Iron Capital Insights

  • Iron Capital Insights
  • March 31, 2011
  • Chuck Osborne

Irrational Investor Behavior

Over the years I have written a great deal about the various problems in my industry. I have discussed the flawed structure of the retail brokerage world, the lack of training of the vast majority of “financial advisers,” the layers and layers of fees, and the conflicts of interest. I also have discussed the psychological mistakes investors make – the desire to fit in, which leads to following the crowd into asset bubbles, and in some cases scams; the desire to not admit mistakes, which leads to holding on to losers far too long; and the overconfidence in investing in areas where one feels comfortable, which leads to under-diversification and the taking of undo risk. I have written about all of these issues and more.

However, not until this week had I seen evidence of how much these phenomena collide. Somehow I got on an email list for an industry newsletter called, originally enough, “Investment News.” Usually its content is nothing but garbage, but this week a title caught my attention: “Advisers Not Charging Enough.” The article was based on a study by a software firm PriceMetrix Inc., which provides practice management software to the adviser community. They studied the fee arrangements of fee-based financial advisers and found that there does not seem to be any rhyme or reason to the fees charged.

PriceMetrix said that finding was their biggest surprise, but that is not a surprise to me. What was surprising – in fact shocking – to me was a statement made by Doug Trott, CEO of PriceMatrix, who said, “Those advisers doing the most business tended to charge more.” He went on to discuss the difficulty advisers have in raising their fees, and here was another shocker: the advisers who were successful at raising their fees were the ones who charged more than average from the start. An even bigger surprise: advisers who raised fees opened 25% more new accounts than advisers who lowered fees. Mr. Trott’s advice to advisers, “The message from the data is that advisers should charge more.”

Relax. Iron Capital is not about to take Mr. Trott’s advice. We have set our fees based on the hurdle rate we believe we can get over to achieve our goal of providing you with market-beating investment results over full market cycles. Nothing kills returns like fees, yet the retail investor still seems to be blind to them.

It has always been shocking to me how people choose an adviser. We have been very fortunate at Iron Capital in that we are the largest fee-only adviser in Atlanta even though the other firms in the top-ten have been around a lot longer. Still, if one were to ask me about the hardest part of my job, I would say it is getting new clients. I have always been amazed at how people like Bernie Madoff were able to gather so many assets running a scam. Yet it is not just the Bernie Madoff’s of the world. I have recently been talking to some people interested in joining Iron Capital. Their firm has fallen apart, largely because one member of the firm put several of his clients into a ponzi scheme. The people to whom I’m talking had nothing to do with it, but you know the old saying about one bad apple. What is amazing is that the bad apple also was the biggest producer in that firm. The nicest, most honest guy in the firm? You are correct, he was the smallest producer.

People make financial decisions for all the wrong reasons. One of our biggest competitors in Atlanta begins every sales pitch by telling prospective clients who their biggest client is, and he is a famous, very successful businessman. Of course, no one should ever make an investment decision based on what someone else has done, but it happens all the time. An important side note here: Iron Capital considers our private clients private, and not only because selectively disclosing client names is against SEC regulations, but also because it also goes against the trust our clients have placed in us.

Investors should look for an adviser based on several important criteria:
• Background – have they ever managed money? The vast majority have not.
• The structure of their business – true independence and a fiduciary relationship.
• Their investment philosophy – does it match yours?
• Their track record of success across all of their clients, not just one star client.

Investors also should pay attention to the total cost of their portfolio. Based on what we have seen in competition, Iron Capital’s total cost is much less than anyone else we have encountered. This is not because we desire to be a low-cost leader or some kind of discount operation. Exactly the opposite is true; our service is greatly differentiated. Our cost structure is this way because our goal has never been to impress, or to gather the most assets, or to make more money than our overpaid competitors. Our goal always has been to deliver the best investment results, and if that is your goal, you try to keep investment costs to a minimum.

Some days I feel ashamed of our industry. Mr. Trott’s findings were bad enough, but to react by saying advisers should just go along and raise their fees because they can, taking advantage of irrational consumer behavior, is truly disappointing. I have a better suggestion: Let’s try to educate the consumer, not take advantage of them.

Chuck Osborne, CFA
Managing Director