Following on my post last week about hybrid Web sites that combine social networking and financial services, a lively debate arose about rating financial advisers online. It seems timely to raise these issues, considering the turmoil in markets recently and the subprime lending debacle. Investors can certainly benefit from better information, and the web makes sharing it much easier.
"Clients of 'financial advisors' that are usually brokers/salesmen simply do not have the knowledge to rate those brokers. I have helped many advised clients and NONE of them understood the fees they were paying, or how their returns compared to the indexes. They had no idea that their broker participated in revenue sharing, or that they were being charged 12b-1 fees. Some thought they paid no fees at all! None knew what their bill for financial costs came to, or the effect of those costs over time. They had all been manipulated into trusting their 'advisor'... blindly.
"The questions asked on financialjoe are very superficial and will NOT give a true rating for advisors. Not even close.
"Uneducated people answering superficial questions and giving unreliable ratings isn't what investors need.
"What needs to happen is that investors need to be educated on what their financial advisor will never tell them. For example:
" 'the BCT study found that the raw returns of equally weighted mutual funds (net of all expenses) for 1996 to 2002 were 6.626% for the investors working on their own and were 2.924% for funds provided by advisors.
" 'In other words, the public working on its own did more than 100% better than financial advisors when it came to selecting equity mutual funds. After factoring in inflation and taxes, clients of financial advisors lost money and lost purchasing power.'
"If someone is calling themself a 'financial advisor', they should advise, not sell. It's almost impossible to do both honestly I have learned.
"To categorize clients who use a financial advisor, essentially saying that they're all too ignorant to rate their brokers, is a gross misstatement! There are millions of doctors, attorneys, business owners, and other professionals that use financial advisors; are they ignorant? There are also tens of thousands of financial advisors who work for all the major wire-houses, banks, and other firms that hold CFP's, CFA's, and Masters of Economics degrees; are they not qualified to advise?
"The majority of investors cannot even explain the functionality of a mutual fund, let alone the fee structure, and most don't want to learn because of the complexity involved. Study after study has shown that investors fail to become educated due to the complexity of the investments, and the level of vocabulary Wall Street injects.
"During our focus testing, financialjoe.com used various levels of vocabulary in the questions. We found the more in-depth the question, the less participation, and completion of the questionnaire.
f"inancialjoe.com's focus is participation. Through participation will come knowledge by way of experienced wisdom.
"Through financialjoe.com investors rate their advisors. As each rates their advisor they become tagged to that advisor, and are exposed to that advisor group discussion. It takes one of the users to bring up the discussion of 12b-1 fees, or anything else they have learned through experienced wisdom. Through these discussions they can together determine if the advisor disclosed the entire fee, or just portions of the entire fee.
"Did the advisor disclose the entire fee for a wrap account (total fund expenses plus wrap fee) or did he essentially lie and just disclose the wrap fee leaving out the total fund expense because he wanted to capture the business.
"The result? Mission accomplished! The advisor has now been exposed to every client that he services who participates as a user of financialjoe.com, as well as every potential client who was thinking about hiring him. This is a permanent record that cannot be expunged by the NASD or any other regulatory who settles financially without admitting guilt.
"The final result is permanently weeding out these types of 'advisors' who conduct unethical behavior. But, this cannot be accomplished without participation! So, in knowing this, why would we structure questions that we know will alienate the average investor?
"The comment also states, 'None knew what their bill for financial costs came to, or the effect of those costs over time. They had all been manipulated into trusting their 'advisor"...blindly.'
"I can assure you through personal experience in explaining fees to clients that there are those clients who, after breaking down the fees to them, say, "I really don't care about the different types of fees, just tell me the total fund expense". I also know of RIA's (Registered Investment Advisors) who tell their clients that their management fee is 1%, but fail to disclose to their client the additional mutual fund expenses held in a separate account.
"As for the questions being 'superficial' that is simply incorrect and needs no further explanation other than the aforementioned.
"The financial industry encompasses more investment vehicles than just mutual funds. The commenter, 'Caution!!', submits the BCT study, but fails to attach the entire package. Yes, the BTC study that Morningstar.com published has a lot of great info, but as Morningstar.com says themselves:
"I can't think of the findings for any study that apply to every single financial advisor in America.
"The study is not perfect. It is unfortunate that the authors use the word 'broker' in their landmark study to apply to almost all financial advisors. Their use of the word 'broker' does not just encompass Series 7 licensed reps who are paid commissions and loads. It truly applies to almost all financial advisors who sell mutual funds.
If you hold a Series 7 or Series 65 license, if you are a registered rep, RIA or IAR, if you work for a broker-dealer, major brokerage firm, wire house, or if you are an insurance agent with a Series 7 or Series 65 license, the BCT study may very well have analyzed your transactions (both buy and sell transactions) during the years of the study. Unless you work for a fund supermarket on a salary, your transactions were probably analyzed in the BCT study.
"In the study, virtually everyone selling mutual funds (even RIAs and IARs) are referred to as "brokers"-even if you don't have a Series 7 license.
"Why are these findings so scary? The BCT study implies that about 50% of all FAs produced returns of less than 2.924% per year.
When you factor in taxes and inflation, the clients of all of these "advisors" lost spending power and thus literally became poorer each year. This gives even more credence to the Wall Street Journal's Jonathan Clements' warning of many years that people would be better off if they avoided financial advisors.
I disagree-if only for the reason that skilled financial advisors provide many valuable services besides investment management-but that is the topic for another article.
"The findings of the BCT study seem to apply most directly to advisors who have been selling mutual funds with a 5.75% load, a 3% or some other relatively high load or a front-end, back-end or level load. Even if the fund is a so-called "high-performance fund," with all these fees on top of the human tendency to buy high and sell low, advisors' returns may be much lower than most FAs ever suspected".
"The BCT study found that it is the combination of high-cost mutual funds and advisor behavior that lead to such poor returns. Thus, it is conceivable that even if an advisor uses super-low cost index funds, he or she could significantly under-perform the indexes simply due to buying when prices are high (and everyone is exuberant about the market) and selling when prices are low (and many people are scared).
"Conversely, it is possible that some advisors using high-cost funds could deliver outstanding performance by buying these funds when the prices are low (and when such funds are unpopular) and then selling them when prices are high (and everyone else wants to buy them). This is not what the BCT study found-but it is possible that a few advisors in America could be delivering such performance.
The above advisors might somehow be able to overcome the performance hindering effects of high-cost funds through their mastery of behavioral finance".
For the ENTIRE article the following link will take you there.
"I will finalize my response with this. No system is perfect, but financialjoe.com will improve as technology advances, and as we find new ways to enhance the services we provide.
"I can assure you one thing will be accomplished. Investors will become wiser, poor advisors will be weeded out, and nothing will have a greater impact on Wall Street than the community of investors who came at them through financialjoe.com!"