Loss of Confidence

There’s a striking similarity between the current state of affairs in government and our financial system: Both are paralyzed by gridlock and in desperate need of regaining credibility. Voters and investors are losing confidence.

The Congressional supercommittee’s inability to address government spending is only the latest failing by our nation’s leaders. Likewise, the financial system’s refusal to remake itself after the trust-busting financial crisis is equally disheartening.

On Wall Street, it’s exasperating that it’s still business as usual. Big banks and wirehouses continue to create wealth management programs that place asset gathering and the firm’s profitability ahead of the interests of clients.

They’re still missing the boat on the most fundamental tenent of wealth management: If it is good for your client, it will be good for your business. Meanwhile, Wall Street is trying to actively torpedo any reform by dismantling Dodd-Frank and other protections for taxpayers and investors.

It’s no wonder the Occupy Wall Street movement still has oxygen left.

A Better Way

In the spirit of extricating the industry from a crisis of investor confidence, we’re proposing a modest agenda of reform:

Be honest. The wealth management industry has positioned itself as an omnipotent, all-knowing purveyor of financial security. What has been lacking is honesty. Investors need to be told the truth about risk and reward, even if they don’t want to hear it. The good news is that unconflicted advisors who don’t have to peddle opaque products or be held hostage to their large firm’s profitability targets are beginning to have an honest dialogue with clients.

Acknowledge mistakes. Large institutions attribute the financial mess to a once-in-a-lifetime debacle, as opposed to any systemic defect in their business models. The rationalization is that no one could have seen the crisis coming. If you’re an unconflicted, independent advisor, you still may not have seen the flood coming. However, you could have responded faster in heading for higher ground. You wouldn’t have been locked in by Wall Street’s investment products that stifle flexibility.

Establish new standards. Advisors need to re-educate investors about performance. It’s not simply about high returns, but rather about performance versus established risk parameters. Particularly for high net worth clients who have already hit the home run, wealth preservation and definable risk management are often a higher priority. Using risk as your primary performance benchmark might not be as “marketable” as cocktail party worthy high returns, but taking the easy route rarely works.

Independent wealth advisors should play a particularly valuable role in advancing this agenda. They can be a catalyst because they don’t need to buy into the Wall Street mirage that “we are smarter and have all the answers.” They can tell the truth, and investors will reward them with the biggest prize: their business and their trust.

At the end of the day, voters and investors are actually looking for the same thing – an alternative to sclerotic party politics or an anachronistic financial services business model. Whoever steps up and tells the truth – and delivers a credible solution – will win the hearts and minds of both for the long run.

I'm Sorry

Time For Wall Street To Apologize

Each day, the Wall Street protests grow. Over the weekend, demonstrations spread to dozens of U.S. cities and three continents, with scores of arrests and increasing violence. Sympathizers in Rome went on a rampage that caused more than $1 million in damage.

The revolt against Wall Street is about many things: Disgust with the broader economy, anger at government gridlock and policy failures, revulsion over bank bailouts, resentment about the growing gap between rich and poor, and generalized rage at the machine. There is also legitimate fury for Wall Street’s role in the misery many are experiencing.

Everyone Needs To Fess Up

The Wall Street establishment clearly needs to do something. After all, the “Occupy Wall Street” movement has its name on it.

What should be done? First, Wall Street needs to atone for the sins that got us into this mess. A mea culpa is due because Wall Street’s multi-billion dollar propaganda machine effectively peddled the worst kind of fantasy – that individuals and institutions who invest with them can achieve superior returns using their newly created “AAA” investments.

Unfortunately, the only people who made money were those who took the other side of the trade. Given that investing remains a zero sum game, not even Wall Street could change the laws of finance.

Wall Street firms need to start with an apology to anyone who ever purchased these new investment products and opened an investment or retirement account with dreams of a predictable financial future.

Advisors Share The Blame

Second, an apology is due from advisors. They believed their bosses who prodded them to sell the delusion that Wall Street’s best and brightest had figured out a way to squeeze addition return out of AAA-rated securities.

Brokers and advisors didn’t need much convincing to get them to go along. To address the fee compression caused by new regulations, wealth professionals looked for additional revenue opportunities by selling these opaque but “safe” investment vehicles.

So Do Clients

Third, clients themselves need to make amends. Their own demands for a safe but outsized return fueled the mania. Investors had come to expect outsized returns during the 20+ year bull market and had established a lifestyle to assume the good times would continue forever.

Clients relentlessly requested high returns and threatened their advisors that they would pull their accounts if their demands weren’t met.

The Way Forward

Once the apologies are made, Wall Street needs to tell it straight.

For starters, Wall Street needs to explain that the new normal for equity returns is likely to be 6% to 8%. That’s a sharp departure from the 10% to 12% growth that led some to believe their wealth would double every seven to 10 years.

In the short term, even the 6% to 8% growth is suspect. Those kinds of returns should be viewed as an intermediate term goal, if we’re lucky. As The Economist noted this week in its cover story, Nowhere to Hide, there aren’t many places to invest these days. The perils include the foundering U.S. economy, still-deteriorating housing market, European crisis, and the slowdown in emerging economies.

In addition to systematically lowering expectations, Wall Street also has an obligation to be more transparent. It desperately needs to fix its broken business model and return to a business that charges a disclosed fee for advice and raising capital.

If Wall Street doesn’t make it right, it will only accelerate the independent advisor movement. That may be the sliver lining after all. We believe strongly that leaving Wall Street is the best option for both investors and advisors.

For their part, clients need to find an advisor at a firm whose business model they can trust for the long term. Parking money in cash is only a short-term solution.

More truthfulness and an apology will be a good start in repairing the damage. Coming clean will also show protesters – and the rest of the America – that Wall Street acknowledges that it must do better.