Carl Richards has a mission to create better investors. For years in the brokerage industry and as a financial planner, he saw average investors earning returns dramatically less than the average mutual funds they were investing in. The problem is investor behavior. Investors continually make the classic mistakes that result in their leaving money on the table that smarter investment behavior could have earned them.
He named the phenomenon the Behavior Gap, and he continues to explore and share how our relationship with money, and what we choose to value, can impact our lives.
Carl was kind enough to answer some questions for us related to his mission and to fiduciary issues.
fi360: One of Behavior Gap’s signature themes is that the process is far more important than the product and planning is more important than the plan. What does this mean in terms of the real value added by an advisor?
Carl Richards: We’re really talking about two related issues. The first is the product vs. process problem. For the longest time the traditional financial services had it backwards. They started with a product and tried to sell it to anyone that would listen without taking the time to understand if it was appropriate. I think that those of us who take the craft of advice seriously understand that the value is clearly in the ongoing process that we guide people through. The products we use at the end are just a byproduct. It seems to me that this attitude is becoming more and more accepted; now it’s just a matter of getting everyone to act that way.
The second issue deals with the idea that people really need a planner and not just a plan. Financial plans are worthless without the ongoing involvement of the planner. The more plan work I do, the less I think of it. Consider the massive amount of “assuming” that goes into a plan. Not only do we know that we are going to be wrong, it’s also out of date the moment we hit print. What clients want is a planner, someone that will help them navigate the financial landscape. They recognize we can’t know what will happen to them over the next 20 years. Clients just want to know we will be there to help them make smart decisions when things come up. The space shuttle is off course something like 95% of the time. When they formulate the flight plan, they know that. The value is not in the flight plan, but in the course corrections.
fi360: If investment decisions shouldn’t be made on investment performance alone, what signs should advisors be looking for when deciding to replace funds or make changes to an investment plan?
Carl Richards: Again, I see these as two issues. The first one is the hardest question facing investment consultants: when do you replace a manager? This will not come as any big surprise, but it has to be based on a set of criteria that involves more than performance. The magic is defining the process and then following it. What happens all too often is that we make performance just one of our criteria. However, past performance is no guarantee of future success, and then our very first screen is 5-year performance results. The outcome is predictable: we hire managers right after they have a great run and just in time for them to underperform. Then we fire them just in time for them to do well again, and we are surprised when a few years later they start showing up in or manager searches for new clients. Behavior Gap originally got its name from the underperformance that results with the revolving manager door.
The second issue is making changes to an overall investment plan. Those changes should be based on the client’s situation. Since the asset allocation decision is traditionally based on client need (or spending policy), then we should only make changes to the plan if those needs change. This decision can be tricky, because we all know that when the market goes up or down, clients’ definition of “need” changes. So it seems to me that one of the valuable roles of an advisor is to remind people of their own goals.
fi360: You have said that your job as a financial planner should be to create the best investors. What makes a good investor and what can advisors and planners do to improve the investors they work for?
Carl Richards: This may sound self-serving, but I am convinced that there are very few of us that can be good investors on our own. Unless you see Warren Buffet in the mirror when you get up in the morning, the first step is to hire someone you can trust. Investing is not about finding great investments; it’s about owning the right investments for you over a very long period of time and that is hard. We are hardwired to make the wrong decision at exactly the wrong time. This reality brings us back to the first question about the role and value of an advisor. The value of an advisor is measured in the cumulative impact of years of making the best decisions given the information we have, over and over again. One of the things we can do better is to acknowledge the intensity of this profession. In order to do it correctly, you have to have a real relationship with people and that takes time and energy.
fi360: You’ve described a “Secret Society of Financial Planners” who act like fiduciaries whether they are or not. What can both the industry and those individual planners do to make this society less secret to investors?
Carl Richards: To understand this concept, you need to watch the video I made. It was one of those days where I had enough of the insane paradox facing our industry: almost everyone needs (and most people even want) help, but based on what they hear and experience, they don't believe there is anyone that can help. Our industry has a huge image problem (if you don't believe it, you aren't paying attention). It might even be deserved, but the REAL advisors I keep meeting are saving people's lives. The impact that a REAL financial planner has on a family is hard to overstate, but no one knows, because we aren't doing a very good job telling our story.
The only thing we can really do to bring this secret society out of the shadows is continue to do remarkable things. In our industry, just being honest is remarkable. If we do that over and over, then word will spread, and one day the meaning of what is means to act like a fiduciary will no longer be secret
fi360: Regulatory reform looks to include a fiduciary standard of care for all investment advice. Do you believe this development would raise the quality of advice available to all investors? Help close the “behavior gap”?
Carl Richards: No doubt it is an issue worth fighting for, and it would be a huge benefit for those of us on the “right” side of the debate. But, I am not sure about what it will mean in the client’s eyes. One of the biggest disappointments I’ve had since leaving the brokerage side of the business 5 years ago has been that clients and clients-to-be don't seem to understand or care about these titles. I thought that if I could educate them about the difference, people would line up to meet with me. It didn't happen.
People just seem to glaze over at the entire discussion. So while the title doesn't seem to matter to people, it is clear that REAL fiduciaries act differently and that matters. So if all of us can increase awareness of what REAL fiduciaries act like, and we get a tailwind in the form of regulatory reform, we better hope that raises the level of professionalism in the industry.
Carl, founder of Clearwater Asset Management, blogs at BehaviorGap.com and contributes weekly to the Morningstar Advisor Markets and the Economy blog. He also spoke at the 2009 fi360 Conference.
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