Posted on January 20, 2009 - by musicwhiz

Personal Finance Part 11 – Financial Advisors

Photo by ~yienshawn92~

While reading through Benjamin Graham’s seminal book on investing “The Intelligent Investor”, I was drawn to the chapter 10 on “The Investor and His Advisers” in which Graham discussed the value of financial advice given by various groups of interested parties. He names

1. A relative or friend (presumably knowledgeable in securities),
2. A local (commercial) banker,
3. A brokerage firm or investment banking house,
4. A financial service or periodical and
5. An investment counselor. Interestingly, he notes that most of these parties are either incapable of giving sound financial advice, or have a vested interest to encourage speculation (as defined in his book) rather than to promote sound investing principles. I shall go through his examples point by point, and also include a sixth category for “Internet Research and Advice”.

It is always good to remember, through these discussions, that ultimately the money invested by yourself belongs to yourself, and thus only you have a significant and emotional interest in growing your money. Others may give advice or tell you how to invest, but they can never know the pain of losing this money or the joy of growing it as they have no ownership of it (unless, of course, some part of your gains or losses directly accrues to them !).

1) A relative or friend – This is probably considered the “nadir” in terms of quality of financial advice. Notwithstanding the fact that your relative or friend could be the next Warren Buffett (an extremely unlikely proposition in any case), this kind of emotionally tinged advice is best ignored and only under very convincing circumstances should it be taken seriously; and then still to be supplemented with one’s own rigorous research as well. The problem with listening to relatives and friends’ advice is that familiarity often means the advice tends to degrade in value, as most friends tend to share hot “tips” and gossip rather than engage in long, boring discussions on valuations of companies (which are more akin to a business meeting – not a scenario likely found among friends or relatives). Friends or relatives may wish to appear helpful and concerned and thus try to “tip” one off on possible investment opportunities. Thus, it is likely that the quantity of recommendations will exceed the quality; an investor will do himself a favour by sifting through the pile and only researching and acting on those which hold more promise.

2) A commercial banker – In these present times, only bank clients with a high net worth of more than S$1 million (sometimes even S$2 million) will be offered a “Relationship Manager” (RM) to manage his or her investments. Commercial bankers these days have the role of RM or Financial Advisors in private banking departments to manage clients with large amounts of money. Thus, it is unlikely that the normal man on the street can receive such personalized advice. That said, the advice given by most commercial private bankers are also predicated upon the recommendations given to them via other departments, which have presumably a team of researchers doing ongoing fundamental analysis on companies worthy of investment. Hence, it is more like an advisor advising an advisor to advise the final client (a case of information passing through more than one channel, and hence probably losing much of its original vigor).

3) A brokerage firm of investment banking house – I think enough has been mentioned in my previous postings about the intentions and ultimate aim of brokerage firms, which churn out reports on a daily basis even when there is no coherent reason to do so ! To summarize, trading is encouraged by brokerage firms as it enhances their commissions, thus encouraging investors to “invest” is sort of shooting themselves in the foot. Hence, most recommendations put forth by such firms are of a short-term nature (e.g. one-year price targets), while others are of a technical nature (prediction of market direction) to encourage frequent trading. Suffice to say such “interested” advice is destructive to the wealth-accumulation efforts of investors, as frictional costs often leave them much poorer. Read more…

Related posts:

1. Personal Finance Part 15 – The Evils of Gambling
2. Personal finance distilled
3. Matrix for Personal Finance Planning