How the Investment Advisor Game is Played

Good morning! Today Troy continues with the investing for beginners series. You can check the previous posts about 

What are stocks and how to value them, How does Currency Trading Work, How are Currencies Traded, Investing in Commodities, What Fundamentals Affect Commodity Prices, What are ETF’s, What are Options, How are Options’ Prices Structured, Investing for Beginners Part 2 – Different Investment Strategies, When does Buy and Hold not Work, An Unconventional Approach to Buy and Hold, An Unconventional Approach to Buy and Hold Part 2

 

To end this section on Buy and Hold, let me give you one caveat. When it comes to buy and hold, do not buy to what your Investment Advisor (IA) tells you to buy. I speak of this from personal experience. This is my story.

Back in my college days, I worked at a co-op position at a bank. I was working on the investment advisory side of things where I worked under an Investment Advisor (IA). In essence, we were doing the retail side of investing (working with mom and pop investors). For the sake of anonymity, let’s call my supervisor (the Investment Advisor) Jake (that’s not his real name).

Jake wasn’t just any old Investment Advisor at our bank – he was one of the VP’s (at 40 years old, he’s a hotshot in the bank). And let me tell you – despite all his credentials and certification (President of this organization and that council), his investment advice sucked. If contribution to society were to be a benchmark for his annual salary+bonus, this guy should have been billed. Why? Because Investment Advisors in general don’t care about generating superior investment returns. They care about growing assets under management. That’s because Investment Advisors aren’t paid on performance fees (eg 20% of profits). Investment Advisors make fees from selling expensive financial products (eg mutual funds) and management fees. Thus, there’s a huge conflict of interest. For Investment Advisors, the more money they have under management, the more money Investment Advisors will make. Whether they generate investment returns on those assets or not is inconsequential.

I can list out the terrible advice that my Investment Advisors gave to his “clients” (more like”victims” if you ask me).

1. Buy stocks in 1999. A year later, market tanks. “Don’t worry about those losses guys! We’re buying and holding!”
2. Sell stocks in 2001, because the “secular bear market is here”. Needless to say, he was 2 months away from selling at the bottom.
3. Buy stocks in early 2006. He made a ton of money in 2006 and some money in 2007. 2008 came along, and half of his assets vanished (losses).

Thus, whenever Investment Advisors like Jake lose money, they will wheel in the standard “buy and hold” line. “Oh, don’t worry about that horrific loss. We’re long term investors, so we’ll just hold onto this loss for 10 years until it breaks even”. Over his career, Jake has made practically $0. But he’s a hotshot at the bank because he pulls in the most assets under management (just shy of $100 million).

That is why you should never listen to Investment Advisors when it comes to buy and hold. Buy and hold is an investment strategy. You have to know what you’re doing. What these IA’s are doing is turning buy and hold into hope, which is not an investment strategy. “If we buy and hold this investment for 20 years, let’s hope we make money”. And we all know that hope is the number one cause of disaster for investors. It’s like a gambling mentality.

I have a friend who told me a pretty funny story. One day he and his Investment Advisor were sitting down during their quarterly review. The IA proudly proclaimed “I haven’t lost any money in 10 years!” My friend practically hit the roof because zero profits in 10 years isn’t exactly a happy thing to think of (bonds pay even more).

So why are most trade Investment Advisors so incapable? Because the Investment Advisor game is wrong. In order to be an Investment Advisor, you have to go through a ton of standardized industry tests. But reality is, these tests are absolutely useless! A successful investor is not determined by whether or not he/she can pass a test or not. Investing isn’t a scinece – unlike on a test, there is no absolute right or wrong answer.

If these tests really were that eff’ing useful, the people with the highest IQ’s would be the best investors. And obviously that’s not true! Some of the best traders and investors were ex-soldiers. They succeeded not because they had a superior IQ but because they understood the concept of risk management.

This post was featured on the Money Smart Guides, thank you!