Are you a customer, client or partner?

Chris Leithner

Leithner & Company Ltd

It’s vitally important, yet hardly anybody has noticed it: remarkably few financial advisers, analysts, brokers, journalists, strategists and the like are financially independent. Few, in other words, own enough assets to generate a stream of income that finances their living expenses. Instead, they rely as heavily as the average adult does – that is, almost completely – upon their jobs and salaries.

 In this wire, I show that the comparatively few people who are approaching (or have achieved) financial independence often seek and take advice from “experts” who probably haven’t reached and won’t achieve this goal. Most providers of financial services, in other words, can’t or won’t practice what they preach. Ethically, that’s concerning; empirically, this glaring mismatch of words and deeds reflects conflicts of interest that the 2018 banking Royal Commission didn’t address (and thus won’t resolve).

What, then, to do? In my next wire, I’ll show that if you’re determined to become financially independent, are nearing it or have achieved it, and you don’t wish to manage your own assets, then it’s logical to invest with a firm that pays no salaries, no bonuses and no more than token directors’ fees. Specifically, seek an investment company which levies no administrative, management or other fees, and whose directors, executives and managers receive remuneration in the form of dividends derived from the firm’s profits from investments.

In such a firm, you’re not a customer (purchaser of products or services). Nor are you a client (recipient of professional support or service). Instead, you’re a partner-shareholder: you stand on a near-equal – rather than in a definitely secondary – position vis-á-vis the firm’s principals. This approach to corporate governance not only eliminates major conflicts of interest between manager-investors and non-executive investors; it also creates a confluence of interest that encourages the long-term orientation and shareholder focus that underpins superior long-term returns. 

How Do You Judge Professionals?

In The Millionaire Next Door (Longstreet, 1996, p. 76), Thomas Stanley and William Danko ask:

How do you judge the professionals [financial advisors, brokers, doctors, lawyers, etc., whom] you patronise? Too many people judge them by display factors. Extra points are given to those who wear expensive clothes, drive luxury cars and live in exclusive neighbourhoods. They assume a professional is likely to be mediocre, even incompetent, if he lives in a modest home and drives [an old Ford]. Very, very few people judge the quality of the professionals they use by net worth criteria. Many professionals have told us that they must look successful to convince their customers/clients that they are. 

Rather than outward appearances or inputs (e.g., credentials, effort, etc.), it’s sensible to judge professionals according to the outcomes they deliver. But that’s often easier said than done: if today you take the advisor’s advice or entrust funds to the manager, it’ll take time – perhaps years – to determine the results. Hence it’s useful to ascertain at the outset: do advisers follow their own advice? Do funds managers successfully oversee significant personal or family assets? Have they achieved for themselves what they say they’ll help you to achieve? High net worth individuals (HNWIs), family trusts, SMSFs, etc., should ask themselves an uncomfortable question: why are you taking advice from or entrusting funds to people who probably aren’t as successful as you are?

The problem is clear: few advisors, brokers and funds managers are now, or will eventually become, financially independent – never mind HNWIs. They advise other people how to accumulate significant wealth, but they mostly haven’t. It’s not because they lack income. They usually earn good and often high salaries: according to the Bureau of Labor Statistics (BLS), the median pre-tax pay (base salary plus commissions, bonuses, etc.) for brokers and others who sold commodities, securities and financial services in the U.S. in 2019 was $US62,270 (ca. $A83,000). But the variation was large: the lowest 10% grossed ca. $US35,000 and the top 10% more than $US200,000. The median salary in Australia in 2019, say ABS data, was almost $A78,000. 

So much for income; more importantly, what about wealth? A small number of major exceptions clearly exists; typically, however, advisors, brokers and funds managers seem to own comparatively few assets. Like most people who earn good-to-high salaries, their balance sheets are relatively meagre. As Texans would say, they wear big hats but own few cattle. Stanley’s and Danko’s data show that, in the asset stakes, they punch well below their weight:

We have always been interested in studying the wealth accumulation habits of stock brokers [Stanley and Danko’s use of this term seems to include advisors and funds managers]. Compared with the members of other industries, stock brokers earn high incomes ... Are all these high-income-producing investment advisors wealthy? Not by a long shot ...

Why do many finance professionals accumulate few investment assets? A big reason is that, like most people, they’re great consumers but poor savers – and without being a disciplined saver one can’t be a successful investor. Another is that they’re usually short-term speculators – and NOT long-term investors. Stanley and Danko report that 

We have asked many brokers about this issue. Perhaps one stated it best when he told us: “I’d be rich if I would just keep ... [my stocks, but I] can’t help but make trades in my own portfolio. I’m looking at the screen all day every day ...” (p. 101).

Perhaps that’s why many HNWIs take little heed of investment professionals! Thomas Stanley (The Millionaire Mind, Harper Business, 2000, pp. 77-78) found that only 11% of the millionaires he studied

Indicated that “having excellent investment advisors” was a very important factor that accounted for their financial success. In sharp contrast, 35% ... believe that “making wise investments” was a very important factor ... Why so little credit to “stock advisors”? Although the majority [of millionaires] ... have an account with at least one full-service brokerage firm, most make their own investment decisions ... As one respondent told me: “If stockbrokers could predict the future, they would never keep on being stockbrokers. They can’t [predict]. They make money selling.

That last sentence is critical. In 2018-2019, the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry repeatedly found that so-called “financial professionals” are actually mostly salespeople. “In almost every case,” it stated on pp. 1-2 of its Final Report

… providing a service to customers was relegated to second place. Sales became all important. Those who dealt with customers became sellers. And the confusion of roles extended well beyond front line service staff. Advisers became sellers and sellers became advisers.

Note the Commission’s language: salespeople sell to customers – not to clients and certainly not to partner-shareholders. That’s bad enough, but the Commission overlooked some related key issues: one was that financial salespeople buy and hold few of the products they so energetically sell to others. Purchasers hope that these products will someday provide investment income and help them to become financially independent; meanwhile, salespeople derive salaries and commissions from the sale of products which you buy but they largely eschew! Their mantra to customers is: “buy what I’m selling – never mind that I’m not buying.” Plainly, that lacks integrity. 

“But I can’t afford to buy what I sell,” advisors, funds managers and others will indignantly reply. “And I can’t quit my job. I need its salary: there’s simply no way the stream of dividends, interest and rents from my paltry portfolio could finance my current lifestyle and mortgage.” Exactly! “Your standards are WAY too high,” they will add. “If they prevailed, few of today’s advisors, etc. – only the owners of successful businesses – would remain; and they’d have to restructure their operations drastically.” Bingo! “The acid test,” wrote Stanley (pp. 78-82), is:

Given the same levels of income within the same age group, who accumulates more wealth? [Stockbrokers or business owners?] ... Nearly four in five business owners (78%) had actual net worths that exceeded expected levels. Only one in three stockbrokers (34%) did ... It’s even more telling to compare these two high-income-producing groups’ [balance sheets] ... Nearly one-half of the business owners (46%) were Balance Sheet Affluent, while only 13% of the stockbrokers were in this category. In sharp contrast, 27% of the stockbrokers were Income Statement Affluent, but only 7% of business owners were ...

Could it be that many of those who aggressively sell stocks and related investments don’t follow their own recommendations? If they did, one might expect to find more stockbrokers in the [Balance Sheet Affluent] group. But stockbrokers made up a disproportionately high percentage of those who have big incomes yet relatively small levels of wealth.

... Whom would you like to provide you with investment advice and products? You’d be better off [with someone] who is a solid member of the [Balance Sheet Affluent] crowd. They tend to practice what they preach. I don’t deal with financial advisors, physicians, attorneys or any other professional who is income-statement oriented, and I’ve had to fire a few of them over the years. Their objective is to maximise their income, often to pay for a high-consumption, highly leveraged lifestyle. They normally have substantial debts, and I personally believe that many cannot provide superior service when bankruptcy is a potential threat. 

“In good times,” Stanley concludes (pp. 309-311), “high-performance sales professionals ... are high in income, but even then they are low in wealth because they spend, spend, spend and borrow, borrow, borrow.”

Fiction Clarifies Truth: “Investment Professionals” Are Salesmen Who Can’t Do without Their Salaries

Margin Call (2011), the movie that dramatised the start of the financial crisis on Wall Street in 2007, is fiction. But like all good fiction, it reveals previously-obscured truths. For our purposes, three are critical:

  1. many “finance professionals” – including senior executives – are salespeople;
  2. especially in a crisis, they’ll do whatever it takes to get a sale; and
  3. they’ll do it because they must – that is, their status and self-image requires that they retain their jobs, and their short-term, consumption-driven lifestyle demands high salaries.
If you’re an employee, you’ll do as you’re told. If you can’t afford to quit your job, then at some point it might – and in today’s financial services industry, it probably will sooner rather than later – put you in an ethical bind. The conclusion is brutal but unarguable: if in business and economic matters you want to follow your conscience at all times, then you must be financially as well as ethically independent.

Recall Margin Call’s plot. Late one evening (they work very long hours), a junior analyst-trader in a major Wall Street firm reconfirms the analysis of a sacked colleague: its mortgaged-based securities are rapidly becoming toxic – and unless they’re sold immediately their plummeting value will bankrupt the firm. Junior informs his senior (played by Paul Bettany), who informs his boss (Kevin Spacey), who passes the news to the top. The firm’s President-CEO (Jeremy Irons) convenes an emergency meeting in the middle of the night. It accepts his assessment that, in order to avert bankruptcy, the firm’s only course of action is to dump these securities en masse first thing in the morning on an unsuspecting market.

After the meeting but before the fire-sale, Spacey expresses to Irons his doubts about the ethics of the decision:

Irons to Spacey: “Are you ... with me on this?

Spacey to Irons: “I don’t know. This one is very ugly.”

Irons to Spacey: “You and I are salesmen. We sell. It’s what we do. It’s not complicated … ”

Spacey doesn’t explicitly agree to Irons’ request that he oversee the sale, but he does so nonetheless. Indeed, he delivers a pep-talk to traders – most of whom will receive a huge bonus at the end of the day and then be summarily dismissed and unceremoniously escorted from the building. After the sale has concluded, he attempts to resign: “I want out.” he tells Irons. “I’m done.” Irons ignores Spacey’s request and dissembles: “It’s been a very difficult day for all of us …” “I need you to release my options,” Spacey pleads, “if they’re worth anything after today. I want my bonus. I want out.”

Irons skilfully baits and lures his prey: “You’ll keep your bonus, your options and your client base,” he assures Spacey, but I need you to stay with me for the next 24 months.” Irons then reminds Spacey that this was hardly the first crisis on Wall Street; furthermore, crises entail hard decisions that create winners and losers – and that, in order to win, you must first survive. Spacey swallows the bait – and acknowledges that he’s a bird in a gilded cage: “I’ll [remain with the firm],” he sighs to Irons, “not because of your little speech, but because I need the money. It’s hard to believe after [more than 30 years in senior positions at this firm], but … I need the money.”

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This blog contains general information and does not take into account your personal objectives, financial situation, needs, etc. Past performance is not an indication of future performance. In other words, Chris Leithner (Managing Director of Leithner & Company Pty Ltd, AFSL 259094, who presents his analyses sincerely and on an “as is” basis) probably doesn’t know you from Adam. Moreover, and whether you know it and like it or not, you’re an adult. So if you rely upon Chris’ analyses, then that’s your choice. And if you then lose or fail to make money, then that’s your choice’s consequence. So don’t complain (least of all to him). If you want somebody to blame, look in the mirror.

Chris Leithner
Managing Director
Leithner & Company Ltd

After concluding an academic career, Chris founded Leithner & Co. in 1999. He is also the author of The Bourgeois Manifesto: The Robinson Crusoe Ethic versus the Distemper of Our Times (2017); The Evil Princes of Martin Place: The Reserve Bank of...

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