Prescriptions Vs Consensus
The presence of a fiduciary element where advisors serve in the best interests of their clients represents the fundamental essence of any relationship between the two parties. This means that the nature of any advice imparted by an advisor who stays true to their fiduciary responsibility would be highly prescriptive in nature. In other words, the advisor is likely to impart advice that is balanced and free of biases. They are also likely to evaluate the investment actions of their clients critically rather than blindly validating each of their clients' actions. And where needed, the advisor would also suggest corrective measures to their clients.
Needless to say, this is not something that would go down well with most clients. This is because most individuals base their investment operations on the consensus view propogated by peers, media and the public at large.
But while the consensus view is easy to validate and follow, basing our operations on the consensus view would always lead to unsatisfactory results over a period of time. And today, I am going to focus on how the consensus view comes in the way of the effective discharge of an advisory engagement. I will then substantiate my stance with examples which compare the prescriptive and consensus views for a given situation and show why the prescriptive view would deliver better results than the consensus view.
A fiduciary relationship between advisors and their clients is very much like that of a doctor and patient. The advisor specifically diagnoses the pain points in a patient's financial situation and prescribes appropriate measures to deal with each of the pain points. Therefore, advice imparted by advisors to clients is akin to a prescription handed out by doctors to their patients.
Now, it is the client’s duty to follow the prescribed measures in the manner suggested by the advisor. But what usually happens is that the client first looks to the views of those around them to see how well their views validate those of the advisor. This is akin to patients going to a pharmacy and asking the chemist whether the medicines prescribed by the doctor are actually effective. And in most cases the views of the client’s peers and others around them are likely to negate the views of the advisor.
This usually sees clients placing faith in the consensus view and either delaying action on the measures suggested by the advisor, or foregoing action altogether. It is extremely dangerous to do this for a very simple reason. While the consensus view is based on generally available information, an advisor's view is based on the specific nuances of the client’s needs.Therefore following the consensus view would only lead to suboptimal or completely unsatisfactory outcomes for the client.
This is because the ideal window of time within which to execute anything related to money management doesn't last forever. And when that window is not properly utilised, the opportunity that is lost is gone for a very long time if not forever. Nevertheless, clients are more than likely to regret most decisions they make based on the consensus view. Even worse, they may go back to the advisor when things don't work out and shift the blame on them even though the advisor had nothing to do with it. All this does is damage the relationship between the parties rather than solve the problem.
Let me now go through a few examples from my own experience to substantiate this. Last year, one of my clients received a substantial bonus from his employer in the form of cryptocurrencies. The client wished to keep the entire amount invested in cryptocurrencies since they were hot at the time and cryptocurrency prices were soaring higher unabated. On the other hand, I was of the opinion that a significant portion of the cryptocurrency bonus must be converted to cash and employed towards the client’s essential long term financial goals.
The remaining portion could stay invested in cryptocurrencies, keeping in mind the personal preferences of the client. My opinion was heavily influced by the fact that cryptocurrencies are currently unregulated in India and its legality is unclear. I duly communicated these facts and their implications to the client. Nevertheless, the client ultimately chose to keep the entire amount invested in cryptocurrencies. Today, the value of the cryptocurrency in which the bonus was paid has dropped by about a third, if not more and I haven't heard from the client in quite a while.
In the case of another client, in late 2020 I asked him to sell off some small cap stocks in his portfolio which he had purchased on the basis of recommendations from an online investment platform the client had subscribed to. The platform touted the stocks as their top picks, highly likely to generate impressive returns over the succeeding months. But the client was the head of a family where multiple members were financially dependent on him. The client was also a personally averse to taking on excessive risk. Moreover, the client held an adequate variety of large cap stocks with stable dividend payout ratios which were sufficient for his needs.
I therefore asked him to get rid of the small cap stocks since they were not a good fit in light of his risk profile, and impaired the overall quality of his portfolio. The client was in favour of holding on to the stocks since they had delivered impressively for him until then. And the fact that the investment platform said that the stocks would continue to perform in the coming months further bolstered his confidence. Surely enough, there was a sharp correction a few months later, and the client lost all of the gains he had made on the small cap stocks until that point. He came back to me saying he made a wrong decision by not selling them earlier.
Both these examples offer very clear takeaways. The consensus view is clearly aimed purely at selling things, whether products, strategies or services at various points of time. And what is sold by the consensus is highly likely to be complex. But as individuals, the things that fit us the best are highly likely to be simple and obvious. Obviously, such ideas are never propogated by the consensus. Naturally, even the most sane advice would be flatly negated by the consensus. Therefore it makes no sense for us to seek validation of what our advisors tell us to do from the consensus. All it would do is create more doubt and confusion in our minds rather than give us clarity.
When advisors work with clients their primary responsibility is not to be a reference point to satisfy the client’s need for validation. Nor is it to guarantee a certain answer, result or outcome for clients. Advisors must understand the needs of their clients, assess the resources available to clients, understand what the best possible outcome is in light of those resources and develop logical plans to work towards those outcomes. And where logic is required blind biases and extreme views do not have a place. And outcomes born out of logic are likely to be more satisfying for clients than any other. Placing faith in the prescriptive approach would therefore lead to better end results for clients. Their trust in the prescriptive approach over the views of the consensus is therefore very well warranted.