A Tale of Accountability: "Buyer Beware"

Posted by Carlos Sera on Aug 14, 2015 11:03:52 AM

39122807_sOne of my beliefs is that people get exactly what they want out of life. I also believe they get exactly what they want from their investments. In many ways a person’s portfolio resembles a fingerprint in its’ uniqueness. I’ve seen traders that can turn a modest amount of money into a small fortune by taking risks that are well beyond my tolerance level only to lose it all in an equally spectacular fashion. They are ecstatic as their money grows and dismayed as it drops. I’ve seen others that are plodders and consistently save out of every paycheck and follow a disciplined investment strategy. I’ve probably seen every extreme. The point is that how you handle your money is a reflection of who you are. Since you are unique you will handle your money uniquely.

I don’t know what drives people to make the financial decisions that they make. I’m not sure why people do the things they do but I know from years of observation that money is a reflection of the person and that the person does exactly what they want with their money. It’s my further belief that the primaryreason that people hire advisors to help them manage their money is because somewhere along the way they recognize they need to protect themselves from themselves. For a multitude of reasons people that hire advisors have an innate understanding of their behavior or they simply are incapable of doing it themselves. They turn to someone they can trust, an alleged expert. I have yet to release some tales, which I call Behavioral Tales.” When I do, they will give you some insight as to why people think they can’t trust themselves and why in most cases they are right.

We learned from A Basic Tale that the individual is ultimately responsible for their financial welfare and that successful investors learn to assemble a team of advisors. Since the individual reaps the benefits as well as suffers the consequences of their actions they are personally responsible. This tale reinforces the idea of personal responsibility as well as shows us a way to manage this responsibility. This tale also illustrates one of many effective ways to diversify. Please recognize that diversification is not just an academic exercise or financial theory. It is not just what you learn in a graduate school finance curriculum. Diversification must be real world. In the real world, there are people looking to prey on other’s greed, trust and inexperience. You must protect yourself from these people. We have throughout history seen Wall Street fraud and we will forever see it. There is no amount of regulation that can stop it so don’t look for regulatory protection. Protect yourself.

In the late 1970’s my father joined a well-known religious fraternity benefit society. I won’t tell you which one because it’s not important to the tale. The importance is that it was a religious society and this implied trust. This society was steeped in tradition and had a financial services component. At the time the financial services component was originally formed I believe it had a noble mission. However, its’ mission has long since outlived its’ purpose and like many of these religious based purveyors of high cost financial products, it should go the way of the dinosaur. They are obsolete and members would be much better served dealing with a competent advisor and then donating their profits to the religious organization of their choice. Getting back to the tale. This society was formed to render financial aid to members and their families and they do this even today primarily through the sale of expensive life insurance and annuities.

Soon after joining this principled society, my father was approached by what I’ll call the life insurance salesman of the society, Mr. Bob. Mr. Bob, a respected pillar of the society and a sales driven advisor or SAD, met with my father and sold him an insurance product that was in keeping with the high standards of the society and of course the perfect solution to my father’s financial needs. He sold him and my father purchased an annuity in his tax-deferred retirement plan. My father wasn’t very tax savvy at the time. He would never buy a tax-deferred investment in a tax-deferred account today, but at the time he was still learning. In reality, he had no idea what he was buying, he simply trusted Mr. Bob. He represented a religious organization after all. Mr. Bob had assured my father that the investment was “safe” and if he needed to sell or liquidate the annuity it would be “available.” I’m sure you know the outcome. What was promised was not what was delivered.

A few months later my father noticed that interest rates were generally rising but that the rate on his annuity was not. Naturally, he reasoned that he could get a much better rate than what the annuity was paying and he called Mr. Bob. My father was in for a surprise. Yes the annuity was safe and yes he could sell or liquidate it at any time, but if he wanted it all he couldn’t recover his original investment because the annuity had a significant surrender charge or early withdrawal penalty. Furthermore, the low interest rate that the annuity paid would not change for quite some time. My father was dismayed. He had trusted Mr. Bob and he felt betrayed by Mr. Bob as well as the organization that sanctioned his existence. Of course, the reason for the significant surrender charge in excess of 5% of my father’s original investment was due to the fact that the SAD Mr. Bob was paid a handsome commission for doing my father such an extraordinary favor as to selling him this highly desirous product.

What did my father do when presented with this situation? His reaction was one I admire, one that people should emulate and is in keeping with the idea of personal responsibility. He cut his losses by liquidating his annuity. He paid the surrender charge and reinvested the money at a much higher rate. He made sure to understood the terms and conditions of his next investment. Soon thereafter my father resigned from this organization after this same set of circumstances was repeated throughout the society and tolerated by the hierarchy. Apparently many other religious brothers had also misunderstood what the words “safe” and “available” meant.

What can we learn from this tale? Obviously, we can learn that we must take responsibility. What else? We learn that “Wolves often dress in sheep’s clothing” and the financial services industry is rife with this type of predator. We can also learn the age-old expression “Buyer Beware.” This investment mistake taught my father an important lesson. He learned that the “devil is in the details” and that if you can’t understand a particular investment, or don’t know what motivates the person selling you a particular investment then you must hire people that do and then make sure that they are doing their job. He failed to ask the simple questions. In the words of our former President Reagan, my father had “Trusted but had failed to verify.” You must always verify. In extreme cases when a financial purveyor is running a con or Ponzi scheme, if you bypass this basic tenet you may end up losing all of your money. Step one must always be to worry about “The Return of your Money and not the Return on your Money.”

What happens when you are incapable of verifying and all that you can do is trust? Don’t do it. Take time to learn and educate yourself about where you are putting your money.

Let’s look at stock investing as another example of accountability. In the late 1960s, almost 10 years before the annuity incident, my father recognized that he had to start allocating money to the stock market in order to achieve higher returns but was at a loss of how to go about doing it intelligently. Like many he understood that investing in the stock market was over the long term likely to produce substantially higher rates of return than investing in safe investments such as bonds. He also recognized that he wouldn’t be able to develop the type of expertise to make stock market investing work for him without hiring an advisor. So, how did my father go about finding a stock market expert or experts? He wasn’t an expert himself. He didn’t even know enough to evaluate what an expert would look like or act like. He didn’t even have an idea of how to determine if the expert was doing his job correctly after he hired him. This was quite a dilemma and one that is faced by almost everyone that wants to achieve higher returns but lacks expertise. I will provide some additional insights into this dilemma in the coming months when I release A Fairy Tale, but let’s see how my father resolved this dilemma 40 years ago. It would still work today because it has all the essential elements.

I think the most intelligent thing my father did when hiring a financial advisor to manage his stock portfolio was to accept the fact that he was responsible for his money and that he would never be an expert on investing in the stock market. He was realistic and didn’t lie to himself. He understood expertise, but had no way to evaluate if the advisor that he was giving his money to was an expert. At first he tried to see if there was some type of financial equivalent designation to his MD degree and sadly he learned that none existed. He read extensively, especially his financial bible magazine called Medical Economics. He asked his colleagues for advice and interviewed their advisors and finally he consulted with his accountant, attorney insurance agent and most importantly with his wife before settling on an individual that would become his “I can talk to him” advisor as he called him. After all of this did it work? Of course not, the 1973 to 1974 recession and stock market decline eliminated a substantial percentage of the money my father had with the advisor whose firm was perpetually “Bullish on America” and is today “Disgraced in America.” Like many before him, at or near the end of the stock market decline my father decided to get out of the market. Did my father make a mistake? Maybe. Was it the advisor’s fault? Maybe. What can we learn from his behavior? I will release A Tale of Destruction in the coming months and the reader will have a better understanding of the psychology of how the client views the stock market or their advisor and then decide who was responsible. I personally don’t blame either one. I blame human nature.

Is there a saving grace to this? The answer is yes. My father through his own initiative and taking personal responsibility had in addition to the money he had given to his “I can talk to him” advisor invested an equal amount of money in a number of stock mutual funds and an equal amount in individual stocks. He had effectively set up three equal piles of money devoted to stock market investing with three types of advisors. He wanted to cover all his bases. He called it diversification for the dumb. His reasoning was that everything he read said that you needed to diversify and since he didn’t know how to set up a diversified portfolio himself, he reasoned that he would diversify otherwise. He hypothesized that the person that ran the mutual fund had to be an expert otherwise they wouldn’t be running the mutual fund. He also hypothesized that the executives that ran large publicly traded corporations had to be expert otherwise they also wouldn’t be running these large enterprises. He practiced his own form of diversification. Furthermore, he remembered that the rich Cubans that had all their eggs in one basket lost it all when Fidel Castro nationalized the country. He didn’t want all his money in the custody of only one “Bullish on America” firm. He wanted it spread around and so he set it up that way. As of this writing, he still owns these mutual funds and shares of stocks in these companies and even though I am in the business of managing money I have never consolidated them under one custodian. The original investments have multiplied in value many times and looking back it’s hard to believe how many times money can multiply in 40 years, but these mutual funds and individual shares are living proof. See A Compounding Tale to understand the effect of compounding over time.

I asked my father why he didn’t sell his mutual funds and individual shares in 1974 when he sold out of his portfolio with his “I can talk to him” advisor. He didn’t have a satisfactory answer as far as I was concerned. He said that it was just easier to make one call to his by this time “Not so Bullish” advisor and tell him to get out of everything. He had also grown attached to the mutual funds and shares that he had selected and since they were spread out in such a way that he would have to make multiple calls and write multiple letters in order to liquidate, that he just left them alone. He also indicated that he was interested in buying a second home at a local beach resort and that the money he had with the “I can talk to him” advisor was the perfect amount to make a 20% down payment on the beach house, so he took it from there. I was amazed at his reasoning. It wasn’t exactly the type of sound, analytical thinking that I would have expected. Nevertheless, in hindsight it worked very well. He kept his mutual funds and shares of stocks and to this day still owns his beach property that has also increased in value by many multiples.

What can we learn from this tale? We learn once again that the individual is responsible or accountable for their money. They are in charge of how they allocate their money or capital. We also learn that often those that appear most trustworthy are actually those that are to be trusted the least. Furthermore, we learn that individuals can recover from investment mistakes and that they must understand the investments they own. We also learn the age-old adage of “Don’t put all your eggs in one basket,” since when my father decided that he needed stock exposure in his portfolio he actually hired three types of advisors. He hired a person that he could speak to, a mutual fund manager that had a track record, and executives at companies that were paid to allocate money for their shareholders.

This tale teaches us four more things. We learn that despite the best efforts to hire an advisor that there is currently no perfect method but good methods do exist. I will release A Successful Tale soon for clues as to methods that may work for you. We also learn that everyone is susceptible to the fear and greed cycle that always characterizes the stock market and that my father was no different since he sold out near a market bottom in 1974. There is a behavioral reason for this and we are seeing it once again as of this writing in December 2008. Many of my tales will focus on this behavioral deficiency as you read more tales. We also learn that there is an element of luck associated with the investments you make as well as the investments you keep. See A One Stock Tale for a great example of an element of luck. Finally and if you ask my father most importantly, we learn that in order to make good decisions you have to surround yourself with a team of advisors, though you are still accountable, thus the title of this tale.

Let me leave you with a visual.  When I was a boy I spent countless hours watching a cartoon called Rocky and Bullwinkle.  One of the characters in the show was named Snidely Whiplash.  His character was created as a parody of the silent film villain who took great pleasure tying damsels in distress to a railroad track.  He wore a black cape and black top hat.  My visual is simple.  If this character were to approach you with an investment idea you would grab your wallet and run.  With this in mind, recognize that the person that approaches you with an investment idea will never look like Snidely Whiplash.  He will come in the form of Mr. Bob.  He will be a pillar of society.  When you meet this person, ask a simple question, what can go wrong?  Ask the question, how can I lose all or part of my money?  You are accountable.


Topics: Investing Tales