By Our Own Petard

Complex systems. Simple rules. What if technology strips away everything in the current financial advisors tool kit? Ben’s “three-body problem” obliterates the pretense of “active” investment management, Joe Duran’s assertion at WealthStack that financial planning will ultimately be fully automated, etc. What if everything is replaced by automated systems with the next leg up in computing power? Rather than discarding the advisor completely, what if it creates a need for an entirely new and different kind of advisor? One whose only function is to share their “human” life experience as the foundation for their ability to offer advice in the first place. An Advisor who makes sense of all the data by leveraging their “soft skills” rather than falsely trying to predict the future. What if all this discussion around fees and commissions and AUM and RIA spreadsheets is really just noise? Of course it’s all bullshit and backwards and wrong. Information asymmetry made it that way and the thundering herd kept it that way. But technology is forcing its hand in a way very similar to the Industrial Revolution and the emergence of Artificial Intelligence and higher order computing power will take all this bullshit away. You say “alignment” is impossible. I think its the only way an advisor can survive going forward. The value add for an advisor will be precisely that which aligns them to their ideal client. If their life history and ability to navigate through the pitfalls and hardships of life resonates with the end client, then they will inherently share aligned interests. It will not matter what firm they work for or how much AUM they have or how much they charge in commissions or how many credentials they have on their non-existent mahogany walled office. The only thing that will matter will be that there is this advisor who has been through some really difficult experiences in life and managed to get to the other side. You know what, that’s really similar to what I am going through. Maybe I should reach out and see if we can work together. Might save me a lot of money and pain. How will I find that advisor? Simple. They are everywhere and being vetted all the time on social media. Their calling card is their story, that’s it. Go find the one who’s story resonates with you because your gonna need someone in your corner to defend you against the giant tech companies who have already stolen all your data and are using it against you.

So, in a way “Yay, alignment!”. Maybe I’m wrong, but I hope not.

It took me a while to absorb the message in the chart that drilled in on the distribution of outcomes at 8% volatility. Once I understood it, my entire view on performance fees changed. That is some powerful stuff Rusty. Well done.

I think you and I probably agree, Thomas.

I personally do NOT believe that advice will be arbitraged away by technology. I believe that the single most powerful form of alignment comes when we recognize that the “technical” forms of alignment we try to engineer through fees and diligence checklists are anything but. That form of alignment is a human relationship with someone that has made themselves vulnerable to us and us to them.

I think an adviser who can deliver that to a client, and a client who can absorb that into their decision-making framework, will be more aligned than anyone who doesn’t, regardless of the incentives of their fee structure. It’s a touchy-feely sort of thing to say, but I absolutely believe it, and it’s why I still believe in advice.

Thank you for the reply and for all your work. I cannot begin to quantify how much your writings have meant to me. Very much appreciated.

Thank you! This is one of the things that I have been trying to explain to clients and regulators ever since the Department of Labor released its Fiduciary Standard. There is no such thing as conflict free humans. There is no ideal compensation method. Every one of them has a conflict. Commissions are evil? Taken to excess, sure, but if you are a buy and hold investor it can be the cheapest way to pay for occasional advice. Advisory fees are perfect? Why does the SEC have a bulletin on reverse churning? (Charging Advisory fees, but not trading frequently enough to make the advisory fee cheaper than a commission model.) Advice only model? Who will help me execute the advice? I get a blueprint, but how do I pick a contractor to make it real?

Don’t even get me started on updating the regulations. Bernie Madoff, Ken Lay, and numerous others were fiduciaries for their investors. It did nothing to protect the investors. Governmental regulations are like a warranty. A warranty may force the manufacturer to repair their product, but it won’t prevent the hassle and other costs associated with a failure in the product. A strong warranty does not make up for a poor quality product. I would rather have a high quality product with no warranty. (Also, any car dealer will tell you that warranty repairs are the ultimate in misaligned incentives.) Technology will take an extremely long time to replace human interaction. (if it ever does.) No one cares about hurting a computer or robot’s “feelings.” We feel beholden to other people. How do I know? Look at physical fitness. How many people have lost weight, improved their diet and turned their life around because they bought a Fitbit or Apple Watch? How many have done it with a personal trainer and/or nutritionist? Investment analysis, portfolio design, portfolio management, financial planning, tax analysis, budgeting, really all of the math components of financial success will be automated. I’m sure there will be several different competing tools. None of them will take the place of a caring human financial advisor that will encourage you to use the tools, understand the differences between them, and provide personalized interpretation (wisdom) on using them to maximum advantage. I don’t work with institutions, I work with people. People want a caring guide to show them the ropes, identify the traps, and generally help them do better than they could do on their own. My clients are part of my packs. I use this part of my pack to help me do a better job for that part.

Excellent long piece as always. Thomas, triple thumbs up.

Rusty-I’m reminded from a line in an Indiana Jones movie, “Son, we are pilgrims in an unholy land”. I’m a discretionary fee-only FA who runs what in effect is a hedge fund for widows and orphans (no 2/20’s or performance fees). I’m getting killed by fee compression. It doesn’t matter that my PERSONAL investable money is right along side my clients’ in the same portfolios, and I pay the same or HIGHER fee than they pay. I can’t possibly be more “aligned” as I suffer or prosper right along side them in both income and wealth. However, such a message/meme never resonates in a market environment that can only be described as the never-ending money chase orgy of free money. Thank you Fed. My approx. 80% of S&P capture with approx. half the risk for nearly 20 years does NOT resonate in the market place. I can only take solace from the notion that a replay of my lower risk 2008 “over” vs the S&P will happen again rewarding those who ignore the Siren’s song of no-risk, no-cost passive indexation and stayed with me.

I’m reminded of, “The problem with doing the right thing is that you often do it alone”. Damn, I feel lonely out here!

I couldn’t agree more on just about every count. Thanks for reading.

Yes, Peter, and it’s not just the free money out there. It’s the fact that people who are decidedly unaligned get to hang out their “yay, alignment” shingles and pretend that just going fee-only, or just talking up fiduciary language is doing the same that as what you have done.

One of the most pernicious powers of narrative is that it cheapens the real thing whenever it does come along.

The thing many fee-based clients don’t understand is this: they are subsidizing commission-based clients. My commission clients (usually older, buy-and-hold, low maintenance people) don’t do nearly enough trading to justify charging them a fee. But they still get phone calls, meetings, Christmas cards, and all the services they need. But maybe they make one or two trades a year. Without the fee-based people essentially paying the bills these commission clients would be passed off to someone else or sent online. And they don’t want that. A lot of them have been with my family for decades. We have relationships. So they get everything they need and it costs them very little. It’s a great deal for them.

P.S. With how rich Ken Fisher is you’d think he could afford a suit that fits him. The guy looks like he’s wearing his older brother’s suit that he bought for the Homecoming dance in 1987.

Hi Rusty. Re your recommendations, how do you suggest calculating the beta hurdle, adjusted for long/short exposures? Thx