Marketing experts frequently remind me that most investors do not want to read about problems. They advise me to focus only on the positive, but not the negative. As I am sure they are right about reader preferences, I expect the title of this paper will cause some to immediately put it aside. I believe however, that when Sir John Templeton told me in 1989, (in response to my question), that 'problem solving skills' are critical to personal success, that he was offering wise counsel. Accordingly, I will ask readers to stay with me for a few paragraphs in my attempt to be bluntly honest about how broken I believe the Wall Street Brokerage community is. Then, I promise to be exceedingly positive, regarding solutions and opportunities for success!
Investment Advice Relationships That Do Not Work
The cost of doing business, the design of their model, and the ways and traditions of the Wall Street national brokerage firms all but guarantee, that it cannot work. If investors realized the total costs, many would be truly discouraged. For example, the next time you buy a bond from a national brokerage firm, call the competition immediately and ask them for a bid on that exact security. Look at the difference in price, (also known as the difference between the `bid' and the `ask'). Then you will know the real profits involved, and the true cost of doing business, to you. But whether it is $1,000 profit per hundred bonds, or $5,000 profit per hundred bonds of longer maturities, the large profits are all well hidden, are unnecessary, and are making Wall Street rich, at your expense. Or look at those commission schedules for the big 'full service brokers.' Who wins when the commission is $200 or $400 or more on a single transaction?
Brokers are really professional sales people. Any person of average intelligence can acquire the license required to be a broker. Revealingly, the licensed brokers are regulated under the 'Uniform Sales Practices' regulations. There is neither a requirement nor a provision that brokers have the knowledge or experience to be investment management experts. Ironically, it is the same great sales people that have the ability to cause their customers to lose sight of these realities.
Further, many of the brokerage offices who employ these sales people may not be designed to protect your best interest either, which is why they need exceptional sales people to keep the business model going. The proof? Check the 'want ads.' Look at the ads for stockbrokers. Read those ads and you may quickly find proof that it is sales skills, not investment skills, which are sought. Its right there, in black and white. Or if you have the courage, go to a large branch of any major brokerage firm and ask the Branch Manager (Sales Manager) to point out the top two brokers, based on profits for the branch. This question may embarrass them, but they will be able to answer it, if they choose ? because they measure those results very carefully, and they know precisely who makes the most for the branch, and who makes the least. Now ask them the question that really counts. Which brokers make the greatest profits for their trusted clients? They may not be able to tell you. Why? Because historically, these organizations have chosen to not measure it. And common sense dictates that if they cared about it, they would measure it. The truth is ' they care about their profits and paychecks, but they do not care about brokerage account performance ' or they would measure it. Ever get a performance report on a brokerage account?
Regarding Wall Street's more recent activities, Elliot Spitzer demanded $1.4 billion in a 2004 settlement. But did Wall Street's earning go down as a result of paying those fines? Or did their earnings hold up, meaning they found a way to pass those costs on to the very customers who were mistreated in the first place. Who among us has received a compensatory check? Shouldn't those millions of millions be returned to the abused clients? Wall Street is broken, and the buyer must be aware, like never before.
Relationships That Do Work: The Solutions
First, seriously consider firing your stockbroker. Vote with your money (your feet). Take your money away from those carefully disguised selling machines, and send it to a professional organization that is designed around your best interest. Require asset management from individuals who have asset management credentials, who are paid fees that are based on assets under management, (that are designed to grow in harmony with your asset growth), and that are fully disclosed.
You can find solid evidence by checking the want ads again; you will see the difference. These firms seek professionals who have the credentials and licenses to function as fiduciaries, rather than sales people. Then, check with management, and find out what they care about by determining what they measure. They measure asset performance because that is what they care about.
Other comparisons are important too. It is a historical fact that the research departments at the Wall Street brokerage firms have rated a very small minority of the companies they research a 'sell.' Wonder why? Because when they tell the world that a given company is not worthy of their own brokerage client's investment, that given company is not as likely to afford them their investment banking business. They may not be asked to underwrite the next 'public offering', for that company. While it is true than new regulatory rules are in place as a response to these conflicts, it continues to be true that very few companies followed by Wall Street are rated 'sell.' It is inescapable that research can't be objective or helpful if one organization has two masters. The good news is that pure breed management firms do not do investment banking. They are far more independent, and may therefore be far more objective.
Morningstar, the research firm, says the average growth mutual fund experiences management fees of about 1.4%. This is a form of professional management that is reasonable in cost, by comparison. Many separate account investment managers charge even lower management fees. And they retain your business by substituting measured results for sales abilities. They are the solution, which I believe every serious investor should consider.
Wall Street is broken. It is a failed business model by design. And there is only one force that can keep it alive. Demand for their services will keep it alive. Therefore, the best solution is to kill the demand. Fire that 'selling tradition' in favor of fee-based 'fully disclosed' professional management. Hire those who behave like fiduciaries, and whose organizations were designed to be the solution.
I know some investors may be tempted to say to themselves, 'Yes, most brokers should be fired, but not mine.' Okay. But keep in mind that if most people reach for the same rationalization, most people will continue the tradition of doing business with people who are willing to be employed by, and associated with, a broken business model. Alternately, finding an asset manager in favor of a transaction broker is as easy as making a phone call, or clicking on the Internet.
Need one more piece of proof that Wall Street doesn't work? The independent research firm known as Dalbar, reports that while the S&P 500 produced an average annual total return of 12.22% between January 1984 and December 2002, the average investor achieved returns of only 2.57% during the same period (Source:IXIS). Why did individuals fare so poorly? Why did they earn so little with investments that earned so much? Because they failed to 'stay the course', in this transaction-based world. Advisors who advise based on long-term fundamentals, rather than brokers who get rewarded with commissions each time the client changes course, just may be the difference!