Blessed by the Potato

In the comments to the first post on regulating financial advisors someone brought up the issue of regulatory burden: the extra paperwork and delays imposed on businesses. Nicole went so far as to call it “onerous” and “strangling” — and that’s just for the regulation already in place, which we’ve criticized as not providing enough protection.

There are lots of examples of regulatory burden out there, for many stakeholders. I regularly suggest that people go with TD Waterhouse to be able to invest in e-series funds over TD Mutual Funds because of the extra steps and forms needed to fill out and mail in to convert an account and the possible limitations of the KYC forms. I never got my CFP/CSC because it’s just not worth my time to take the courses and exam for what the designations would bring me; if something like that were to be a mandatory requirement to talk to clients about investing and their financial plans that would keep me and several other part-time educators/planners/coaches/DIY-support people out of business.

But a certain amount of form-filling, records-keeping, and education overhead should be expected in any business. The correct amount of regulatory burden is highly unlikely to be zero, and if it brings important consumer protections then that’s a good thing.

However, the way regulations and reporting are structured can have huge impacts on the eventual regulatory burden. Consider for example something I have some experience with: applying for a grant to do some medical research. You could apply to the US National Institutes of Health (NIH) and or to the Canadian Institutes of Health Research (CIHR). In both cases the basic document outlining the experiment you’re looking to fund would be say 13 pages. On top of that you’d have a detailed 5-year budget and a justification for the funds you were seeking, a half-page lay summary for the funding agencies to release to the press or the elected government representatives, and some kind of CV to demonstrate that you had the experience and ability to carry out the research you proposed.

Now both funding agencies take very seriously the protection of research participants and have fairly similar rules and regulations in place for that protection, but the implementation and regulatory burden is night and day in my mind. In Canada, your grant would now basically be complete: CIHR’s protection of research subjects rules are separate from the grant process, and all institutions sign on to it before they can enter a competition. They know that any research is going to be reviewed by a research ethics board that meets their standards, and will get a copy of the approval before releasing funds (if you’re successful in the first place). If the experiment calls for anything terribly out of the ordinary, then it’ll have to be explained in the proposal anyway. Compare this to the US, where the proposal part of the grant submission is almost like an afterthought to the stacks of appendices and tables that have to be filled out — including some that no one really seems to understand (including the NIH help staff I’ve spoken to), where you have to predict the racial breakdown for any proposed study (how many whites, blacks, asians, etc. will you recruit), but then also the “latino/non-latino ethnic breakdown” (how many latino asians vs non-latino asians will you include in your study??). It’s stressful and confusing (Spain and Portugal aren’t included in the countries of origin for people considered hispanic?) and totally bizarre (why do they care about this stuff? Will they really reject my grant over this?). For basically the same mandate and ultimate protection of research subjects, the regulatory burden is quite different between the agencies because of how they approach the problem and where they place the reporting requirements. By having so much paperwork up at the application stage it creates a lot of work for the ~80% of NIH applicants who will not get their grants funded because the scientific component wasn’t competitive enough for the severely limited funds.

Also, some protection comes with virtually no on-going regulatory burden. The Residential Tenancies Act sets out many protections for tenants, but aside from modifying what you can put into a lease there is no paperwork for landlords or tenants to fill out in the regular course of business beyond what you’d need anyway. Indeed, you get some of that for better than free: by standardizing certain terms, responsibilities, and practices they don’t have to be separately negotiated and drawn up in a lease. Everything is handled on an enforcement basis: only after a problem arises does someone end up having paperwork to fill out. Now at that point it can be very onerous (dealing with the LTB is no picnic, especially for landlords), mostly due to the delays involved. But for most people most of the time, it’s reasonably strong regulation with little overhead cost.

So I think that implementing a better model for financial advice and regulation thereof can be done in a way that minimizes the regulatory burden. It’s something that can and should be kept in mind as a new regulatory framework is thought out (especially the implementation aspect), and kept in balance with the benefits.

Sometimes being mean can be fun. No, that’s not right. Sometimes when I’m having fun I can come off as mean. I don’t aim to be mean, so this is a tough blog post to approach because that is just about all I have to offer. Let us pretend that I have been possessed by Greg McFarlane and this is a guest post FRotM: Book Edition.

A little while ago I got a piece of email that I ignored as being basically spam: a request to review and blurb a new book (actually titled: “A Free Investment Book for You”). Pitched as “a “How to” guide to obtaining compound returns of 20 percent, 30 percent, or more annually from investing in stocks and to do so in a manner that’s worry-free for the investor.” and “The Sane Approach to Investing in Stocks for Insane Profits.” I decided to be nice and junk it. That kind of pitch turned me right off: it looked like it was either not refined enough to know it’s contradictory, or a scam.

Then he followed-up. Clearly this was a real person and not a robot emailing me, so I wanted to put him out of his misery. This is what I sent back:

“I don’t think I would be a good choice for you as a reviewer/blurber. I don’t think 20-30%+ returns and “worry-free” can be put together like that, so seeing it as the central part of your message is troubling. I work as an editor so my reviews tend to be critical in the first place, and starting off on a bad foot already might not lead to a review you would like.”

He still wanted to send me a book, calling me “an excellent candidate for reviewing my book… my desiring your participation at this stage is a testimonial to the respect that I have for you and your work.” Ok kid, flattery will get you everywhere. I got the book. I read the book. I was open to having my mind changed: maybe it was a good investing book and he just needed to work on his email marketing. Alas, it was about as bad as I feared, shy of not advocating that readers borrow money from friends or remortgage their houses to invest.

Rather than tearing into it wholly, I just want to pick on one specific part: those worry-free 20-30% returns. In the book he lays out the 10-stock portfolio that brought him a 128% return in under 5 years. He compares that to just 45% on the S&P500. But that is a mistake. This is basically a giant case of getting a little bit lucky with stock picking, and a lot lucky with timing. He bought in 10 chunks through the end of 2008 and the beginning of 2009 — yes, he just happened to start investing at a generational low in the market that was followed by a massive, unrelenting bull market. No wonder he thinks 20% returns are worry-free. Anyway, it looks like he’s comparing his portfolio purchased across several time-points that span the market lows to a single time-point for the S&P500 from before the Lehman Bros event. It was easy enough to look up the S&P500 total returns and compare an index portfolio that made purchases on the same dates as he did, and the actual comparison would then be 104%. Yes, his picks out-performed, but it’s not nearly as impressive. Oh, and most of those same picks were hit way harder in 2008/2009 than the index was, so if there’s a repeat then so much for the “worry-free” part.

Then he lays out a second 16-stock portfolio that only has a bit over a year of tenure. He boasts a 29.6% return versus the S&P500 at 26.3% [figures not audited]. Yet that portfolio includes one position that just so happened to return 243% in a year. Exclude just that one outlier, and the portfolio underperformed. By a lot. Sure, sometimes that’s how investing works, but that’s not the kind of track record you base a book around (and again, hoping for a single lottery-ticket-stock to pay off while almost half your portfolio declines in an amazing bull market year is not my definition of “worry-free”).

I cannot in any way recommend this book — I haven’t even mentioned the title because I feel bad for the kid, and I don’t want this to be the only review that comes up in Google. But I warned him, and he asked for the review anyway.

Now he did start off by thanking his editors (amongst others), and on a micro level it’s a fairly tight text. With my own self-interest in mind paying for a few editing passes can help make a book more digestible (especially a self-published one). Unfortunately, the over-arching shortcomings cannot be saved by layout and grammar. It really needed a peer review — and some robust back-testing — before being sent off for a copy edit as the basic premise appears to be flawed, based on a mistaken return comparison and a great deal of luck. Though mentioned often in how the book was presented, the issue of worrying and freedom thereof was not covered.

Page distribution:
Completely blank, not even page numbers (colouring fodder for your young daughter!), 10%.
Small investing nuggets not even fleshed out enough for a blog post (e.g. 431 words on coattail investing does not blow me away with content), 30%.
Specific information* on companies found in a stock screener that will be instantly out-of-date in book format, 25%.
Index (the kind to look stuff up, not the S&P500), 4%.
Drivel, 7%.**
The purported approach/method/secret, 2%.***

* – Includes estimated future EPS growth rates to two decimal places, though all the percentages round precisely to X.00% so I don’t know why the digits were necessary in the first place.
** – Harsh but accurate summary.
*** – Totals may not add to 100% because math is hard and fact-checking is for losers who don’t have insane profits to chase. Also, yes, depending on how liberal you want to be on what counts as part of the approach versus general rehashing of Warren Buffett quotes, just ~2% on that topic. Spoilers: use PEG, buy when below 0.75-1.

In the last post we talked about the importance of regulation: to create an environment where a non-expert, without the ability to independently evaluate an expert, can come to trust a complete stranger because of the regulations and mechanisms in place to create and maintain quality and ethics. There are lots of examples of industries and professions with varying degrees of regulation that we can learn from.

Car salesmen are regulated (OMVIC in Ontario). The regulations set some minimum standards for disclosure and how prices can be advertised: it’s not especially strong legislation (for instance, the dealer does not have an obligation to work in the best interest of the customer), but then the general public understands explicitly that the car salesperson sitting across the desk from them is in a sales role. They don’t couch themselves as “transportation advisors”, and if you went to one you would know that they would try to sell you a car (and you would not walk away with a recommendation for a bicycle and transit pass even if those might suit your situation better). They might be able to help you pick a particular car that’s suitable: compact over a truck, but even then you know that if you walk into a Chrysler dealership with a need for something fuel efficient you won’t be driving out in a Prius or Leaf: the best they could do is a 4-cylinder gasser that their dealership sells. To my mind, this is most analogous to the current MFDA designation in the financial sphere, but without the universal, mutual understanding of the sales and commission-driven nature of the role.

Some trade organizations exist more to protect their members and a monopoly than to protect consumers and build trust with the public. Since it’s been a while since I’ve done so, let’s pick on realtors: there are minimal barriers to entry, and no formalized processes to manage conflicts-of-interest (except for those set up at individual brokerage offices). There is a dispute mechanism, but from casually looking at cases and allegations, they seem to take realtor-on-realtor aggro way more seriously than allegations of misleading or mistreating the lay public. In other words, CREA/TREB is not a model I would want to copy: the initial quality standard is not rigourous, there’s no continuous improvement, there’s next to no policing or efforts to maintain the public trust: it appears to be a trade organization out to serve its own interests.

In cases where the decisions are literally life-or-death the regulatory body tends to take a more active role. Medical physicists for instance are responsible for calculating radiation doses in cancer therapy and ensuring that the machines are accurately delivering the doses prescribed. Over-dosing can kill through radiation effects, underdosing can allow cancer to proliferate. The Canadian College of Physicists in Medicine requires a graduate degree in one of several related fields, a fellowship program (education), examination, continuing education, periodic re-certification, and practice reviews.

Banking, at least the deposit-taking part, is a highly regulated industry. Not just anyone can rent out a space with marble pillars and a vault and call themselves a bank. Because trust is essential to preventing a run on the banks, a government-backed insurance scheme (CDIC) is in place to guarantee that if all of the regulations and oversight somehow still manages to fail, depositors will get their money back (up to a limit of $100,000 per account). Now, that’s not to say that a bank won’t ding you with service charges or sell you services you don’t need — they walk a fine but well-defined line of trust and conflicting interests for sales.

Franchises are not something handed down by the government or enshrined in law, yet by building strong brands people know that stopping at McDonald’s or Subway for a meal will provide a fairly uniform meal experience — they can trust that even in a strange city far from home that they’re going to get what they expect. It’s a way of accomplishing the end goal of letting someone with no easy way of independently evaluating quality to walk in off the street and know that they’ll be in good hands.

So what would I like to see? I think good regulation will be stronger and faster* than building up a brand/franchise, though the end result might be better that way as an organization shooting for excellence doesn’t have to play to the lowest common denominator. Either way, I think getting rid of embedded commissions and their inherent conflicts-of-interest and obfuscation is the first step: it’s an uphill battle for education and standards if that basic component of the business model isn’t fixed first. We could follow the UK and Australia in that direction, and it will be interesting to see how their experience plays out over the next few years.

Either way, training and examination requirements at the start, including an ability to explain how fees work, the impact of fees, cash flow planning, and managing behavioural issues. Explaining risk at some level is necessary but is tough because even experts have trouble defining it precisely — perhaps just understanding that there are aspects of risk. Levels or specializations of certification, and an understanding that some situations should be kicked up the chain. Re-examination, auditing of practices, and other systems to keep quality high. And a correction mechanism: some way to feed back new or unresolved problems back through continuing education, to arbitrate disputes, and compensate customers who were wronged.

The regulatory body should ideally be separated from the body that looks to maintain a monopoly or promote the profession so that it can be client-serving and not self-serving. Because it can be confusing as to what the responsibilities of the advisor are (especially if a term like “advisor” is used), someone (who?) should make it clear to the public what the relationship is, possibly disclosed up front (“Hi, I’m a salesperson and I do not have a responsibility to do what’s best for you, just to make my commission and not recommend something egregiously bad. Let’s look at a 7-seater, shall we?”).

Unfortunately I still haven’t had a chance to read the private member’s bill in Ontario so this might all be covered already.

* – from implementation to helping people. It will likely be slower to be crafted and passed in the first place.

A little while ago a social media guru in our pubic affairs team said that you had to maintain a “presence” on Twitter by posting at least three times a day. We just wanted a place for people to get updates on a new project, which with lecture announcements might mean one quantum of content per month.

John Scalzi said that he was culling his follow list by removing the people who rarely tweeted.

I don’t get it. I check my Twitter feed about once a day, and though I only follow 36 people my screen is always full. Those accounts are carefully curated so that I usually want to read to the end of a day’s updates — but the general signal-to-noise on Twitter is atrocious. What finally got me to write this rant was friend of the blog @barrychoi tweeting about a new post on his blog eleven times in a single day! When people have really active Twitter accounts, especially with high levels of noise (like live-tweeting just about anything in depth, or just seeing half a conversation) it really turns me off. Following a couple dozen accounts like that and unless I just camped on the Twitter app I would start missing content — even at a miserly 140 characters the tweets add up.

And maybe that’s the problem: so many people are so swamped by the uproarious nature that they just sample their Twitstream at random intervals, which forces people to re-post their tweets again and again hoping to catch the eyeballs of their so-called subscribers, which exacerbates the high noise level. Ugh, that’s just not a game I can play.

Maybe it’s because I use the default web-based interface rather than a 3rd-party app with more capabilities (i.e., doing it wrong). I believe the way people use Twitter is to politely follow anyone who follows them first, then mute them with the list functions of the 3rd-party apps. Or else there’s something I’m just not understanding about the whole thing — which is likely given how incredibly difficult I find expressing anything in 140 characters. Seriously, my whole stream is basically poor-man’s-RSS announcement of new posts, and tweets full of [1/3] multipart markers.

As long as I’m ranting: hashtags are really annoying. When used sparingly they can be used to tag tweets, particularly when trying to tag that tweet to something in particular that might not show up in a general search (such as #becausemoney for questions and commentary directed at the podcast). But just adding the symbol in the middle of a sentence makes it harder to read and doesn’t help at all with the intended function — no one is out there searching for highly generic terms like #money or #Canada… and if those words were in the tweet anyway a search would pull them out without wasting a character and reducing readability. Without careful, conscious application, hashtags just become more noise. Oh, and “via” means “by way of; by means of” and is usually used to indicate who sent you a link you’re passing along to your followers — putting via [yourself] is like talking about yourself in the third person, it’s weird and off-putting.

CBC Marketplace recently ran an episode looking at financial “advisors”, sending a woman in to several with money to invest and a hidden camera that has made some waves. Some advisors were ok (which of course didn’t air), but there were some that were just atrocious. They provided shockingly bad advice, or couldn’t answer simple questions about how much they were paid and what fees would be.

I don’t know how the advisors were selected: the show gave the appearance of picking randomly from large firms, but they may have been tipped off about bad ones in advance. The industry has tried to couch this as just a case of running into a few bad apples, but as Sandi says, that’s a load of bull and lets them continue to get away with a broken model for the industry. Some of them were so bad that a bad apple metaphor doesn’t cut it, but rather one with a grenade in it. That should never have happened.

Yet such incredibly bad advice is not so unusual — the system and the major firms do not set a high bar for financial advice.

This is a major issue. Financial advice/planning has a large impact on people’s lives, yet conflicts of interest abound and problems take years to show up. Moreover, people who need advice largely do not have the ability to evaluate the quality of their advisors (even with the benefit of hindsight), so recommendations from friends are basically useless. Combine all that with hidden and confusing fees, and this is an industry that cries out for regulation. A we-can-do-better retreat and voluntary code of conduct is not going to cut it.

Regulation can come in many forms: the government can step in to regulate from the top down, or industry groups can self-regulate. Often a hybrid emerges, where the government will help legally protect a professional title, and members of that organization will self-regulate.

Right now, the conflicts of interest inherent to the existing salescritter-cum-advisor model are making it to the public consciousness. That erodes trust in the whole system, yet there’s very little in place to replace it.

Here is the central issue as I see it: the system needs to be reformed so that someone with no knowledge and no way to evaluate quality in advance can go to get advice from someone and trust in that advice (and get reasonable value for the fees that they pay while they’re at it). And really the best way to build trust for the lay public is to have a trustworthy expert give the thumbs-up — that is, regulation.

What does good regulation look like? There’s some kind¹ of quality standard set, with a mechanism to get it there in the first place (training, examinations). There’s a mechanism to maintain quality, through reducing conflicts-of-interest; ongoing training and continuing education; ongoing oversight, evaluation, and auditing; and even formalized specializations. And a way to make things right when the few bad apples inevitably get in: dispute resolution mechanisms, compensation funds. In return, a profession gets formalized and protected credentials and naming rights. Culture is important: a focus on ethics and client needs, on openness and honesty.

Not every element is required there. And government isn’t necessarily required: creating a brand that people can trust can also work. That can be a faster approach to get started, but doesn’t carry as much weight without the government behind it. In the next post I’ll look at some examples of professions that are out there now and how they are regulated. In the meantime, check out this week’s BecauseMoney podcast where I discussed this issue with hosts Sandi Martin, Jackson Middleton, and special guest Noel D’Souza.

1- actually the quality standard itself is important too — it should serve the right people (i.e. the public rather than the banks), have associated metrics, be achievable, consider structural issues and conflicts-of-interest, etc.