Why would a stockbroker leave the office for lunch and end up spending the afternoon at a movie theater watching a Clint Eastwood triple feature? It’s hard to imagine a broker abandoning work in the middle of the trading day, but that broker was me. To understand what drove me into that darkened theater, you need to know what I was going through at the time—and how that experience contributed to one of the most important lessons I’ve learned during my 50+ year career in finance.

My fascination with the stock market began when I took my first investment class at Wharton Business School in 1967 during my MBA program. Investing was a new world to me (my father and grandfather weren’t investors—they both had pensions), and from that day on I wanted to learn as much as possible. I read investing books, followed the market’s movements in the newspaper and on TV, and listened to many so-called experts. It’s no surprise that this interest led me to a career in the investing world.

Along the way, though, I discovered that most of what you hear and read doesn’t teach you what you need to know to be a successful investor in the real world. Too often, investment “advice” is focused on specific products, like the stocks or mutual funds, or annuities, that someone wants you to buy. However, you can’t make sound investment decisions and manage your emotions without a grounding in the principles that lead to financial success. For me, I had to gain that knowledge through experience.

Some of those experiences were painful and humbling. Others were empowering. Now, more than 50 years into my journey to become a better investor, I want to share some of these stories and their lessons. I hope you can take something from my experiences to help put you on your path to investment success.

Investment class at Wharton—1966

A particular moment from my first investing class at the University of Pennsylvania made a big impression on me. One day, our professor asked us to calculate how much money we would have at retirement according to the following assumptions:

• We saved 10% of our starting salary the first year after graduation and continued saving 10% of our salary for the next 40 years
• Our salary would grow by 5% a year
• Our investments would earn 10% a year

I assumed a starting salary of $12,000 (which was a little optimistic—it turned out to be about $9,000), and then I began doing the math. We did not have computers back then, so I had to use manual calculations to work through all the figures. When I was done, I had an ending value of $1 million at age 64 in 2007.

I remember thinking this had to be a mistake. A million dollars was practically unheard of back then unless you were very wealthy.

I checked my work and got the same result. That’s when I realized that it was possible to become a millionaire by age 65 with a couple of reasonable assumptions—and a disciplined saving and investing strategy.

Lesson Learned: Compounding works wonders if you let it work.

Every retirement guide will tell you that starting to save early and keeping it up is the key to success. But it can be hard to stick with that approach because you must be willing to delay your gratification and ignore the noise around you – good and bad.

Investing doesn’t reward you consistently year after year. Some years you might not make much progress; other years, you might fall back a bit. Likewise, compounding isn’t exciting from one year to the next. Over long periods, though—like the 40 years you might spend saving for retirement—it’s going to make a big difference.

Clients and team members I work with have already experienced what compounding can do. They’ve been saving and investing for long enough that they can look back to where they were 20 years ago and be satisfied. Those of us in this fortunate position can help our younger friends and family members grasp the power of compounding.

When my granddaughters were around ten years old, I explained the Rule of 72 to them. It’s an easy way to quantify the benefits of compounding by calculating how long it takes for your savings to double. You divide the expected annual return of your investments into 72. For example, earning 10% per year means you’ll double your investments roughly every seven years, or six times over a 40-year career.  And remember, compounding continues to work even after you retire—so your savings can double a few more times in your lifetime.

Check back each month for the next lesson from Rick Hill’s long view career.

You might have seen articles making equity returns predictions for the next 5, 10, or 20 years. These predictions often forecast dire conditions, which in turn get the reader asking questions like “Is this true?”, “Should I be worried?”, “How should I use this information?” When reading these articles, it’s essential to step back and think about what we can control, what we can’t, and how we should act with that knowledge in mind.

Are these predictions accurate? No one knows. Equity markets are volatile, and the timing or magnitude of returns is tough to predict. Even experts have a terrible track record of reading the tea leaves and investing based on their predictions. Said differently, even those who get it “right” don’t get it right all the way. A common source of error is timing. A famous example is Robert Shiller, credited with “predicting” the 2008 housing market crash with the phrase “irrational exuberance.” The problem? He made that claim in June of 2005, and the market continued to rise for another three years. By the end of 2010, within two years of the crash, global markets on average were once again higher than the June 2005 levels and have remained higher ever since.¹

Should you worry? Since you can’t control near-term future returns, there is little benefit to trying to predict or worrying about them. However, based on the past 100 years or so of market history, we can be generally confident in the long-term future of positive global equity returns. This is because investing in equities involves taking risks, and investors would not take that risk unless they expected some positive return in exchange. Moreover, we know from the past that the range of short-term outcomes will be broad: sometimes positive, sometimes negative. Knowing that short-term results can vary may sound like a bummer, but it can help us build confidence (read on to find out how). 

How can I use this information? Using historical returns, we can determine how much investors, on average, have been compensated for investing in equities over the long term. We can also understand something about the range of possible outcomes over shorter periods. This info is useful when constructing your financial plan. 

At HIG, we can perform an in-depth analysis that includes the financial factors you can control, like saving and spending, and the ones you cannot, like market returns and inflation. Our team uses a sophisticated statistical tool that runs thousands of simulations to determine a range of different potential outcomes for your specific situation. Comparing this range to your goals can give you a sense of your personal “odds of success.” When the analysis shows >85% probability of meeting your goals, we find most clients are comfortable that they are on the right track. The benefit? Confidence. You can focus your time on what’s truly important and ignore the crisis of the month. In other words, we have your back.

If you would like to talk more about this, our CIO office hours are open. Feel free to schedule a 30-minute call.

Forbes writer and TLV podcast guest John Jennings wrote a piece comparing the norms of the wealth management industry to the seven deadly sins. Because we have seen these sins committed regularly and built our firm to avoid them, in the spirit of clarity and transparency we feel that it’s our obligation to our clients and friends to make sure that you are fully aware of them. Read his piece below.

The Seven Deadly Sins Of Our Industry

By John Jennings

In his investment book “Where are the Customers’ Yachts?” Fred Schwed opens with the story that gives the book its title:

Once in the dear dead days beyond recall, an out-of-town visitor was being shown the wonders of the New York Financial District. When the party arrived at the battery, one of his guides indicated some handsome ships riding at anchor.

He said, ‘look, those are the bankers’ and brokers’ yachts.’

‘Where are the customers’ yachts?’ asked the naïve visitor.

Although the wealth management industry has evolved since Schwed’s book was published 81 years ago, the underlying issue remains: it is first and foremost a money-making machine for those who work in the industry. This doesn’t mean the wealth management sector is made up of bad people (I’m one of them!) but rather that their incentives aren’t usually aligned with acting in clients’ best interests. Like Upton Sinclair says, “It is difficult to get a man to understand something when his salary depends upon his not understanding it.”

According to Roman Catholic theology, the seven deadly sins are the primary feelings or behaviors that inspire further sin. The misaligned incentives of the wealth management industry roughly correspond to those deadly sins, and knowing them is essential to being a wise consumer of financial services. Once you understand what drives the wealth management industry, you can better choose which advisors to work with, evaluate their advice with clear eyes, and push back as necessary.

The seven deadly sins of the wealth management industry are:

1.    Advisors are incentivized to provide the least amount of service possible (sloth). An investment professional I know who works in the trust department of a large bank told me that a common refrain at their bank is “don’t wake the dead.” In other words, don’t call clients unless they call you first. There’s a fundamental tradeoff in any business between customization and scalability. And it’s particularly acute in the financial services industry. Wealth management firms are incentivized to scale rather than customize because the more clients they can serve with limited people and resources, the higher the profits. By ignoring clients and being reactive rather than proactive, advisors can handle huge client loads, collect more fees and increase firm profitability.

2.    Advisors spend most of their time looking for their next client (lust). Years ago, I interviewed an advisor from a global investment brokerage who was looking to change jobs. When I asked why he was interested in our much smaller boutique firm, he told me he went into the financial services business to help people but doesn’t get to do that much. “About 80% of my time is spent on business development, and only 20% on actually advising and helping my clients,” he said. Unfortunately, this is common in wealth management firms because they’re structured so that advisors “eat what they kill.” To make more money, they must constantly obtain new clients. As a result, most advisors spend most of their time wooing new clients instead of caring for those they already have.

3.    Most advisors are compensated based on revenue and profitability, making them view clients as profit centers (greed). The compensation structure for most financial advisors creates an inherent conflict of interest that can lead to bad advice. For example, while reviewing the portfolio of a new client, we noticed he had a substantial margin loan. When we asked about the purpose of the loan, he said his previous advisor had recommended he use a loan rather than sell investments to fund his living expenses. Considering that the advisor was compensated based on a percentage of this client’s invested assets, this advice was suspect. By recommending a margin loan, the advisor not only maintained the full level of fees from the client’s investment assets but also earned fees on the loan.

I’ve also seen advisors discourage clients from making lifetime charitable gifts because it would reduce the assets under management and, in turn, the advisor’s fees. Or they use a higher fee mutual fund even though the fund has a lower fee share class because they make more money from the higher fee one. Similarly, many investment firms sell structured products like hotcakes because they are very lucrative for them but not necessarily for their clients. These are just a few examples.

4.    Wealth managers introduce needless complexity to justify their existence (wrath). Investment diversification is essential, but most portfolios are stuffed with way more funds than is needed. Why do advisors use five funds when one would suffice? A primary reason is the Shirky Principle, which holds that “institutions will try to preserve the problem to which they are the solution.” If advisors design simple portfolios, why would their clients need them?

I experienced this first-hand at a seminar for investment professionals who work for family offices. The 40 of us were divided into six investment committees and tasked with recommending an investment strategy for a hypothetical client family that had recently sold its business for hundreds of millions of dollars. The first five investment committees presented similarly complex portfolios with allocations to muni bonds, taxable bonds, high yield bonds, distressed debt, equity index funds, actively managed funds, growth and value funds, large and small-cap funds, developed and emerging markets international funds, hedge funds of various styles, private real estate, venture capital, and so on. Their pie charts were colorful and had many slices. By contrast, our investment committee, which presented last, proposed a portfolio of two funds: a muni bond fund and an index fund that tracked the global stock market. At first, the other participants were incredulous. It seemed crazy to suggest such a simple portfolio. But when our committee asked who was confident their complex portfolio would beat our simple one, no one raised their hand. A chief investment officer for a multi-billion-dollar family office noted that the biggest problem with our portfolio wasn’t its likely after-tax performance but that he’d have to fire his staff of 10 investment analysts and possibly himself.

5.    Most advisors won’t say “I don’t know” (pride). The economy and stock market are inherently uncertain. Pandemics, boats stuck in canals, major pipeline hacks, terrorist attacks, Elon Musk tweets, and a host of other unpredictable events affect the economy and financial markets. The wealth management industry typically responds to all this uncertainty with overconfidence. Predictions of what the stock market will return and how clients should shift their portfolios are the rule rather than the exception. Yet investment professionals’ track records show they are terrible at making these predictions. But they continue to do it anyway. Why? One reason is that they think their clients expect them to have all the answers, so they don’t feel comfortable being honest about not knowing what will happen in a financial system that’s inherently nonsensical. But which do you think is better? Investing in flawed predictions or constructing portfolios with the recognition that the future is uncertain?

6.    Lack of transparency about fees (gluttony – sort of). This wealth management sin is more dishonesty than anything else, but it’s driven by gluttony: the desire to feed the endless craving for more fees. Even if your wealth management firm clearly states their management fee, such as a percentage of assets under management, figuring out the total fees you’re paying is tough. Underlying investments also charge fees, which can take some digging to figure out. For example, when we became the family office for a client whose investments were spread across several large banks and brokerage firms, one of our first projects was to find out how much he was paying in total fees. When we asked the relationship managers at the investment firms, they didn’t know or were reluctant to tell us. It took one of our junior analysts hours of pouring through fund prospectuses to arrive at an answer, which was that our new client had been paying fees much higher than he realized. Because high fees are a significant drag on investment returns, doing this calculation is essential.

7.    The tax drag of investments is treated as secondary or ignored altogether (not exactly envy, but it’s the only deadly sin left). Like fees, taxes weaken investment performance. In fact, they’re typically greater than or equal to the total investment management fees. Yet, the wealth management industry tends to pay lip service to the tax drag on a portfolio. They use sophisticated software to track investment performance, but tax drag isn’t something they report. It takes work to figure out how much tax is generated by various investments. Advisors may use portfolio turnover as a proxy for tax efficiency, but that’s only a rough estimation. Assessing the actual tax drag requires looking through a client’s 1099s or tax returns. Considering the impact that taxes have on returns, this is a massive industry oversight.

What To Do About the Sins
Most advisors aren’t sitting around the office thinking of new ways to underserve and overcharge clients. Rather, the seven deadly sins are subtle; advisors serve multiple masters, and clients aren’t usually at the top due to misaligned incentives.

As a financial services consumer, the most effective thing you can do is choose an advisor at a wealth management firm that has structured itself to minimize the seven deadly sins. To do this ask prospective and current advisors questions such as:

1.    How does your firm make money? Do you receive any income from products? Any indirect compensation from any other financial firm?

2.    How are your people compensated, and on what metrics is their compensation based?

3.    What metrics do you use to assess client profitability?

4.    How many other clients does my advisory team serve?

5.    How do you incorporate tax efficiency into your portfolio recommendations?

6.    Will you provide a completely transparent report of all fees that my portfolio will incur?

The answers to these questions will reveal to what extent your relationship with your advisor will be negatively affected by self interest. You work hard for your money and deserve to have a yacht, too.