Over the weekend (6/15) I completed the 3rd and final installment of the CFA examination. While there were less than 100 students taking the exam with me, I heard that more than 250,000 took the one of the levels on Saturday. Completing the program is getting harder as it gains notereity. I expect that in 10 years, the group that takes level 3 in San Diego will be 400 or more. I learned more over 3 years than 8 years of formal education in Undergrad/Grad programs. Thank you to the CFAI.
Back to the program; here are the cliffnotes for your reading pleasure.
Consider that your relationship with your advisor is a long term investment. It effectively is! If you think that none of the below is important, you are very wrong. In a world with valuable, inexpensive ETF’s, these are the only reasons why advisors will be needed.
In short, there are three areas outside of simply picking good companies that can cause an advisor to miss the client’s mark. These areas primarily determine the NET WORTH of the financial advisor to the investment client. First, cognitive and emotional bias often cause investors to miss investment goals. They are distractions to becoming a “rational man”. Second, conflicts of interest that put an advisor on the other side of the table from a client. These include fee structure and agent/principal mentality. Third, and most importantly, the overall relationship with the client both at the beginning of the relationship and over many years. This shortcoming I like to call, “low levels of KYC (Know Your Client) due diligence.” Even a simple indexing strategy is difficult to execute for an investment client if these three areas aren’t dialed in.
Research has proven that emotional biases are nearly impossible to moderate and work around. For those with emotional biases, you must have a strong relationship with your advisor, since it is likely that you will be uncomfortable if your emotions aren’t considered on every investment. Strange how evidence of this is so persuasive. There are 6 distinct emotional biases.
However, cognitive biases can and should be moderated through education, time, and rapport. Cognitive biases fall into two categories – information processing or belief persistence. These are all shortcomings that investors know that they have, but they have trouble eliminating. Using a rational steward of their money, investors add tremendous future value to their portfolio. There are 8 distinct cognitive biases.
The structure and fee – Clients traditionally pay either a flat fee on assets, commissions on trades to agents, or a performance fee on net profits. The flat fee on assets is becoming the most common, and while there are certainly advantages, many clients aren’t even aware of the fees. I have worked with over a dozen people who didn’t know they were charged a flat fee. This is akin to paying a doctor every month and never going in for a checkup. Commissions on trades are not only in finance, but on real estate and many other products. While this is okay, it creates more incentives for the advisor to sell to the customer than buy and hold. Finally, performance fees are for the active managers. Those that are not trying to sell anything because they make money mainly from generating wealth for clients. All in all, this is the best incentive structure. A common stock is this structure. The CEO is effectively the investment advisor, and shares in the profit of the firm. 
Further, there aren’t many differences between an advisor and a CEO. CEO’s (or a centralized board) make long term decisions on behalf of shareholders, including investments and hiring decisons for improved operational ability. Google does it, Amazon does it, J&J does it. Every public company does it. Thus, if you pay performance fees, you are more investing in the company’s long term ability rather than simply the investments you own at the company. This is certainly more risky for any client versus the standard flat fee. You’ll need assurances that your advisor’s reward is higher than that risk posed. However, as the flat fee advisor promises to be less risky, there will be less potential reward. 
A combination of both a flat fee and performance fee is the best structure. 
Because of this “advisor as the CEO” paradigm, the mentality of the advisor must be incredibly entrepreneurial and courageous. Additionally, the advisor needs to factor in client objectives and risks. Reducing the stress of the client from managing their own portfolio to putting it to an advisor is the ultimate goal. The client often outsources the portfolio only because their time is worth more in other areas. No matter what goals, effective risk management is top priority.
KYC due diligence – The three questions important to measuring client risk that I have found most useful: How did client make wealth? What time horizon is there for different goals? Are there emotional biases to work around? In the book, these questions are well covered. 
In short, clients deserve consideration of these three areas in depth. Reviewing possible biases and the possibility of overcoming them. Structuring the organization and fees around a clients interest so client and advisor are always on the same side of the table. Finally, knowing the client and being detailed in assessments of risk and return objectives.

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