May has been a watershed month for a change in sentiment. This only serves to reinforce the job that we must be doing as advisers.
Our role is to work with people and advise them on the choices they can make in relation to their financial wellbeing, and emotion, whether fear or greed, should play no part.
Adam Smith’s moral philosophy, The Wealth of Nations, published in 1776, is a study of choices people make with money. Smith and other economists of his time thought those rules were moral rules. He was the father of economics as a science.
It is up to us, as modern financial planners, to apply these same principles to everyday life for our clients. Human actions are not based on pure economic calculation. Our emotions get in the way and we decide our actions based on fear, greed, hope, jealousy, love, hate and a range of other emotions. We have to first remove our own emotions from the process if we are to advise other people and to be as dispassionate as we need to be is a difficult task. It is the mark of a true professional.
Still, there are general rules we have to abide by in life and in economics to live in a modern society. These rules form the basis of an environment that allows even people who disagree to live together. The capital market system has been the most successful system in the history of humankind to build the prosperity of the bulk of society. Property rights and the rule of law, along with securitisation, allow us a wide degree of liberty upon which others cannot intrude. The system must allow people to make mistakes and they have to bear the consequences of those mistakes. Until May, overconfidence was in the ascendancy and now we are facing a very different client coming to our door.
Advisers who act fundamentally as product salesmen, selling investments based on their immediate past performance, are going to be hardest hit. They are often as bewildered as the clients they are supposed to be serving. It is only when the adviser has provided a disciplined process for making long-term decisions that the investor gains the confidence to stay the course.
We have to put in place for our clients a set of rules and the fewer the rules the better, and generalised principles work best. We have to know what we stand for and why we stand for these principles. They need to be intuitively explained and backed by scientific evidence over very long periods of time in several different markets to prove they are universal. The alternative is to be caught up in the emotionally fraught practice of stock picking and market timing or attempting to build a business out of predicting the future.
There will always be advisers who jump from one bandwagon to the next and eventually they will lose their credibility, and in Darwinian terms be selected against. The threat to us all is that in their death throes they cause all of our reputations some damage. There are more onerous conditions and responsibilities for those of us giving advice and this can only be a good thing. Compliance is not just about obeying the law but also about adding something of real value to the consumer.
At times like this when market sentiment seems to have changed, we need to step up to the plate. It is during these periods that we add our greatest value as advisers.
A lot of wealth is lost at market turning points, but we don’t know when those points will be. The work that needed to be done to protect clients from the downturn of the tech boom had to be done during the upturn. The same can be said for the property boom or the recent resources run. Our job is fundamentally one of managing expectations and preparing our clients emotionally for the inevitable storms that lie ahead. That is the difference between advice and salesmanship.
Compliance should not have to include risk disclosure as it should be done as the essence of advice in the same way that explaining how fees and charges need to be kept to a minimum as they are a drag on performance. Unfortunately for some, risk disclosure and fee disclosure are still an afterthought. Fortunately it is a diminishing band that Darwin will be watching and with time they will be removed from the financial planning gene pool.
These types of firms will exist, of course, just as the crocodile remains at the top of the food chain in its ecosystem, despite few adaptations or innovations in the past few million years. People will still work for the crocodile firms but they will cease to be part of the evolutionary mainstream that will tap into the great future that awaits firms that steer their clients through the inevitable changes in investment sentiment. The last month has just been another of those road bumps designed to trip us up. The evolution continues.
