In recent months, I have spoken to several clients of traditional wirehouse brokers. I don’t know if this string of brokerage clients is a random occurrence or a sign of general dissatisfaction with the brokerage industry. However, given the chance to review many portfolios and hear about investor experiences at these firms, I think I’ve got a decent picture of what’s happening today. It’s not pretty.
I take no pleasure in speaking ill of the brokers. Been there, done that. But if my recent peek inside the curtain reflects what’s going on there, I feel obligated to call it out. The stakes are too high. The financial safety, security, and success of millions of individuals and families is on the line. They deserve something better than a system that rewards the selling of expensive and inferior investment products with little or no regard for their total financial picture. Here are some common threads I noticed from speaking with these brokerage clients.
Illiquid, Expensive Products – We believe that “simple beats complex” when investing. I can only assume that brokers think differently. I’ve seen everything from private BDCs to leveraged loans, private equity, and opportunity zones on recent brokerage statements. While some of these investments provide liquidity with 30-90 days’ notice, the private equity and opportunity zones are illiquid for 7-10 years. All of these products are expensive. Management fees range from 1.50 – 3.00% per year, and many charge performance-based fees, which means they also take a percentage of the profits. But the most challenging part to wrap my head around is the amount of a portfolio dedicated to illiquid funds. In some cases, more than 40% of an investor’s money is tied up in investments that cannot be sold for months or years.
There is a time and a place for investing in private markets. Private investing makes sense for investors with long time horizons and substantial financial assets who are also willing to deal with administrative complexity. When a private investment is packaged into a broker-sold product, it’s most likely watered down and marked up in price. Don’t be dazzled by fancy, complicated products. If every Merrill broker offers it, believe me, it’s nothing special.
Rudimentary Financial Planning – A financial plan is only worth the effort and level of detail in the planning process. Garbage in, garbage out. A financial planner should ask detailed questions about assets, liabilities, income, and expenses both now and in the future. Back-of-the-envelope planning and rules of thumb will not cut it here. Assumptions for cost increases and investment returns have to be conservative but realistic. There are thousands of different data inflection points, and finalizing a decent financial plan involves a both art and science.
My approach to planning has evolved through the years. I acknowledge the phenomenon of the “Go-Go, Slow-Go, and No-Go” spending years in retirement. Spend more while you are young and able to enjoy the fruits of your labor. No one is guaranteed tomorrow. Most of us will naturally slow spending in certain areas as we age: less travel, less movement, less appetite. Other areas of spending will increase, notably health care costs. I often start with a “worst-case scenario” for a well-funded plan to provide peace of mind. Some examples include never earning another paycheck, an extended need for long-term healthcare, or some combination of low investment return and high inflation. I’ve seen 100-page reports that are completely worthless because the “planner” never took the time to ask the right questions.
No Coordination of Tax Planning and Investments – You only get to keep after-tax returns. I am shocked by how little attention is paid to the tax implications of investment decisions made on behalf of individual investors. The rise of direct indexing has made tax-loss harvesting a table-stakes requirement in wealth management. Old school separately managed accounts, with no tax-loss capability, do not belong in brokerage accounts. Why am I still finding relics of actively managed mutual funds in taxable accounts throwing off massive year-end capital gains distributions? If you owned a mutual fund that paid out a large capital gain distribution last year, it’s time to find a new advisor.
Overuse of Annuities – Give a man a hammer, and every problem starts to look like a nail. Pay that same man 9% each time he drives a nail, and you have an annuity-selling machine. Annuities remain among the most over and improperly sold financial products. Anytime I see an annuity on a statement, I ask why the annuity was purchased. Rarely do I hear a reason that matches an actual benefit of owning an annuity, and there are some good reasons to use annuities. No one ever intends to annuitize the contract and receive a steady stream of income payments. The result is that most annuity owners have an investment portfolio with an expensive annuity wrapper they never intend to use. Unless you have a well-intentioned tax deferral strategy or a plan to annuitize, you probably don’t need an annuity. But a broker or insurance agent will always love to sell you one because they pay huge commissions.
Using Condescending and Fear Mongering Language – Many investors fired their brokers after our conversations. That’s when, in some cases, the gloves came off. I was shocked by what brokers said to clients on their way out the door. Conversations ranged from last-ditch attempts to win back the business to borderline psychologically abusive language you might call gaslighting. One broker suggested that his client was making a grave mistake in searching for a firm that offered more comprehensive services, such as tax preparation in-house. Another broker was blatantly angry and blamed the client for taking money from her pockets. My Southern upbringing has me grasping at my pearls. If you can’t think of anything nice to say, it’s best to say nothing at all. Perhaps the cracks are becoming real for many brokers. Their business model is designed to sell products, not give advice. Clients want advice.
The financial advice industry has a bad reputation for good reason. Despite some regulatory progress and the growth of professional designations such as the CFP, too many advisors working in business with clear conflicts of interest still exist. Incentives are the most powerful force in economics, and the fact remains that brokers are incentivized to sell the most profitable products to their clients. The most profitable products are rarely the best options for clients, and the entire system misses the fundamental need for comprehensive planning, not just investment recommendations. I do not expect these systems to change, but I do expect more clients to vote with their feet and work with independent advisors who are not incentivized in such ways.
