Brokerage firms like UBS (the “Raiding Firms”) are paying millions of dollars to hire brokers who generate big fees and commissions and who can bring perhaps 80% of their customers with them. In response, other firms (the “Raided Firms”) are promising waivers of fees for as long as two years to their managed-money customers to keep them on board, according to a recent article in the Wall Street Journal by Aaron Lucchetti. We know why the Raiding Firms shell out the big bucks ? they stand to make a whole lot of money off of the customers of those brokers who move their accounts. Customers are important assets to any firm, and the name of the game is to make those assets pay.
But there are other questions: (1) why would the Raided Firm try to keep customers on board by waiving fees for two years, and (2) why would customers who lost half of the value of their accounts want to follow or stay with a broker?
The answer to question one is that firms can still make money off of accounts with waived management fees through undisclosed fees and charges called markups. The answer to question two is: they shouldn’t, because advertising claims made by Wall Street firms that they offer valuable personalized financial advice to their retail customers and that they carefully monitor their customers’ accounts are perhaps the biggest of all of Wall Street’s frauds.
The firms know very well that recommendations they make beyond asset allocation are, at best, of little benefit to their clients, are often wrong (sometimes disasterously so as, for example, advice to load up on financial stocks in 2008), are based on the demonstrably false premise that the firm’s recommendations can consistently outperform the market, and serve only to benefit the firm.
The development, over the past 50 years or so, of a quantitative approach to investment analysis based upon statistical models, is broadly referred to as Modern Portfolio Theory, or MPT. Among the most basic and important precepts that have arisen out of MPT, and have come to be understood and widely accepted in the academic and financial communities (including Wall Street firms), is that asset allocation – i.e., the mix of asset classes, such as stocks, bonds, and cash – within a portfolio is responsible for over 90% of the variability in portfolio performance over time. In other words, what particular stocks and bonds are bought is of very little importance compared with the overall asset allocation.
Have you ever had a conversation with a broker about MPT or asset allocation? Have you ever been asked by a broker before investing: What is the most you could stand to lose in your portfolio? The answer to that question is obviously important to what percentage of stocks you should have in your portfolio. But questions like that do not advance the sale of securities, and that is how the firms make their money.
No one can reliably predict where a particular security or the “market” as a whole will be ? or even the direction it will take – in the next three to five years. That is why money that you may need to spend in the next three to five years should not be invested in the stock market, and also why it makes no sense to stay with or follow a stockbroker in order to receive advice that is bogus and service that you can get from a lower-cost alternatives.