A couple days ago, I was doing a talk (my book release and book signing event) and during the question and answer period I was asked a great question by Bill Kelly, the CEO of The CAIA Association. His question was which did I think was better for an investor, an advisor that takes investment discretion, meaning the advisor makes investment decisions without getting permission by the client prior, or one that did not? It was a terrific question, one that I had not been asked in public before.
My response was that while ideally an investor who hires an advisor should let the advisor do their job and not override investment decisions, there are investors that cannot emotionally deal with letting go and they would likely terminate the relationship anyway, so for these investors non-discretion is best. However, this excellent question begs for greater review I think, but for this discussion I am only addressing the one question, what is best for an investor, discretion or non-discretion. I am avoiding related questions such as conflicts of interest with discretion, or advisors that refuse non-discretionary clients or other nuanced, but nonetheless important issues.
For some fascinating perspective on the impact of second-guessing your advisor, I go back to my own personal experience when as a rookie broker in 1987, I watched the literal chaos on Black Monday, October 19, 1987 when the market dropped 22.6% in one day. It remains the largest percentage drop of the Dow Jones Industrial Average. I was working at the 14 Wall Street office of Shearson Lehman Hutton, an office of roughly 100 brokers. What I saw and heard was unnerving. Clients were calling their brokers and telling them to sell and sell fast. What many of the brokers were advising their clients to do was not sell, and in some cases the broker could not even get a price, yet the client demanded the broker to sell their stocks at any price, despite not being able to get a quote! In those days, and at that firm and that type of firm investment discretion was not permitted, so a broker would do the best they could to persuade the client, but in the end they had to obey the instruction of the client. History of course proves out that many of these clients made a grave mistake that day by not listening as the market recovered and made gains in only a few short years later.
When one thinks about what is best in a vacuum, assuming the investor selected the right advisor, it makes logical sense that the investor should not override their investment professional, after all, why have an advisor if you believe your own investment skill sometimes is better? Makes no sense from an objective stance. In a follow up interaction, Bill made a very funny, but great point. “The most important step after recognizing the need to get financial advice, is the due diligence in the hiring process to get a qualified, competent and independent partner. Once done, you should let the professional do her work. We don’t sit up mid surgery, take over a deposition or finish a brake job with other professionals, and our behavioral instincts are particularly misguided (in most cases) when it comes to financial decisions.”
Adding to the point, as research studies prove out the mathematical value of advisors, very often the most important time to have an advisor is when there is turmoil. Turmoil in the markets, turmoil in your personal life. During emotional times people tend to make the most mistakes, and this is when the advisor adds the most value.
Echoing this concept, I have talked with and interviewed many advisors, financial planners, and other types of advisors who bemoan the fact that when a client ignores great advice it is not only frustrating, but the client is actually sabotaging themselves. Again, it makes no sense. However, there are investors who have a very hard time letting go and trusting and if their only option was investment discretion, they would never use any advisor at all. For these investors, while not perfectly ideal, the non-discretion route is the next best thing.
If you are an investment professional reading this, I’d love to read any feedback, thoughts and opinions on this issue!