John Wayne always portrayed a fearless lawman. As Rooster Cogburn in the 1969 film True Grit, Wayne was everything you'd hope a regulator would be. He'd say things like, "Young fella, if you're looking for trouble, I'll accommodate you." Men would tremble while women would swoon. Rooster was tough, uncompromising and willing to take on the whole gang of outlaws single-handed.
Unfortunately, there is no Rooster Cogburn style regulator protecting Australian investors. There are rules, but they are weak. And there is a regulator but it's not a 'doing things' policeman, like Rooster. ASIC does not police financial advice with gusto. Instead, it relies on advisers, or their employers, choosing to meet the standards that it sets.
In effect, investors are often largely on their own when it comes to financial advice. The good news? There are great advisers out there. But the bad news is that it can be hard to tell the good from the bad, even when you are already a client.
These five questions will reveal the good advisers. If you can answer 'yes' to all five questions, you have found an adviser with good process who acts in your interests, and one you can trust.
1. Does my adviser really know me and my risks?
The ASIC standard says advisers must 'know the client', but there are no rules about what that means. Advisers often only know the bare minimum in order to complete a transaction with you. That could be as little as your name and age.
Really good advisers around the world make sure they know at least three important things:
- Your risk tolerance - How much investment risk you are psychologically comfortable with
- Your risk capacity - How much you could afford to lose through investments without endangering your financial situation or goals, and
- Your risk required - How much risk you need to take on to reach your goals.
There will often be mismatches in these three components of a risk profile. For example, you may not have enough money to reach your goals through conservative investments, so you have to take on higher risk to seek higher returns. That extra risk may take you outside your psychological comfort zone. The art, expertise and talent of a good financial adviser is in helping you balance these important factors of your risk profile.
2. Has my adviser helped me consider alternative strategies?
Investments should not be the only tools in an adviser’s toolbox. Good financial advisers have many ways to help clients. Sometimes, the best solution is not a higher-risk investment. It might be another strategy like working longer instead of retiring, or revising your end goal to something more attainable for you.
The best choice may be to make an investment, but a good adviser will always discuss the other options with you first.
3. Does my adviser really know these investment products?
They will tell you that they do, but most of them don't. Advisers work from 'approved lists' of investments. Most have not evaluated those investments themselves, because that's what research people do. Most advisers only know the product is 'okay' to recommend, but they often have little clue about the investment's potential risks and rewards. Without knowing about those potential variations in asset values it is hard for you to decide if an investment is suitable for you.
4. Has my adviser explained all the risks to me so I understand?
If you do not understand, it has not been adequately explained to you. Explaining risk as 'standard deviations' is useless if you don't understand this type of mathematics, and most people don't. Similarly, giving you pages of numbers won't help you if you think in pictures, or vice-versa. Helping investors understand the risks in their financial plan and the investments within it is a critical step, which is often hurried or even overlooked.
5. Did my adviser get my 'informed consent'?
Before they operate on you, doctors must get your 'informed consent'. They must explain what they will do and all the potential outcomes, so you can then make an informed choice to proceed. Financial advice should be the same. The adviser should explain the risks - and why they are appropriate - in ways you understand. Then, they should have you 'sign-off' on the plan.
Some advisers do follow a process similar to this, but many others don't. Many are reputable, but others are taking shortcuts.
Use these checks to avoid the worst
In the worst cases, there are outright crooks out there giving financial advice. ASIC should actively hunt out these crooks, and also address those who are short-cutting regulations to reach a quick, unsuitable sale. ASIC uses a 'standards-based' approach.
That's different to APRA, which supervises Australia's banks. APRA makes rules and actively enforces them by directly monitoring banks' behaviour. Recently, it demanded that banks hold more capital to offset their property home-loan books. To be fair to ASIC, it's got a tougher job! It regulates tens of thousands of people, while APRA only has a few dozen banks to watch over.
And we know that APRA-style regulation doesn't work in financial advice. ASIC used to set very detailed regulations to be followed, but it added extra work, slowed things down and often failed anyway. That's why regulators of advice around the world are adopting standards-based models.
But that's little comfort for the average investor. To be safe, you need tools like these five questions to protect your own interests. Anything can happen when no-one is watching, and the reality of today's regulation is that there is no Rooster Cogburn watching over you.
Paul Resnik is Co-Founder and Director of Finametrica, a risk profiling system that guides ‘best-fit’ investment decisions.