Journal of Financial Planning: November 2011
Rick Adkins, CFP®, ChFC, CLU, is president and CEO of The Arkansas Financial Group Inc. in Little Rock, Arkansas. He served as the 2003 chair of the Board of Governors of Certified Financial Planner Board of Standards. You can write to Rick at RickA@ARfinancial.com.
One year ago, I made the huge sacrifice of missing the second half of the Arkansas-Texas A&M football game in order to hear Dan Ariely, Ph.D., speak at a general session of the FPA annual conference in Denver. This was a great opportunity to hear one of the “newer” thinkers in the area of behavioral finance speak to a group of FINANCIAL ADVISERS. My only regret now is that I missed the second half of a great ball game to hear a guy who, in less than one year, was going to trash the very people who paid to hear him speak. Yes, these were the same “financial advisers” he compared to “highly trained monkeys” in his September 2011 Harvard Business Review column—and I quote:
Typically, a financial adviser takes 1 percent of assets under management—annually!—to balance a portfolio, and makes investment decisions on the basis of our answers to two questions: (1) “How much of your current salary will you need in retirement?” (2) “What is your risk tolerance on, say, a 10-point scale?”
Frankly, I think highly trained monkeys could do the same basic job given answers to those two questions. Certainly algorithms can do it, probably with many fewer errors. This is just not something for which we should pay 1 percent of assets under management. But the real reason we should not pay for it is that those questions don’t help optimize our portfolios.
I must confess, there are several levels on which his column disturbs me. Yet, there’s an element of truth to his comments that remind me that those of us who do more than “take 1 percent of AUM in exchange for managing a portfolio based on having asked the wrong questions” still have a major PR challenge ahead. Here are the key issues he raised that we must become better known for solving so that, in the least, Ariely or others like him recognize the flaw of painting everyone with the same brush.
High-Quality Answers to Real-World, Complex Problems
I totally agree with his comment, “We need to spend more time helping people understand and deal with complexity and less time concocting dumbing-down mechanisms. When we face something as complex as money, we have an urge to simplify the problem. But we often oversimplify it by creating add-water-and-stir solutions.” For the past 35 years I’ve watched the financial services industry do this over and over. There’s a persistent view that if we can just create a simple product to solve this problem, we can make a bajillion dollars! That mind-set has given us universal life, limited partnerships, variable annuities, alternative investments, and more recently, packaged retirement income products.
This mind-set will always drive sales organizations bent on dumbing down complex problems so that they are neatly solved by products they just happen to have. How convenient! But those companies and their products are killing the reputation of professional planners who do far more for their clients.
The Need for More Relevant Questions
Ariely has the impression that the two questions you and I “typically ask” are: (1) “How much of your current salary will you need in retirement?” (2) “What is your risk tolerance on, say, a 10-point scale?” I have no idea what led him to that conclusion; I don’t think he polled the audience last year.
He rightly suggested that a better alternative to Question 1 might be, “How do you want to live in retirement?” I agree, because most clients over-expect what their portfolio will do and under-expect what they will spend. Those of us who actually do this for a living know how messy it is to help clients manage their consumption to fit the realities of their portfolio.
His comments on “the risk question” clearly demonstrate how challenging it is to quantify a feeling. At the end of the day, precisely quantifying risk tolerance is a pipe dream. That doesn’t mean we don’t examine it systematically; we just can’t neatly put it in an overly simplistic 1-to-10 measure. Sadly for our profession, the only folks I know who do something so simplistically stupid are in sales organizations looking for an easy way to make a quick sale. Yet, Ariely has now lumped us all into this single category.
The Need for Embracing Complexity and Delivering “Better” Answers
Ariely concludes that, “Unless we admit how complex the world is and how little we really know, we will not search for better questions, better ways to comprehend the world, and better answers. A deep understanding of what we’re trying to accomplish will always yield better answers than a ‘red is bad, green is good’ approach, even if it doesn’t feel that way.” Over my career, I or my clients have been burned so many times by simple solutions to complex problems that at least his conclusion resonated with my belief system.
My sadness in reading this column stems from Ariely’s incredible ignorance of the fact that many of us have spent our lives living his conclusion, and that he is guilty of what he accuses “the typical financial adviser” of doing: he has taken a complex problem (the need for the public to have access to objective, fiduciary-based, fairly priced financial planning advice) and dumbed it down into a “one-size-fits-all” characterization (charge 1 percent per year to do little, and worse, ask the wrong questions) of all in our profession.
The Need for Greater Recognition of the Distinction of Industry vs. Profession
This last point is my own conclusion to the problem of this article. If you were drawing a Venn diagram of the financial services industry, you would begin with a great big oval that encompasses banks, brokerage firms, insurance companies, and investment advisers who simply manage money and those who deliver relevant answers to complex financial questions. When you start adding circles for each of these groups, you begin to see the relative size of each group and the areas of overlap. The problem is that “the industry” is far larger than “the profession.” While the challenge of making the distinction clear is massive, I’m hopeful that there actually is hope.
The real hope lies in the way you and I live out our professional lives, practicing a profession that does far more than charge 1 percent a year, ask the wrong questions, and function on a level of highly trained monkeys. The way we rebut such an oversimplified, inane proposition is to deliver sound advice to our clients in a complex world—those of us who can, do; those of us who can’t, will continue to teach and write simplistic articles.