Now available on line are the televised hearings of the recent 19-day Royal Commission into Australian banks. The formal public inquiry led by a retired judge not surprisingly uncovered the common list of wrongdoing including bribery and fraud rings, poor lending practices, and pervasive lying to regulators. For an excellent summary of the evidence submitted see: Why Banking Scandals will continue. The financial-advice business is inherently flawed and possibly unfixable. Here is the universal bottom line:
Nothing will change unless authorities recognize three fundamental facts about the way the system is set up now. First, the privatization of retirement savings has put too much power in the hands of unprepared citizens. In Australia as elsewhere, state and corporate pensions have been replaced, in full or part depending on the jurisdiction, by self-funded arrangements, usually encouraged by sometimes generous tax incentives.
The shift places the responsibility for planning, saving and investing on individuals. This assumes a level of financial knowledge and acumen, if only to be able to distinguish between good and bad advice. It’s unlikely that most people, whatever their other expertise, possess these skills.
A lack of information creates moral hazard, placing savers who are managing significant sums of money at the mercy of financial advisers. The problem is compounded by the increasing complexity of investment choices, risks and rewards, and tax- and estate-planning considerations. Relying on the banks’ fear of reputational damage to enforce good behavior has historically been a bad bet.
Second, ordinary investors are unwilling to pay for advice — or at least, to pay enough for the kind of service and expertise they require. Financial advisers are thus reluctant to move to a fee-for-advice model, as it may reduce earnings. Instead they rely on sellers of financial products to pay them upfront or through a trailing commission, in return for promoting their products.
Third, too many clients are unwilling to accept good advice. Many investors have an unrealistic expectation of returns and frequently underestimate risks, making investment choices which are inappropriate to their circumstances. This reflects not just their lack of financial sophistication but peer pressure, where neighbor Jones always seems to have higher returns. Stagnant incomes and rising living costs mean that higher returns are sought to compensate for inadequate savings rates.
Ultimately, nothing can save an investor seeking to get rich quickly.
