Street signs at the intersection of Broad and Wall Street.

Field Work

Questioning Wall Street Convention

Walk into your financial adviser’s or broker’s office, and the conversation inevitably leads to your portfolio’s “asset allocation” and “total return.”

Financial planners, the media, investors – we’ve been under Wall Street’s spell for three decades.  But a small chorus of skeptics, bucking the orthodoxy, argues that brokers and planners don’t always match investments with an individual’s goals and needs.  The human gets lost – in more ways than one.

“People are being guided by the asset management industry,” said Boston University finance professor Zvi Bodie, co-author, with consultant Rachelle Taqqu, of “Risk Less and Prosper: Your Guide to Safer Investing.”

The industry’s premise is that “you can’t afford not to take risk,” he said, referring to the tenet that more risk means a larger potential return.  But what happens if you roll the dice and lose?  “They never say that,” he said.

Keen to this critique, Barclays in London and a few other large investment houses have started pitching wealthy clients by focusing on their “unique” circumstances.

This minority view may resonate with baby boomers whose retirement planning was derailed by the 2008 stock market collapse.  (Annualized five-year return for the Standard & Poor’s 500 stock index: —0.25%, according to Morningstar.)

If investor frustration triggers a backlash, it will be long in coming.  It’s rooted in the 1960s, when Edward C. Johnson 3rd of Fidelity Investments began selling mutual funds to everyman.  As defined benefit plans began their descent, Americans tiptoed and then ran into DIY retirement accounts.  The big money managers in Boston and on Wall Street now dominate, and pursuit of investment returns has become the norm, asset allocation the buzz word. The burst of the late-90s high-tech bubble was a notable disaster.

Bodie’s coauthor Taqqu said wealthy people can handle market ups and downs.  But “middle-class people are often taking too much risk.  If they instead think in terms of goals, and what can I do without, they won’t put that [money] at risk.”

In a sign of dissension within the financial industry’s ranks, Allianz in Germany, PIMCO in California and Barclays incorporated trendy behavioral economics into their services for wealthy investors.  Behavioral economics holds that individuals are psychological beings, so applying unbending investment theories based on “rational man” is deeply flawed.

“It’s astonishing that not just an academic discipline but an entire industry was built on these assumptions,” Greg B. Davies, head of Barclays Wealth’s Behavioural and Quantitative Investment Philosophy, said in a recent interview.

Davies said his investment group goes with “irrational man.”  For example, rather than rely on an investor’s own emotionally blurred view of their tolerance for risk, Barclays measures it with a “personality” survey – the financial version of Briggs-Meyers.

The survey asks them to rate statements from “strongly agree” to “strongly disagree.”  Sample questions are: “I fear for the worst;” “I have more experience with investing than the average person;” or I am concerned my money is “not aligned with my long-term goals.”

Davis said the focus is clients’ “emotional comfort.”  Barclays might tailor a portfolio that “gives up a little long-term classical efficiency” – and presumably return – to ensure clients “stick with the journey and achieve their investment goals.”  Translation: prevent client panic.

While Bodie might not see eye-to-eye with Davies, he might agree on this.  Conventional wisdom “forgets to factor in the fact that, to get to the long-term, we have to live in the short-term,” Davies said.

2 Responses to Questioning Wall Street Convention

  1. John Graves says:

    Keynes also said “the markets can stay irrational far longer than I can stay liquid.” Behavioral economics attempts to design from above, with the client in mind. I suggest, in my book “The 7% Solution,” that portfolios should be self generated. That means each portfolio fully reflects each person’s need. Today’s portfolio management process fully ignores the client – by paying lip service. The end result remains one that “gives up a little long term classical efficiency…” This giving up is the lip service. The client still has to be shoe horned into the ill-fitting shoe (classical efficiency).

    I suggest these trappings of Econ Man are the Emperor’s new clothes. These fine new threads are simply more foolishness from the mad clothiers. Quite expensive threads, so shear as to be invisible. The middle-class investor is “still taking too much risk.” In fact, it is the middle-class investor, the 401(k) participant, who in 2008 took money off the tables and survived, according to SEI investigations into capital movements within qualified plans. While the soothsayers on Wall St. led the lemmings over the cliff of buy/hold and asset allocation, we boomers sat (and sit) on the sidelines. We are bemoaned as the duffers who destroy the game, while we sit in the clubhouse enjoying the 19th hole!

    Our view towards risk varies with our experience and situation. That is an entirely different equation from modern portfolio theory. Once the financial services industry recognizes this, real retirement planning may begin.

  2. Nick says:

    I couldn’t agree more with this article! Seeing the struggles of those who planned on retiring within the last few years, it is clear to see that changes need to be made. We all know the definition of insanity, so why are the majority of people still throwing money at mutual funds, crossing their fingers that it will grow?

    More people should be exposed to this blog at a very young age.