August 22, 2022
Forefront‘s Monday Market Update
Incentive Matters
Last week, I met with a prospective client, and she sat down with an article she had printed from a popular financial blogger. It was the top question that should be asked when hiring a financial advisor. I LOVE when people are prepared and organized for meetings because it lets me provide value immediately in that first conversation, but the first question I was asked was a doozy.
What will my performance be?
All advisors have received this infamous question, which always makes me chuckle. For those who know me personally or are my clients, I always introduce a different way of thinking to people gently and hopefully humorously. Hence, I told her that some years she could expect her performance to be positive—some years, her performance to be negative. The joke didn’t land like I was hoping.
I explained that the market, not the advisor, determined performance. The best thing I might be able to tell you is that I will beat the market by some arbitrary amount, let’s say 1%, for this example. That extra 1% is still relative to the market, so it is the same thing when the market is up 5%, and you are up 6%, and when it is down 20%, you are only down 19%. In both cases, we have outperformed the market by 1%, but your general feelings about that outperformance are very different in each scenario.
Why does this matter?
So, why does this even matter? We all know the market and not the advisor dictates that performance, and if you have read anything I have ever written, you know that the plan is the product, not the portfolio.
We all don’t know this, and I continually see the same mistake being made before clients join the Forefront Family. Back in 2004, when I started my career, I remember a prospective client asking my mentor what kind of performance they could expect because another advisor they were interviewing had told them 8% was what they could expect. I never quote people on expected returns because no one knows from year to year. As it turns out, from 2004-2014, we had market performance of about 6%, and that client came back to me in 2011 and told me his story.
The advisor he went with could only achieve an 8% return by using high dividend preferred shares in financial financials. From 2004-2008 he certainly did achieve his 8% returns, but in 2008, with nearly 1/3rd of his portfolio in Lehman Preferred shares, he saw that portion of his portfolio lose 99% of its value in a matter of weeks.
Mindset
It would help if you remembered something when considering hiring an advisor; financial decisions are more often about consequences than facts, especially when dealing with an uncertain future.
I posed a question to this prospective client and asked if you have a mortgage of 3% on your starter home, but your family Is growing, and space is running out quickly. Would you sell your home and buy a larger home with a higher interest rate?
The mathematical answer is no, keep the lower rate and deal with it, but the mathematical answer is not the correct answer in this scenario. Consequences matter more when making financial decisions than any other time.
Incentive matters
Instead of asking about performance when looking to hire an advisor, begin to ask them about their incentive. Most “financial advisors” are simply salespeople, not advisors, and are paid for the products they sell rather than the advice they give. Every problem looks like a nail when you are paid to sell hammers.
Incentives in this scenario can also be looked at as compensation. How is the advisor paid? If they are paid via a commission or compensated by another company to use their portfolios or products, that is a direct conflict of interest. Seek out advisors who are “fee-only” and are only Registered Investment Advisors. The industry has found a loophole with advisors being duel registered as part of an RIA and a broker/dealer where they can sell products for a commission. Incentive matters the most when hiring an advisor because a conflict of interest can be controlled, while performance can not be controlled.
So What?
So how does this impact all of you?
- Financial decisions are more often about consequences than facts, especially when dealing with an uncertain future.
Stock market calendar this week:
| MONDAY, AUG. 22 | |
| 8:30 AM | Chicago Fed national activity index |
| TUESDAY, AUG. 23 | |
| 9:45 AM | S&P U.S. manufacturing PMI (flash) |
| 9:45 AM | S&P U.S. services PMI (flash) |
| 10:00 AM | New home sales (SAAR) |
| WEDNESDAY, AUG. 24 | |
| 8:30 AM | Durable goods orders |
| 8:30 AM | Core capital equipment orders |
| 10:00 AM | Pending home sales index |
| THURSDAY, AUG. 25 | |
| 8:30 AM | Initial jobless claims |
| 8:30 AM | Continuing jobless claims |
| 8:30 AM | Real gross domestic product, revision (SAAR) |
| 8:30 AM | Real gross domestic income (SAAR) |
| 8:30 AM | Real final sales to domestic purchasers, revision (SAAR) |
| FRIDAY, AUG. 26 | |
| 8:30 AM | PCE price index monthly |
| 8:30 AM | Core PCE price index monthly |
| 8:30 AM | PCE price index year-over-year |
| 8:30 AM | Core PCE price index year-over-year |
| 8:30 AM | Real disposable incomes |
| 8:30 AM | Real consumer spending |
| 8:30 AM | Nominal personal incomes |
| 8:30 AM | Nominal consumer spending |
| 8:30 AM | Trade in goods, advance |
| 10:00 AM | Fed Chair Jerome Powell speaks at Jackson Hole retreat |
| 10:00 AM | UMich consumer sentiment index (final) |
