Are financial advisors a scam? Dilbert’s Scott Adams thinks so. In a blog post earlier this week, Adams argues that stocks are negatively affected by risks being overstated due to poor results from financial advisors. According to modern financial theory, the Price to Earnings (PE) we are willing to apply to a stock is correlated to its risks versus other assets. In a situation where stocks and bonds are expected to provide yearly returns of 10% and 5% respectively, depending on how much riskier stocks are versus bonds, affects how high or low a PE will be.
According to Adams, the greatest barrier in decreasing risk in stocks and increasing PE values are financial advisors. As research has shown, over time professional advisors underperform the market, leading to an overall situation where risks in the market are greater than they really are due to the participation of poor advisors. Adams argues that removing them would lead to higher sustained values and returns for equity investors, or in his words, “So my suggestion for permanently lifting the value of the stock market to new sustainably high price-earnings ratios is to pass a law making it illegal to offer financial services without disclosing the truth – that they are mostly a waste of your time.”
Adams goes on to state that governments should step in to create better labeling of financial advisors, in the same way they have done to cigarettes, stating, “The financial industry as it stands now is the world’s biggest scam, and most of us agree that the government is the right agency for rooting out crime, pyramid schemes and the like. And I think most people would agree that putting warning labels on cigarettes, and nutrition information on food, has served us well. It’s time to do the same with investment advice.”
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Disregarding economic arguments that are sure to be created against the theory that removing financial advisors will lead to expanded PE values, Adams’ rhetoric of questioning the need of financial advisors, money managers, or whatever we want to call them is sound. His opinion isn’t new and is among the central reasons why Vanguard, and their array of index-based funds, has become a $2.4 trillion behemoth and the largest fund manager in the world. It has also led to ETFs and basket investing becoming one of the more notable areas of venture funding over the last two years. So-called ‘Robo’ investor funds, such as Betterment and WealthFront, which provide automated long-term investing use ETFs as their choice for allocating funds. Similarly, Motif Investing and Quantopian has taken the ETF approach and offers customers the ability to create their own baskets of stocks to take advantage of an investment trend in the market.
Beyond just products, regulators also appear to be paying attention. In the UK, over the past year, the Financial Conduct Authority (FCA) has investigated the risks involved with copy and social trading, as well as conducting analysis on broker transactions. Similarly, after witnessing hundreds of foreign firms create suspicious financial operations using their foreign-based incorporation status, the New Zealand Financial Markets Authority (FMA) created an overhaul of their registration standards to weed out firms without proper compliance and accounting standards. While not specifically targeted towards financial advisors, since the 2008/09 financial crisis, actions from regulators show that they have become more suspicious about the practices of brokers and traders. Ultimately, as this trend continues, it has the power to increase public awareness of the risks involved with ‘expert’ investors, which could rotate more investors away from the professionals and towards non-managed index like investing.
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