholesalers, all of whom have agendas to sell certain products. The middleman financial advisor has minimal independent thoughts. Thus, like a parrot, the middleman financial advisor will then simply repeat the lines that he was taught at the recent sales meeting. Believe me this is true. Hang around financial advisors long enough and watch them give their scripted pitches over and over and you will see how many of them operate. They just repeat whatever they were told by someone who had influence over them.
Now, in light of all the recent scandals in the last decade at brokerage firms you could see how being a “parrot” might lead to a bad outcome for the client. How can you trust these firms after they acted so irresponsibly (greed) regarding mortgage debt, ultimately going bankrupt and needing a bailout? Brokerage firms with investment banks attached or who own asset management firms, produce products. These firms have managers who educate the brokers on how to sell these products. The brokers contact their clients and recite what they were told by management and instruct the client as to how much of the product to buy. Sometimes the products are hedge funds or asset allocation investment management accounts. Other times they may be a bond manager, structured note or a limited partnership. The key point is that they are products being sold by a salesperson.
So to sum up the middleman financial advisor, he has these traits:
- May or may not have an education related to the profession.
- Sells products (which may presented as sophisticated investment management accounts)
- Charming & charismatic
- Excellent presentation skills
- Mediocre problem solving skills
- Limited creative ideas or independent thought
- Works at a major Wall Street Brokerage firm
- Repeats company taught sales lines, over and over
Does this list sound like a winning combination to you? Study the list for a moment. Would you want the scrub nurse doing the surgeon’s work? Essentially, that is what you get when you hire the middleman financial advisor. You get someone who is friendly, knows how to talk the industry jargon with you and can certainly talk over your head if need be, but at the end of the day, often lacks the deep technical skills or the personal drive necessary to carry out the mission.
Are you starting to see why you don’t want the middleman financial advisor?
No value-added is the answer. With the middleman financial advisor, especially those who are employed at the largest Wall Street Brokerage Firms, you get high cost coupled with below average expertise and skills. This is not like adding 2 + 2 and getting 4. Instead, this situation is akin to adding 2 + -2 and getting 0!
Ok, show me an example of the middleman financial advisor in action.
Bob & Sally are hypothetical clients of a middleman financial advisor. They met the middleman financial advisor at their country club, where he has been a long-time member and is well liked. They have known him for a number of years. On paper, Bob & Sally look like this:
- Sally is 55
- Bob is 65
- They have two children together, and Sally has a daughter from a previous marriage.
- $3 million of investable assets
- Sally is a teacher and Bob is retired.
- One of their children is in a shaky marriage and he is also bad at managing his finances. Bob & Sally are concerned that if he were to inherit money, he may lose it quickly.
- They own a house and a vacation home.
- Both pieces of property are in Bob’s name.
- Sally has a 403(b) with no beneficiary.
- Most of their $3 million is in Bob’s name only.
- Their only planning document is a will from 25 years ago when they first met.
- Bob had a bout with cancer that he won, but his health is not the best right now.
The middleman financial advisor invested Bob & Sally’s $3 million dollars into a portfolio of investment managers (products) recommended through his firm. The portfolio is a diverse mix of investments including stocks, bonds, etfs & mutual funds. The investments remained in Bob’s name and no new estate planning documents were developed. Sally’s 403(b) beneficiary was never updated. The middleman financial advisor doesn’t manage the money, and is largely removed from the asset allocation decisions. As a result, he almost never looks at the accounts. In fact, the only time he ever looks at the accounts is when he meets with Bob & Sally which is about once a year. However, he does get paid $30,000 (1%) a year by Bob & Sally for privilege of setting up their accounts and directing their money to the investment managers his firm recommends. The investment managers and the middleman financial advisor’s firm also need to get paid too. Thus with these additional costs added on (another $30,000), Bob & Sally are paying a total cost of 2.00%, not all of which they see or understand.
So how is this situation bad for Bob & Sally?
- Like many of the middleman financial advisor’s clients, Bob and Sally mistakenly believe that the middleman financial advisor is watching their money. He isn’t.
- Bob and Sally are paying high fees for generic asset allocation & investment management. They could replicate this approach on their own for a fraction of the cost (Well under 1%) by using no-load asset allocation mutual funds and ETFs.
- The middleman financial advisor spends about 4 hours per year with Bob & Sally, between their annual meeting and the occasional phone call. Is he worth $7,500 per hour?
- Bob and Sally’s primary needs, which are estate planning related, are not being met:
- Bob’s assets which include their real estate and most of their investments, will have to go through probate should he die before Sally. Given his health issues, this is a real concern.
- Bob & Sally have no legal documents in place to protect their children & their wealth when they pass away.
- Bob & Sally should have a trust created to protect their son’s inheritance. Without a trust, he will inherit money outright which, if history shows, he will spend immediately.
- Sally’s 403(b) should have a beneficiary other than the estate. Otherwise, when she passes her retirement account will need to be probated.
- Bob & Sally’s investment strategy is the typical potpourri of investments now offered by many of the middlemen financial advisors. This investment strategy is called, “set it and forget it.” In other words, buy a little bit of everything, charge the highest fee you can negotiate, and move on to the next client.
- These brainless buy everything strategies seldom perform well in the long run. In today’s low interest rate environment – the mounting risks in the bond market may soon bring significant losses to those who have recently bought bonds solely for diversification purposes. Buying asset classes just to buy them, regardless of the pricing, can be very dangerous.
How would a good advisor have handled Bob & Sally’s situation?
- Asked lots of questions, and listened.
- Quickly determined Bob & Sally’s need for estate planning.
- Educated Bob & Sally on what their options were for passing their wealth to their heirs, how trusts work, and avenues they may consider.
- Worked with Bob & Sally’s existing attorney to draft new documents and/or introduced a new attorney if they did not have an attorney.
- Discussed tax planning strategies.
- Followed-up on getting all assets re-titled relative to the estate plan that was produced.
- Helped Sally update her 403(b) with the proper beneficiary.
- Determined a proper asset allocation strategy, based upon Bob & Sally’s unique goals, objectives and emotional appetite for risk.
- Invested the money in a portfolio with a clearly defined investment philosophy & strategy.
- Make certain that all of Bob & Sally’s concerns had been addressed.
Is the picture becoming clear now?
Just because you have known your financial advisor for 20 years and he is known as a “good guy” shouldn’t be the sole reason to hand over your hard earned fortune for him to manage. While they may be trustworthy, charming, and all around “good guys” the middleman financial advisor, or middleman financial advisor team/group (they tend to herd together these days) is either not competent enough, or too lazy, to solve your problems. Good planning and valuable investment advice takes, time, effort, and creative thought. In short, it takes a lot of work.
Any of the items on the following list, exhibited by middleman financial advisors, can compound for a very negative final outcome for the client:
- Lack of desire to really address the client’s complex planning needs.
- Lack of education or simply not using an education.
- Not actually managing the money.
- Not knowing how to conduct proper due diligence (this is skill all to itself) on investment managers.
- Lack of knowledge regarding estate planning.
This article is not meant to demonize the investment management products that the middleman financial advisor offers. Some in fact will be very good in their own right. But are those products right for you? Often times, due to a lack of understanding capital markets and investments in general, the middleman financial advisor does a poor job at asset allocation for his clients. What that means is that your portfolio may not be as aligned with your goals and needs as it could, or should, be.
Another way to think about this situation: If the middleman financial advisor isn’t following through on estate & retirement planning and he also isn’t even managing your money, but simply passing the money off to someone else to manage, then what value is he providing? Answer: Very, very little at all.
What steps should I take to determine if someone is a middleman financial advisor?
- Research the advisor’s bio. No college degree, or a degree in marketing, general business or communications are not good places to start from. While the lack of education is not the end-all be-all, you are going to have to then interview the advisor to see just how much self-education and on the job training he has done. Don’t let industry jargon or high-power salesmanship fool you. Most of these advisors are experts at influencing people and will put on a good show. Better bring your ‘A’ game to this meeting…
- oA good advisor will have an undergraduate degree in economics, finance, or accounting. Additionally, he will have advanced degrees such as an MBA or a J.D. Credentials such as the CFP, CPA, or CFA are also desirable.
- Plenty of middleman financial advisors also can have lengthy educational achievements. Again, don’t be fooled. Just because someone is highly educated isn’t the end-all-be-all. There are plenty of lazy, well educated parrots! Additionally, a stack of degrees doesn’t mean the advisor has deep technical competence
- Ask how the advisor how he arrives at investment recommendations. What process does he or his team go through to conduct due diligence on investments. Does he simply rely upon his firm’s recommended lists? If he does his own homework, how does he do it?
- Failure to clearly communicate a well defined investment review process is a clear sign of the middleman financial advisor.
- Only following the firm’s recommended list demonstrates weak analytical skills and parrot-like qualities.
- A good advisor will quickly and proudly articulate to you how he reviews investments and ultimately decides upon which investments he uses for clients.
- Inquire about the advisor’s process for monitoring client investments and client 3rd-party investment managers.
- A good advisor will have a well defined process for continually monitoring the investments you have or the investment managers he helped you find.
- The middleman financial advisor will not have a process.
- The middleman financial advisor will tell you that, “his firm has experts, smarter than him, who take care of that” - Which means he does nothing.
- Ask the advisor what his service plan is.
- A good advisor will tell you up front what the frequency of in-person meetings or over the phone conference calls, will be. A good advisor will be able to communicate to you right away what the anticipated advisor-client contact will be like and who will initiate the contact.
- A middleman financial advisor may be good at service. Don’t get fooled by this trap. Because the middleman financial advisor doesn’t bring much else to the table, he often tends to excel at client service and may also become your friend. Great service is certainly something that you want and expect from your advisor. But if the great service is to cover up other inadequacies, caution should be exercised.
- Ask the advisor to define his overall philosophy regarding investing.
- A good advisor will passionately describe to you his beliefs and why he holds those beliefs.
- A parrot will deflect this question and instead tell you that he relies upon the expertise of the investment managers he uses. He will likely ramble on about how smart they are, talk about their credentials, and how much money they manage. All in an effort to impress you. Don’t take the bait.
- Ask the advisor what his value proposition is and why he is different/what makes him unique.
- A good advisor will immediately demonstrate to you the contrast between him and most other advisors. He will quickly show you where he excels and how he can help you.
- The middleman financial advisor will either not have much of an answer for you or give you some canned elevator pitch about helping you reach your goals and reducing your taxes. They teach them this stuff in sales school. Take note.
Ethan S. Braid, CFA
HighPass Asset Management
800 – 672 – 7916
About the author of this article.
Ethan S. Braid, CFA is the founder of HighPass Asset Management – an independent, fee-only, registered investment advisory firm with a fiduciary duty to the clients it serves. Mr. Braid has been passionate about managing client investment portfolios and providing customized financial planning advice since he started working in the investment industry 14 years ago. Mr. Braid earned a BS in Finance from Robert Morris University, an MBA from Cleveland State University and he is also a CFA Charterholder.
Mr. Braid is devoted to being an expert in the field of wealth management for high net worth individuals and families and for many years, has read one book per month on subject areas such as: estate planning, retirement planning, investment analysis, mergers & acquisitions and behavioural finance. Mr. Braid also has a passion for business history with a focus on the late 19th & early 20th centuries.
When Mr. Braid is not helping clients, he enjoys: cooking, wine, exercise, his yellow Labrador retriever, fly fishing, hiking, travel, playing guitar and duck hunting.