Highlights:

  • Trust and investing go hand and hand.
  • Investing requires trusting the exchanges used to make trades, the custodian that has possession of your investments, the advisors you rely on, and the advice you are given.
  • Asking the right questions of your investment adviser and doing some simple research to verify the quality of the advice you are given can ensure your trust is well-deserved.

“I’m not upset that you lied to me, I’m upset that from now on I can’t believe you.”

-Friedrich Nietzsche

In the mid-1970s, the Soviet Union and America’s medium-range nuclear arsenals were of similar strength.  Shortly thereafter, the Soviet Union began replacing its older intermediate-range SS-4 and SS-5 missiles with a new intermediate-range missile, the SS-20, effectively shifting the balance of power in favor of the Soviets.  In response, NATO adopted a “dual track” strategy to counter the Soviet’s SS-20 deployments.  One track called for the deployment of updated nuclear intercontinental ballistic missiles; the second called for arms control negotiations between the United States and the Soviet Union.

NATO’s strategy lead to the Intermediate-Range Nuclear Forces Treaty (INF Treaty) between the United States and the USSR.  President Ronald Reagan and Soviet General Secretary Mikhail Gorbachev signed the pact on December 8, 1987.  President Regan famously described the accord with the old Russian proverb: “Doveryai, no proveryai,” which means “Trust, but verify”.[1]

Peace between nations requires trust, and no less is required for prudent investing in stocks and bonds.  Investors need to trust the custodians who hold their investments; the broker-dealers and security exchanges that facilitate trades; and the advice received from financial advisors.  If that trust is betrayed at any point, large losses can result. 

The following are some steps you can take to make sure your trust is not misplaced.

  1. Verify the Exchanges that Handle Your Trades are Properly Regulated. While there is good reason for investors to trust well-established and highly regulated U.S. stock markets such as the New York Stock Market Exchange (NYSE) or the Nasdaq Stock Market, other less established exchanges may be less trustworthy.  For example, a London-based regulatory tech firm for digital currencies and blockchain found that just 14% of 216 global crypto exchanges were licensed by regulators.  Nonetheless, 43% of millennials trust crypto exchanges more than the major U.S. stock exchanges, according to a recent survey by cryptocurrency trading platform eToro.
  1. Verify the Custodian of Your Investments is Financially Secure. The bankruptcy of Lehman Brothers in 2008 brought to light just how important it is to take note of the financial strength and business practices of the institution that will have custody of your securities.  If you manage your own investments, it will be up to you to select a custodian.  If you work with an investment advisor, the custodian or broker-dealer that is used by your advisor will hold your investments.  Either way, here are steps you can take to ensure that the custodian of your investments can be trusted.
    • Check the custodian’s financial strength by reviewing its balance sheet, credit rating, and shareholder equity.  
    • Evaluate the account statements the custodian provides.  Are they understandable, and do they provide you with all relevant information regarding your portfolio’s performance and degree of risk?
    • Is the technology you will use to access your account easy-to-use, up-to-date, and reliable?  Will you be able to electronically access statements, confirmations, tax documents, and your transaction histories?  Does the custodian have a robust approach to cyber-security?
    • While it is not uncommon for an investment advisor to work for the firm that custodies their clients’ accounts, it is very important the advisor not control the custodian.  Bernie Madoff was able to swindle almost $65 billion from his clients’ accounts because his firm also custodied those accounts, making it possible for him to conceal his fraud by issuing bogus account statements.
    • Are the fees charged by the custodian reasonable and fully disclosed?
  1. Verify that Your Advisor is Trust-Worthy. Just 35% of respondents to a 2016 poll by the American Association of Individual Investors said that they trust investment advisors.  Of that 35%, just 2% trusted investment advisors “a lot”, while 15% only trusted them “a little”.

To evaluate a financial advisor’s trustworthiness, consider their competence, honesty and reliability.  Things you can do to determine if you should put your faith in a particular investment advisor include:

    • Does your advisor have the educational background to provide you with competent advice?  What licenses does he or she hold?
    • Does your advisor fly solo when giving advice, or does he or she use a team approach?  If the later, what are the qualifications of the team members?
    • Is your advisor acting as a “fiduciary” when giving you advice?  If not, then he or she is not obligated to tell you when a conflict exists between what is in your best interest and what is in the advisor’s best interest. 
    • Has your advisor acted badly in the past? You can look up their disciplinary history and other background data at Finra’s Broker Check website.  You may also want to conduct a background check using an accredited consumer reporting agency.  Some states host sites where you can search for criminal prosecutions.  Wisconsin’s Court System Case Search (“CCAP”) website is one example.
  1. Verify the Advice You are Being Given is Worthy of Your Trust. Honest, well-intentioned advisors can mistakenly give bad advice.  For example, many investment advisors have been trained to have faith in stock picking, market timing, and similar attempts to outsmart the stock market, even though there are countless academic studies that demonstrate this is nearly impossible to do.  To guard against this, be prepared to question your advisor’s approach to portfolio management, and then look into whether that approach is supported by independent academic research.

Another example: some well-intentioned advisors are comfortable recommending high-cost mutual funds and other expensive investment products because they’ve drank the Kool-Aid served by the promoters of those products; that is that they are worth the extra cost.  Be sure to ask your advisor to fully disclose all fees you could incur if you follow their advice.

In Evan Almighty, newly elected Indiana Congressman Evan Baxter (played by Steve Carrell) has to trust God (played by Morgan Freeman) when told he can change the world by building an ark.  Now that is truly a leap of faith!  You can watch a trailer for movie here.  (As always, ignore any pop ups that might appear during the video.)

I hope that helps.  Thank you for reading,

Mr. Market Commentator

[1] On February 1, 2019, the Trump administration announced the U.S will be withdrawing from the INF Treaty, in response to Russia’s purported building and testing of nuclear missile systems prohibited by the treaty.

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