CHG Issue # 174: TRUST

This is a cross-post from?CHG Market Commentary on Substack. If you're subscribed to this newsletter you should consider subscribing for free on Substack to get this when it comes out on Mondays and receive more frequent market updates on?Substack Notes?as well as other exclusive content.

It is a hopeful time of the year and has been a hopeful couple of weeks for equity investors. One of the things we are always striving to do is understand the reasoning and motivation behind what other investors (our colleagues and competitors) are doing. I recently sat in on a talk at the CFA Philadelphia Private Wealth Conference given by Brian Portnoy, PH.D. of Shaping Wealth, and was fascinated by some of the statistics he quoted.

The headline statistic came from a report by Nonfiction titled The Secret Financial Lives of Americans:

64% of people with financial advisors feel like they don't have anyone to talk to about money.

I know lots of good financial advisors and RIAs, and Brian gave this statistic to a room full of them, but it wasn't meant to condemn their work; Instead, it highlighted the complexity of our relationship with money.

Nonfiction highlights several shocking statistics like 52% of Americans have cried at some point in their life because they didn't have enough money. The key word in that sentence is enough.

Consider any individual at any period of his life, and you always find him preoccupied with fresh plans to increase his comfort. Alexis de Toqueville, Democracy in America, Volume II, Book 3, Chapter XXI

What is enough? The report also describes how wealth and social status have always been and can only ever be a comparative endeavor and how today we have social media which is constantly giving us new standards to compare ourselves against. The problem is these are highly biased measuring sticks.

28% of millennials admit to posting to Instagram to make themselves look wealthier than they really are.

?As the Apostle Paul said:

'I do not understand what I do. For what I want to do I do not do, but what I hate I do. ' Romans 7:15

We have created the equality that money is wealth, and wealth drives social status, and social status determines meaning and purpose. Even though we all know this is not healthy, or even true, we find ourselves living this lie and we find the world encouraging us to keep doing it and rewarding us for doing so.

Our frantic scramble for satisfactions and status markers, our haunted search for elusive soulmates with whom to build a life - all of it continually collides with limits that seem arbitrary and test our patience. Why We are Restless, p.170

We see evidence of this tireless struggle for more in our economic numbers. Many financial commentators have blamed the politicized Fed for keeping rates too low and the profligate Federal government for running up too much debt, but both are simply giving their constituents what they want: the means to achieve social status.

People know that they are doing what they don't want to do and are unhappy that they can't find a guide to help them get out of the rat race. Portnoy quotes from a Financial Planning Association report titled "Developing and Maintaining Client Trust & Commitment in a Rapidly Changing Environment":

• Only 49% of clients agree that their planner's financial recommendations are based on client's personal goals, needs, and priorities;
• 50% of clients think their planner is open to discussing what client values most in life; and
• 39% of clients say their planner contacts them on a regular basis to see what changes in life may affect the financial plan.

The unfortunate truth of the matter is that the financial services industry was never created to meet these sorts of client needs. It started out by simply selling financial products which gave customers more investment options than they had before and helped increase financial intermediation. This functionality was primarily for trading and speculation which increased liquidity in the financial markets and supported economic growth. Then the industry expanded to include longer-range planning and the idea of investing through a portfolio of different financial products. The industry not only provided the products but also advice on how to use those products to build a portfolio. As that function grew, 401(k)s replaced defined benefit retirement plans, and the responsibility for securing your retirement was transferred to the public who had never been appropriately educated on how to do that. The financial industry responded by enhancing the allocation service to a more holistic planning service. Now you can go to a financial firm, and they can help you plan for the big life events like college, weddings, and retirement.

As great as these services are the problem is the advisors providing those services are engaging their clients in deeply personal things without the proper education, training, and vocabulary to really talk about money with their clients. Sure, they can decipher the myriads of different products and build a reasonable portfolio for you, but very few are equipped to give their clients what they really need; and they know it!

The difficulty for advisors is it is very difficult to scale the sort of relationships that their clients really want, and clients struggle to communicate or even understand what it is they really want. It is much easier to lend a sympathetic ear to your client and then put them in a 70%/30% portfolio and call it a day. But in doing so we are only putting a band aid to the problem and increasingly clients are coming to this realization and looking for something different.

Elon Musk's plan for the company formerly known as Twitter is to turn it into a so-called "everything app" providing users with not just social networking, but professional networking like LinkedIn, video calling, dating services, and, you guessed it, financial services. Elon isn't the only one. Apple is already disrupting banking with Apple Pay and high-yield savings options, Meta is developing payments services across its platforms, and Microsoft has partnered with fintech firm Finastra to integrate financial services into its ecosystem.

The Nonfiction report highlights that these tech companies are "relentlessly customer-centric" which is a huge departure from traditional financial service companies which we would describe as "product centric." While the tech approach has its advantages it has many disadvantages, the biggest probably being the recent privacy controversies that these firms are struggling with.

The CHG house view is that the root of this problem is the fact that we don't give people the tools and education to navigate the financial system or have a healthy relationship with money. Personal finance literature is inadequate and hardly focuses on the art of decision making, which lies at the heart of the matter. If our motivations are based on false beliefs about how we derive meaning and purpose in life, then the decisions we make will be as transient as our beliefs.

The good news is that this is all changing. We got a glimpse of this during COVID when people actively engaged in the markets and started learning on their own. Sure, this phase gave us meme traders, but the virtue underneath the silly exterior of those traders is that they are taking control of their financial destiny. Instead of passively accepting advice that is not really meant to be advice they started learning and figuring things out on their own aided by the vast resources available online today.

There are so many financial wizards who have gone independent and freely give away what used to be privileged knowledge and wisdom of the financial elite. The vast majority of that have been democratized and the big players find it increasingly difficult to derive alpha from an informational edge. Technology has enabled so many smaller hedge funds, RIAs, independent financial advisors, and individual investors to employ sophisticated strategies that were once only the purview of big institutions with deep pockets.

JP Morgan has a commercial that shows an investor in a portal of swirling financial information and advice. The investor is confused and scared, and the commercial offers to simplify all that complexity with a JPM advisor who can set you on the right path for your financial future. It's a great commercial, but it is only a repositioning of a business model that has become outdated. Financial firms derive much more value from being your trusted advisor than you do, and the numbers in the Nonfiction report prove it.

Why limit yourself to one financial firm when they aren't giving you what you want and don't even try to?

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?In pretty much everything else we consume we shop around, research, negotiate, and demand the best for what we pay for but when it comes to financial services, we stick our heads in the ground. We operate out of fear, trying not to make a mistake, and we end up going with a big firm where there is low risk of getting conned, and even if you do you won't look like a fool to your friends for banking with a big firm. We do this, we are not happy about it, but we can live with it until something goes wrong. Then all that resentment comes to the surface, and we see big social movements, like Occupy Wall Street, form in opposition to financial services companies. These movements come and go like fads but over the years resentment continues to build and people increasingly look for an alternative.

It's heartening to think that when given a chunk of free time during COVID people chose to dive into learning about the financial markets, but the hard part is knowing who is for real and who to trust. We are right back into that JPM commercial with our blood pressure rising as we try to figure out this complex world for ourselves.

As we said earlier, this is all changing; and the future is bright. This letter is part of that change as we contribute our small part by analogizing the markets and life. Life is a universal experience where we can find unity in the diversity and complexity of the world around us. The more we take time to understand something the more likely we are to trust it, and the more trusting we are the less fear we have because we have people in our lives to turn to and rely on.

If you enjoyed this article you can subscribe for free to?CHG Market Commentary on Substack, explore my?Knowledge Base, and find more of my writing at the?CFA Institute's Enterprising Investor Blog?and on?Medium.