When Financial Advisors Give Bad Advice (or Worse)

That’s No Help Last month, The Wall Street Journal revealed that several UBS clients had suffered large losses from an options-trading strategy that had been recommended to them by their advisors. One woman dropped $750,000 on a $3 million purchase. This greatly surprised her, because, she says, her advisor lauded the program’s safety, stating “If the word came to an end tomorrow, you’d be the only one with any money left.”

(Then again, as the world is still extant, that promise has not truly been tested. Perhaps that will serve as UBS’ defense during the arbitration hearing.)

This story accompanied the news that a Chicago-area financial advisor pilfered $2 million of client assets for personal use, including $815,000 from a man who had received a settlement for being wrongfully imprisoned for 10 years. (From the frying pan into the fire.) That $2 million dollar figure was familiar: This spring, another Chicago-area advisor was convicted of stealing that same amount from his clients, several of whom suffered from life-threatening medical conditions.

Technically, the first case differs from the next two. It concerned bad investment advice, while the other two involved fraud. However, from an investor’s perspective, the calamities were three of the same. People paid for professional help but instead bought disaster. They would have been better off with the first mutual fund to appear in a Google search.

Less Is More Let's check that statement. When I type "mutual fund," the initial entrant is an adverplacement: Thrivent Mutual Funds. Pay to play. Sigh. But I click anyway, to enter the company's site. The first fund to appear is Thrivent Aggressive Allocation TAAAX. It carries a distressingly high expense ratio of 1.23%, but it has gained 9.8% annualized over the past decade, placing it slightly above its peer group average. That works.

Truth is, it didn’t matter what mutual fund I selected, as long as I didn’t choose one that was leveraged or highly specialized. The worst-performing diversified U.S. mutual fund over the past decade has been Zachs Market Neutral Investor ZMNVX, which, splendidly and poetically, posted a 0.00% annualized 10-year return through Aug. 31, 2019. Give the fund credit: It couldn’t have been any more "neutral" than that. Also, give it credit for being better than trading options or getting fleeced.

What I am suggesting is that investment services are … strange. Normally, it's not riskier to hire top-priced professionals than it is to use lower-cost options, or to go it alone. For example, if I visit a beautician instead of a barber, I won't get scalped. And both services have a higher expected return than my own attempts. Similarly, paying for a boutique wash rather than visiting Turtle Wash won't hurt my car, and choosing to hose it off in the driveway won't improve matters, either.

But having more money, thereby qualifying for top-level professional help, increases the chance that that something dreadful will happen to my investment account. If I have $20,000, nobody will bother with me. Odds are, I will end up picking my own mutual fund. If not, I’ll walk into a bank branch, or talk to my insurance agent, and will be placed into a generic load fund. All fine--I won’t be hurt by that.

But possessing $2 million raises my profile. Now I merit somebody's ill intentions. I don't mean to imply that most financial professionals are predators. Overall, wealthy investors who visit full-service professionals receive fine advice. Nonetheless, there lies the risk of encountering an outlier that causes more damage than can come from the mass-market options of robo-advisors and target-date funds, or by do-it-yourself decisions.

Preventative Measures How to prevent future occurrences?

The tools to protect investors, it must be granted, are insufficient. The form ADV provides required information about Registered Investment Advisors who control more than $25 million in assets, but not everyone who gives investment advice is an RIA, nor do all have more than $25 million. In addition, the ADV doesn't contain the critical items. It doesn't tell how an advisor's clients have fared, or what they think of the services they have received. Nor, of course, can it indicate fraud that has yet to be committed.

This isn’t to say that disclosure about advisors is particularly poor. If I wish to research a prospective doctor, or estate planner, my tools would be no better. It is ironic, because financial professionals work with absolutely known quantities: stocks, bonds, and funds that come accompanied by detailed prospectuses, with precise records of their historic total returns. Meanwhile, their clients cannot do so. But I understand; it would be difficult indeed to present a summarized version of client results that convey the complete story.

Fool's Gold One improvement investors can make is to avoid advisors who downplay investment risk. Being in the financial markets means accepting volatility. Accept that, or don't invest at all. Because the alternative consists of being talked into things that seem too good to be true--and often are. Bernie Madoff famously claimed to run a fund that never lost money. The UBS strategy promised to resist the world's demise. And the second of the Chicago-area advisors--the one who bilked ailing clients--brandished a business card that read: "Not low risk. NO risk."

The precept of "too good to be true" can also be applied to looks, clothes, and cars. Most financial frauds are handsome devils, with suits to match. See, for example, the first of the Chicago-area advisors, who appeared regularly on the society pages. This indicator is imperfect, because while most good investors aren't much to look at, there are enough exceptions to make this observation no more than a gentle guideline.

Those are just suggestions. Ultimately, the solution to financial-advisor fiascos rests with those companies that hire and serve them, not with investors. The trend is positive. As advisors have redefined their practices, emphasizing portfolio strategies rather than one-off sales, the possibility of disaster has declined--although not eliminated, as witnessed by UBS’ problems. But the work is not complete. In particular, the safeguards against fraud must be strengthened. There’s no excuse for having systems that permit advisors to withdraw their clients’ assets.

John Rekenthaler has been researching the fund industry since 1988. He is now a columnist for Morningstar.com and a member of Morningstar's investment research department. John is quick to point out that while Morningstar typically agrees with the views of the Rekenthaler Report, his views are his own.