00:00:00 John
So First off, how many people do you know that have a financial plan or or that are motivated to work with a financial advisor? If you tell them their return expectation is 5%, many people have come to expect higher returns for benchmarks for for if you were to buy the S&P 500, if you were to buy the bond index or what have you. But.
00:00:20 John
Of course, markets don't have fees, and of course, benchmarks don't have advisors that charge fees. So FP Canada says that in order to plan properly, you have to back out the cost of the product.
00:00:31 John
Product and the cost of the advice. So if the products are let's say low cost ETFs that costs say 25 basis points on average, that's one quarter of 1% of of return that gets gets lopped off. Let's say the advisor charges a fairly traditional 1% advisory fee for his or her services that is.
00:00:51 John
A rate of return that almost no one is assuming, and if I could be so bold, represents an existential crisis for the wealth management industry.
00:01:01 Sam
This is the future Ready Advisor, a show about transforming your financial advisory practice. I'm your host, Sam Sivarajan, a wealth management consultant, behavioral scientist, and keynote speaker.
00:01:15 Sam
In this podcast, I dive deep into the real challenges advisors face and bring you insightful conversations with top industry experts. Together, we'll explore practical strategies grounded in behavioral science to help you better serve your clients, optimize your time, and build a future ready practice.
00:01:34
Yes.
00:01:35 Sam
Hi everyone I'm your host Sam Sivarajan. Welcome to today's episode of The Future Ready Advisor. Today I'm here with John Dugui, wealth advisor, author, and podcast host. John, welcome to the show.
00:01:51 John
My pleasure to be here.
00:01:52 Sam
Good to have you. Let me quickly introduce you to our audience.
00:01:56 Sam
John is a passionate advocate for investor rights and client first practices as a portfolio manager at design securities, he helps families achieve their financial goals. John has a wealth of credentials. Let me share a few.
00:02:13 Sam
A certified Financial Planner, certified investment manager, and fellow of FP Canada, John is committed to education, best practices and transparency. He is also the author of three books and the host of the podcast Make Better Wealth Decisions.
00:02:30 Sam
Twice named one of Canada's top 50 advisors by Wealth Professional magazine, he provides valuable, cost effective and diversified investment advice.
00:02:41 Sam
John.
00:02:42 Sam
That's a great background.
00:02:45 Sam
Can you share a bit about your journey in the financial advisory industry?
00:02:51 John
Here, Sam, I think I should begin by saying that I very few people who actually work in personal finance actually aspired to work in personal finance when they were growing up and in school. For me, I wanted to work in the public service, and I was doing a Masters degree in public administration at Carlton in Ottawa, and it's a Co-op program. And and when I was starting, I I was given a chance to work on.
00:03:14 John
Consumer and corporate affairs looking into credit card rates and and then later into the effect of the.
00:03:19 John
As he and I realized at at that age that I was a bit of an advocate, and that was where I got the bug for being a consumer advocate. And so when I moved to Toronto and started as a financial advisor back in 1993, that was always in the back of my mind as to where I was going to go and what I was going to do.
00:03:40 John
So I started in the business in 1993. By the turn of the Millennium, I made the determination to move away from commissions to be a fee based advisor. So that was probably the next major phase in my development.
00:03:52 John
Got their credentials and after the global financial crisis, as it ended at the end of in March of 2009, I realized that there are some real challenges in getting people to do what they ought to do, and it would probably be easier and better if I was a portfolio manager so that I could exercise discretion.
00:04:12 John
Because it's one thing to say you're a behavioral coach, but it's difficult to get people to behave like they ought to sometimes. But if I could just go in and automatically do what ought to be done without having to even, you know, get prior commitment, that's a better way to get people from, from where they are to where they want to go. And I think.
00:04:29 John
That that helps us as well. Along the way, I've written a couple hundred articles, three books, as you say. And you know, I've done a fair bit of media things. So I've become advocate and and a a consumer advocate in parallel with my role, my day job as I would call it as as a financial advisor. And that brings us to where we are today.
00:04:50 Sam
Well, as you say, I didn't know about your masters in public policy, but I can see the parallels between public policy and consumer advocacy. I mean, in many cases, I think there is.
00:05:02 Sam
Needs to be a greater awareness of financial literacy and the industry and all of our goals, and I think you've been. I've watched you from afar and from a close, I think you've been a tireless advocate for for the industry and I think for the consumer in your podcast and the book, you talk extensively about what you call the optimism.
00:05:22 Sam
Uh.
00:05:23 Sam
Can you describe what that is, how it is developed in the industry and why you think it poses such a risk for investors?
00:05:31 John
A simple definition of optimism bias, and by the way everyone is biased. And by the way, there are dozens if not hundreds of biases that we're all subjected to. So it's not like I want to pick on optimism bias, but I wanted to write about it in particular because it is often overlooked and misunderstood, as you suggest.
00:05:48 John
Optimism bias is when people think that bad things won't happen to them. They recognize that bad things happen. But they have this hubristic approach to thinking it won't happen to me. I recognize that people get divorced, but I'm not going to get divorced. I recognize that people are sometimes in car crashes, but not me. I'm not gonna be in.
00:06:07 John
A car crash.
00:06:08 John
So that view of acknowledging that bad things will happen, but somehow.
00:06:14 John
Simultaneously thinking that you're immune because you're special for some unidentified reason is dangerous, because now you recognize that there could be a broad macro problem, but you don't stop to reflect upon how it might impact you impact you should it happen to you. And that's really dangerous. And one of the things about biases.
00:06:34 John
And there again there are many is that many of them are unconscious.
00:06:38 John
So what I mean by that is a lot of people will be aware and will acknowledge that they have a bias. Everyone has them, but many people are biased in ways that they themselves don't recognize. They don't think they're biased, they are, but they don't think they are. And so when you have you go through life making decisions, when you've got a filter that causes you to look at things a certain way.
00:07:00 John
And that then creates blind spots because you're not considering other alternatives. There's danger there and. And, you know, I don't want to go into too many details, but that's that's the the the short.
00:07:10 Sam
Look, it's a great point. We do have lots of biases, as you say, everyone of us has them and we don't have time to get into some of the evolutionary and biological reasons for it.
00:07:21 Sam
Some of those were good reasons that existed because of our environmental conditions a few thousand years ago, but our human wiring hasn't changed. Well, our environment has the optimism bias, particularly strikes me as something that is potent, and I love the way you described it, and it's everywhere in the industry. In my former life, I was an investment banker and I.
00:07:43 Sam
Remember that equity analyst, for example? I've remember seeing a stat that of all of the equity analyst reports that you get something on the order of 55% of equity ratings. Stock Ratings are a buy about 40% is a hold and 5% is a sell.
00:08:03 Sam
I mean and the.
00:08:05 Sam
That strikes me, and I'm sure you and others as that's that's, you know, optimism bias operating there at A at a pretty fundamental.
00:08:16 John
I strongly agree. I will. I will.
00:08:18 John
Maybe couch that to give the industry a little bit of leeway and that is that one of the things that people say about personal finance is that it's not like other elements of business and business. We have a a bias toward action. Now, don't just don't just stand there, do something, but in investing a lot of what makes sense is to don't just do something stand there.
00:08:39 John
Which is to say, there's a evidence shows that you are 10. You tend to be rewarded for being deliberately inactive, and the the, the the joke is that an employer is like a bar of soap. The less you touch it, you know, the more you touch it, the smaller it gets and and so.
00:08:54 John
Well, we we have to find ways to leave things alone. So that could be part of the explanation for the 55% by the 40% hold and the 5% sell, but I think.
00:09:08 John
So I'm giving the industry, throwing them a bone to say that could be one explanation, but I'm with you. I think it's highly suspicious that there's so much of A bias toward buying and thinking positively and optimistically about what great things will befall you in life as a result of having bought XYZ stock and just waiting long enough. And I think that is dangerous.
00:09:28 Sam
No, you're bang on. And look, we all have the biases in our industry in every industry and I think the challenge is to get that balance between action bias, the rush to do something without enough information and the status quo bias. The temptation to do nothing. And as you rightly put it, particularly in personal finance affairs.
00:09:48 Sam
That becomes an even more cogent challenge that we all have as advisors and investors for financial advisors that are aiming to build a future ready practice.
00:10:00 Sam
What strategies would you recommend for managing optimism bias, both in the advisor themselves and the clients? I mean, part of it is, as you can say, that you don't get clients by being pessimistic. You know you have to have a solution to the challenges or the pain points that they get. How do you manage that conundrum, if you will?
00:10:22 John
So the first thing that I will draw attention to is that managing it and getting the clients in the 1st place are different skill sets because you need to be optimistic enough in order to get clients to to come on board to, to hire you to provide yourselves. But once you've got once you've been hired, you need to be realistic in in what their expectations are.
00:10:42 John
And so that can be the same thing, but my experience is that a lot of financial advisors out of the ordinary business imperative of needing to gather.
00:10:52 John
Sets we'll we'll promise the some of the starters to their clients and then of course that's great. If it helps you to get the client, but then it's not so great when the client expects the son of the stars from you on a go forward basis for the rest of the relationship because you've set an expectation that you can't adhere to.
00:11:07 John
Let me give you a specific example. FP Canada, which is the organization that confers the CFP mark, puts out annual assumption guidelines at the end of April every year.
00:11:17 John
And it tells you what you should expect in terms of what the CPP benefits will be, what the inflation rate will be, actuarial tables for, for life expectancy for males and females and couples. But most importantly, in the eyes of many financial planners, it puts out return expectations for different asset classes.
00:11:35 John
And the 2024 expectations are are fairly clear that return expectations for bonds are sort of in the neighborhood of three or at the most 4%.
00:11:45 John
And for stocks, it's 6 or 7%. So a balanced portfolio using just ordinary benchmark returns might be expected to return something like 5%. So First off, how many people do you know that have a financial plan or or that are motivated to work with a financial advisor?
00:12:06 John
If you tell them their return expectation is 5%, many people have come to expect higher returns. Many people actually think double digit returns are reasonable, and they categorically.
00:12:16 John
Are not.
00:12:18 John
It gets worse. Those return assumptions that I mentioned a moment ago with the 5% for a balanced portfolio is what you should be expecting as a return for benchmarks for, for if you were to buy the S&P 500, if you were to buy the bond index.
00:12:31 John
Or what have.
00:12:31 John
You, but of course marks don't have fees and of course benchmarks don't have advisors that charge fees.
00:12:38 John
So FP Canada says that in order to plan properly, you have to back out the cost of the product and the cost of the advice.
00:12:46 John
So if the products are let's say low cost ETF that costs say 25 basis points on average, that's one quarter of 1% of of return that gets gets lopped off. Let's say the advisor charges a fairly traditional 1% advisory fee for his or her services.
00:13:02 John
Now that's set 5% expected return for a balanced portfolio becomes 3 3/4 percent rate of return.
00:13:10 John
That is a rate of return that almost no one is assuming, and if I could be so bold, represents an existential crisis for the wealth management industry, because as of right now, as of 2024, you can get that kind of return, taking no risk at all by popping your money into.
00:13:28
MHM.
00:13:30 John
Vic.
00:13:31 John
So the industry as expected, returns have been compressed, are going to have to find new and improved ways to add value. And I'm looking at you tax optimization and and and estate planning and behavioral coaching because the the expected return premium that you might be getting from managing money is not likely to cut it if that's your only value.
00:13:54 Sam
That's a.
00:13:55 Sam
Fantastic point. What do you think about the influx, if you will, of call it high alpha products as a way to offset this lower expected returns on call it through traditional markets. So I'm talking everything from private investments, real estate, etcetera. Do you see that?
00:14:15 Sam
Just playing a role and I'm asking you to generalize. Do you see that as playing a role in people's portfolios or do you think it's a straw that people are grasping in order to kind of not have that conversation?
00:14:28 Sam
Or not have.
00:14:29 Sam
That.
00:14:30 Sam
Adaptation of the practice to kind of add value in the way that you are describing through tax optimization, estate planning, behavioral coaching, etcetera.
00:14:40 John
So I'll I'll make a distinction here, Sam, because Alpha is is a term that that refers to beating the market on an absolute and or risk adjusted basis. And I don't believe that's possible in a reliable way. You can get lucky just like you can win a lottery ticket, but that doesn't mean you can reliably.
00:14:56 John
Pick lottery.
00:14:57 John
Numbers, so I don't believe alpha exists.
00:15:01 John
So anyone who has a product that is predicated on the delivery of alpha, I am highly, highly skeptical.
00:15:08 John
However, I do believe in diversification and if you have asset classes that are maybe a little bit riskier but have a higher expected return that are weakly or negatively correlated to other assets that you might otherwise own, well, then that's the reason that I that I that I think you should consider those sorts of products and strategies because now.
00:15:28 John
If we can extend the so-called efficient frontier, which is the the universe of portfolios that you could construct that gets you the highest rate of return expected return I, maybe I should say for a given amount of risk.
00:15:39 John
Tolerance than if using different asset classes or strategies will extend that frontier, even if it's only 20 or 30 or 40 basis points. You know right now return is very precious and it's hard to come by and if you can get a slightly better risk adjusted return, I'm all. I'm all for exploring. You know what you might be able to do and how you might be able to do.
00:16:00 Sam
No, I think it's a great point and it reminds me 20 years ago is working at a firm where we had this flagship product that was diversified across.
00:16:11 Sam
Us a variety of asset classes and geographies, etc. Had a 10 year track record of something in the order of 12% annualized return and 5% volatility. So you can imagine 20 years ago it was selling itself. We didn't really have to do much about it and it worked beautifully until of course soon.
00:16:31 Sam
An 8 when it didn't work anymore and the point that you make about diversification and the returns being precious, the learning that I got from that was that no model or no product or no approach works in all mark.
00:16:44 Sam
Kids and this comes back to the role that an advisor can play is to be vigilant on behalf of their clients and ensuring that the the portfolio or that the advice or that the plan that they give them is current for the current market circumstances and environment.
00:17:01 John
Yeah, I I agree. And that's one of the things that I lament in in bull shift. And one of the things that I lament about the industry is that the industry is so.
00:17:10 John
Set in its ways, and that might be a status quo bias for the industry in terms of what, what the what proper advice is and what that constitutes and what it looks like.
00:17:18 John
That the industry will say, well, 6040 is an appropriate portfolio, OK, I I understand and I understand that strategic asset allocation is critically important, but what are your thoughts about a 60% allocation toward equities when the PE ratio for equity markets is 15? What if the PE ratio is 25?
00:17:39 John
And what if, as as it is now in the middle of 2024?
00:17:43 John
We have a cyclically adjusted price earnings ratio for the S&P 500 that's over 30.
00:17:48 John
5 which is to say that by valuation standards, the US stock market is higher than it has been about 9098 or 99% of the time. It's extremely rare for the stock market to be this expensive and expensive is a proxy for risky.
00:18:06 John
So I'm all for 6040, but should we perhaps step back and think critically and say, look, 6040 is a good general benchmark, but should we at least consider and at least have a discussion?
00:18:19 John
About the risk that we're taking by being 60% in the stock market when the stock market is trading at 35 times earnings, which is a different proposition than being 60% in the stock market or stock markets plural when they're trading at 15 times earnings and that is a consideration that I think the industry oftentimes it it, it's not sufficiently.
00:18:39 John
Contextual it just says this is the right thing to do and we're going to do it and we do it all the time and we don't stop and and sit back and assess and say maybe we should be a little more careful now and and I don't see, I don't see that as much as we as I believe we.
00:18:54 Sam
I love that. I think this is another example of your optimism bias that you talked about. It's absolutely bang on and part of the challenge and we can have a whole segment about this is the rather 1 dimensional view that the industry takes in many cases of what risk is. So yes, you can talk about risk as volatility, but there is other risks that we're not.
00:19:14 Sam
Accurately taking into account when we are saying say 6040 even in a historically overvalued market.
00:19:25 Sam
Now.
00:19:26 Sam
You, as we mentioned earlier, have your own podcast make better wealth decisions. Can you talk a little bit about the focus of that podcast and you know, some of the guests that you've had and you know what your objective is in terms of?
00:19:42 Sam
You know what's the message and the focus of that pod.
00:19:45 John
Thanks. So make better health decisions is very much predicated on the things that we've just been talking about for the past 3 or 4 minutes stopping, reflecting and say before I before I just do what everyone does all the time because that's just the way things are done.
00:20:02 John
Let's let's assess the the universe here and.
00:20:06 John
Before we decide.
00:20:08 John
Think about whether or not valuations are a consideration and and should we change what we what we do and to be clear.
00:20:18 John
Given what I was saying even earlier with regard to the bias toward inaction and status quo bias.
00:20:24 John
Maybe we don't do anything. It doesn't necessarily mean that we have to do something different. What I'm trying to get people to do as they make better wealth decisions is to contemplate the universe of alternatives so they can make a fulsome decision.
00:20:39 John
Thinking about everything and and thinking holistically about, you know, their tax situation and their estate planning with their children and you know what will the ramifications be?
00:20:49 John
Before they just do what they always presumptively thought was the right thing to do without really thinking critically. So I'm trying to get people to make better decisions by thinking critically and challenging assumptions that are rooted in, well, that's just the way we do things around here, which is.
00:21:05 John
A lot of what the industry does.
00:21:07 Sam
In other words, you mean to get your clients or investors to think and consciously act or not act as the case may be without implicitly doing it or not doing it, which is what the the default position seems to be in our world.
00:21:24 John
It is so that's part of why I became a portfolio manager 15 years ago is that.
00:21:28 John
And I, and again everyone, no one really resists their own ideas and and everyone can be subject to overconfidence. And so, you know, perhaps I'm overconfident as a portfolio manager, but my experience is that many advisors and this was really rooted in what happened in the global financial crisis of 07 to 09 people say I I have a long term time horizon.
00:21:46
I'm.
00:21:49 John
Have XYZ risk tolerance and then reality strikes and people realize that.
00:21:55 John
What you mean stock markets can actually drop by 60% and even just what we saw in 2022, you know what stock markets can go to by go down by 20 or 25 and bond markets can lose 15% really.
00:22:07 John
Like you know, a lot of people just didn't think that was possible because of recency bias, because they haven't experienced it recently, so they don't think about it. So my view is that it's it's better in my personal practice if I can.
00:22:21 John
Sort of. Take the gun out of other people's mouths, because if they feel convinced they will commit financial suicide. If if left to their own devices and it's easier for me to help them to do what's right by simply doing it without having to talk them down from the ledge without having to get them to say, well, you know, stocks are on sale, they're they're they're down by over half. And so you a 6040 portfolio.
00:22:24 Sam
Yeah, yeah.
00:22:44 John
Your $1,000,000 is now now down to 700,000 because your 600,000 and stocks is now down to 300,000. What we need to do is we need to take over $100,000 out of your bond position and put it into your stop.
00:22:55 John
Opposition. That's what financial planning 101 says you should be doing. That's what portfolio management 101 says you should be doing, but my experience in 2009 it was that it was extremely difficult to get people to do it. They knew they should do it. We had talked about it many, many times, but getting people to do to act when when none of their friends or neighbors are doing it.
00:23:07
M.
00:23:16 John
And now we have this hurting effect and no one wants to do it because no one wants to go 1st and as a result, inertia that sets in and we don't move forward even though that is a big part of the brand promise of what advisors say they are offering to.
00:23:29 John
Your clients.
00:23:30 Sam
Look, you're absolutely right. It's hard for anybody to be objective and rational when it comes to their own affairs. I mean, so it's not just on portfolio. We see this in other professions. Doctors should never treat themselves. We've seen evidence of cases where doctors have misdiagnosed themselves.
00:23:51 Sam
Thinking that it's a stomach ache when it actually is a heart attack, there's the old saying that a lawyer who represents himself has a fool for a client. It's very much in tune with what you're saying. It's not that the doctor is not.
00:23:58 John
As a.
00:24:04 Sam
Table it's not that a lawyer is not capable. It is when it comes to your own personal affairs or someone close to you's affairs, it is hard for even the most professional of us to stay rational and objective and not given to emotion. And that's what you're bringing to your clients, or what any discretionary portfolio manager is bringing to their client is that.
00:24:25 Sam
Ability to remain a little bit more objective and a little less emotional because it's not your money that you're managing.
00:24:33 John
Exactly. And I don't want to overstate it. No, I'm human, too. It's not like I can't make mistakes or, you know, anyone is prone to mistakes. But I'm hoping that the odds are a little more in your favor if you can provide that objectivity, as you say, combined with experience and and the ability to read the room.
00:24:51 John
So to say, so to speak.
00:24:53
So.
00:24:54 Sam
Technology is becoming increasingly a a a factor. And how do you see technology playing a role in helping advisors manage biases and make more informed decisions? Do you see this playing a good role or bad role in terms of some of the optimism and other biases that you talked about?
00:25:13 John
I see technology as being First off, it's inevitable. So whether I like it or not, it's going to happen. But the other thing that I would say is that most technology, like anything in life is only as good as garbage in garbage out. So as long as the factor inputs are robust.
00:25:27 John
Then you would expect the outputs to be good. So for instance, good financial planning software isn't going to do you a lot of good if you're using unreasonable assumptions as one example. But.
00:25:37 John
When it comes to managing risk that that's where I think is where the rubber hits the road. So regulators in the past two or three years have been talking about client suitability being being run through a ringer with two tests, which is a risk tolerance and risk capacity.
00:25:53 John
And if you can use questionnaires that can do a better job of analyzing risk tolerance capacity because those things make First off are different things. And then secondly, we need to manage portfolios to the lower of the two. So if you're tolerance is an 8 out of 10 and your capacity is a six out of 10, the portfolio should be.
00:26:13 John
6 out of 10 because you you you can't exceed either. You have to, you know, go no further than the most aggressive of the two.
00:26:21 John
And in order to to be able to do that, you need to be able to reliably quantify where that threshold is. So good questionnaires that will be more psychometric and not just intuitive because a lot of the questionnaires that are used even today are not that great.
00:26:38 John
We'll probably do a better job of using technology to help advisors be compliant.
00:26:45 John
And so they're not offside with regulation, but also helping their clients reach their objectives, because the best portfolio is 1, you can stick with and it does you no good if you recommend an 8 out of 10 portfolio and that's relatively aggressive and the person can't handle an 8 out of 10 either for tolerance or capacity and then they bail and then they move to a three.
00:27:01 Sam
Exactly.
00:27:06 John
And portfolio because they lost their nerve. And now now we're really not going to meet our objectives. Technology is useful, but like anything, it has to be in the right hands and you have to use it judiciously and and apply.
00:27:17 John
Quickly.
00:27:18 Sam
That's a great point. Looking ahead, what do you think are the biggest challenges and opportunities for financial advisors in the years?
00:27:26 Sam
In the well, I would say that.
00:27:28 John
I would say the industry needs to think more about evidence and professionalism. So my first book, the professional financial advisor, talked about how the industry was professionalizing the way doctors, dentists, lawyers and accountants.
00:27:41 John
Professionalizing and that is is continuing, but it happens very, very slowly and my my foolish assumption was that it would professionalize as a result of regulatory reforms that will.
00:27:52 John
Those higher professional standards, my experience in the 25 years as an advocate that I've been working as an advocate within the industry since I started writing my first book, is that regulation is slow to the point where instead of leading the industry to to being more professional, it tends to lag and that the best advisors and firms.
00:28:14 John
Push the envelope forward and regulation changes after maybe 20 or 25% of the of the early adopters have have already moved in.
00:28:23 John
So I think that will continue. I think that's positive. I don't really care how we get things moving forward as long as we move things forward that'll be that'll be good in terms of best practices, but also with regard to evidence, you know there's a mountain of evidence that active management doesn't really add value in aggregate that is is understood by.
00:28:43 John
By ethical and and intelligent people. But there are a lot of people who don't really fully appreciate what that involves, so I'll give you one example and then I'll.
00:28:53 John
And then I'll stop with this.
00:28:55 John
A paper came out about seven or eight years ago called the misguided beliefs of financial advisors. Now, this was a study that was done as an academic study. Peer reviewed, published in a learned journal, and it showed that these are now mutual fund registrants. So these are not security advisors, but they looked at two dozen of the biggest mutual fund firms in Canada and the advisors and.
00:29:15 John
They had maybe a couple 1000 advisors and 10s of thousands of client relationships that they looked at in, in gauging what was actually being recommended and what they found was that advisors on mutual fund registrants in Canada, Chase past performance, were indifferent to product costs and ran concentrated positions.
00:29:34 John
You're going to say, well, isn't that because there are inherent biases because of embedded compensation or whatever you would say?
00:29:41 John
No, actually, the evidence showed that these advisors did this even with their own accounts, and even after they retired from the business.
00:29:48 Sam
Mm-hmm.
00:29:49 John
So these are these are people who believe things that are simply not true and and so in terms of the industry moving forward, I think we need to agree on facts. Right now. It seems as though there are, there are even facts, things that should be self-evident that there are many people who are giving the advice who don't recognize the facts imagine in the.
00:30:09 John
1964 the Surgeon General report came out in the US saying that cigarette.
00:30:13 John
Smoke is is dangerous for your health. It it's harmful. At the time there were more, there were more physicians smoking in the US per capita than the general population, which is to say, if you were a doctor, you were more likely to be a smoker than a non doctor. In the United States in 1964, when the paper came out. So there's a great deal of cognitive dissonance.
00:30:36 John
And the people who are giving the advice were the ones who had to stop and look in the mirror and recognize that perhaps the advice they were giving was not correct and they needed to confront the evidence. And that's really, really hard. But that's where we need to go.
00:30:50 Sam
No, that's a great point. I read that paper by Steven Forrester and I like it and it informed a lot of my doctoral research. I think you're absolutely right. It was advisors were investing their own portfolios the same way that they're recommending clients. One of the conclusions I took from that besides what you've just said is.
00:31:09 Sam
That look, there's a lot of speculation by in the popular press that that there was conflicts of interest and everything else, and at least one conclusion I took from that finding was it wasn't a conflict of interest. It was this almost this belief that, look, I'm recommending all of my clients do this because it's the best advice.
00:31:30 Sam
To them, because I myself am taking it so it's it may be misguided beliefs, but not a conflict of interest, right? And The funny thing is, I think that we've got.
00:31:38 John
Exactly.
00:31:40 Sam
A lot of regulations, including now coming out there trying to fight conflict of interest, which by the way, I totally agree with. OK, I don't like conflict of interest, but I think the point that you're making and that the evidence points to is that maybe one problem and one problem that we're solving. But there's other issues that we've got include this idea of misguided beliefs, etc.
00:32:00 Sam
That, I think, is pernicious in our industry, in every industry, including in the average person.
00:32:07 Sam
Out there and if we can solve that, I think we'd make a bigger dent in peoples lives.
00:32:14 John
Yeah, I strongly agree. I I think it's one of those elephants in the room that no one wants to. They think it's a question of wrong incentives or misplaced agency and it could be those things. And those are bad things. And I certainly wanna. I'm. I'm with you. I you know I I think we should try to root those things out as well but misguided beliefs is a lot more.
00:32:31 John
Insidious. It's a lot more counterintuitive, and it is, in my opinion, likely to be more dangerous, but because you can't obviously identify it, it sort of flies under the radar and people don't notice it. And one of the things that I would say is that, as an example of that, this paper came out in 2016, late 2016.
00:32:37
M.
00:32:51 John
So it's almost 8 years old now and the industry hasn't done anything really to disabuse advisors of these misguided beliefs, so they're aware of the problem, and this is part of what I say. Regulatory reform takes a long.
00:33:04 John
Time regulators don't seem to be too fussed about this. They would rather talk about the things that we're talking about here in terms of misplaced agency and and better compensation causing bias with regard to product recommendations. But they're not really doing anything to deal with misguided beliefs, and that's as big as or, in my opinion actually a bigger problem.
00:33:24 Sam
Yeah. And last point, not to beat this dead horse, as you say, it's easier to show action and something that is visible and tracking as in conflict of interest and compensation, etcetera you.
00:33:39 Sam
And show the error. You can show the the bad behavior you compensate, you can fix, etcetera. I think misguided beliefs is under the radar and it requires like academic data and evidence. It doesn't mean that we should say OK, because we can't see the problem that we shouldn't solve it. It just means we got to get more creative in trying to identify.
00:34:02 Sam
How we measure the problem and our effectiveness in solving it.
00:34:07
Yeah.
00:34:08 Sam
So let's go back to the dangers of optimism bias in investment decisions. I'd love it if you can walk us through practical example of how you think and advisor might approach this with a clients investment strategy.
00:34:20 John
So as I mentioned a moment ago, regulators are now looking at buying risk tolerance and risk capacity.
00:34:27 John
And and managing building portfolios, making recommendations that take those things into.
00:34:32 John
Account.
00:34:33 John
So how do we actually get a handle on what those are, and specifically, how do we fulfill our role as advisors as behavior modifiers as as behavioral coaches to help people to stick with the plan? Is is really the question a few things the the most obvious thing I had to still of Solomon, who's a who's a prophet U of T beer talk about this at a client event that I had.
00:34:55 John
He says one of the great things is to have clients to pre commit put, have them put it in writing that even if the stock market drops by pick a #2030%.
00:35:00 Sam
MHM.
00:35:04 John
That I will not sell in a panic and that I will rebalance My Portfolio to bring it back to the the target asset allocation. So if you can get it committed, get people to commit to it in writing now it's not now. Now they're making a commitment to their to themselves. So you make a commitment with your prior self that when this happens and you always say, Oh yeah, yeah, yeah, I will have the resolve.
00:35:21
MHM.
00:35:26 John
Moment when you don't actually have to do it, but when the time comes to do it.
00:35:30 John
Yeah, that so.
00:35:31 John
Much.
00:35:31 John
Yeah. One of the things that you can do to help get that pre commitment in writing.
00:35:37 John
Is there's two things. One, one thing I call a lifeboat drill and one thing I call a pre mortem. Danny Kahneman talks about a pre mortem, so let's do that. First pre mortem is where you know what a post mortem is, right? So when there's a, you know there's a suspicious death and they bring in the corner and they try to figure out whether or not foul play was involved. And that's the the post mortem. You figure out what caused the person to die. How?
00:35:57 John
Why? What were the terms and conditions? A pre mortem is where you stop and you imagine something's not working.
00:36:04 John
Yeah. So you're buying this new Whiz Bang investment and you think it's going to be the next best thing, best thing since sliced bread. I I'm gonna go to my maximum 10% allocation that My Portfolio will have for one investment. And I'm gonna go right up to 10%. And this is this is I think my a core holding that I'm gonna be holding for the.
00:36:21 John
Next 20 years at least.
00:36:24 John
OK, great. You can do that.
00:36:26 John
Tell me what it looks like if that investment doesn't workout because it misses multiple earnings reports because there's been a report of corporate malfeasance because of whatever.
00:36:37 John
What will you do?
00:36:38 John
And if you can imagine.
00:36:41 John
What? What? Something going wrong?
00:36:44 John
You might say, well, you might still buy it at 10% as I say, but you might say you know what? Maybe I should only put 6% of My Portfolio into this because it's maybe I am taking more company specific risk or industry risk or political risk or what have you as a result of going all in on this. So that kind of a.
00:37:02 John
Purposeful, thoughtful, imagining. Something going wrong has been shown statistically to lead to people making better decisions, and then the other thing that I was going to talk about is the lifeboat drill. So one of the things when I started in the business in 1993, yes, I'm that old.
00:37:19 John
Was that we would the firm I was at would actually show you $1,000,000 portfolio and actually show you what would happen if let's say we have a drawdown like we what we had in 1974 or even a drawdown like what we had in 1982. So we'll show you real numbers based on recent stock market performance and this is how things drop and how much they drop. And this is how long it will take you to regain your.
00:37:43 John
Previous position.
00:37:44 John
Here it is, Mr. Jones, are you OK with that? You are great. Can you sign here, please? So we'll put it in your file so that if something happens, we'll show you that we had this discussion on, you know, whatever it is, you know, September 20, twentieth of of of 2023, and now it's about a year later. And now the market is not doing so well and.
00:38:04 John
And you said just a year ago that you could handle this?
00:38:08 John
So what are we doing here? And I think forcing people to confront their own limitations and their own prior hubris is a good way to get them to acknowledge if, if even if you don't get them to change the behavior, you get them to acknowledge, yeah, that they're, they're changing the behavior that they pre committed to. And that's worth something.
00:38:10
MHM.
00:38:16
MHM.
00:38:28 Sam
No, I I totally agree. It's it's a failure of imagination on the part of clients. We all have it. It's one thing to sit there and say, oh, well, the markets go down 10 or 20% and you can nod and say, Yep, I'm aware of that. You're aware and a theoretical level, but not in a practical.
00:38:42 Sam
Level doing that lifeboat drill that you talked about and I've used something like that in my career. I think it allows clients a better way of visualizing what that actually looks like in dollars and cents, etc. The analogy I use is it's like staging a home. OK, you know that this is all rented furniture, rented pictures, etc.
00:39:02 Sam
You know you should be buying for the physical structure of the house and the the location and everything.
00:39:08 Sam
But because the buyers have a failure of imagination, we give in to staging. And as you say, this isn't necessarily going to stop them from indulging in that misbehavior, if you will. But it will at least give them a moment to pause and think about it. And I think that itself is a huge victory, OK?
00:39:28 Sam
John, we're coming to the end of our podcast. So I have a few final rapid fire questions for.
00:39:35 John
So #1 professionally, what is the most important lesson you've learned over the years? I would say, and this is going to be controversial, so brace yourself, Sam. I would say that the industry is not as independent as it purports to be. There are lots of firms that say we're independent, but one of the experiences that I've had is that I write articles and sometimes firms will say, well, you can't write that.
00:39:56 John
Well, well, well, why not?
00:39:58 John
Well.
00:39:59 John
We don't like what you're saying and it's like, well, wait a minute. You're. You're independent. We're independent here. Just and. And here's my evidence, and I'll actually show people. So one example will be this misguided belief paper I've, you know, I've shown this and other papers. Bill Sharpe had a paper that came out in the 1990s called the the arithmetic of active management. So I.
00:40:17 John
Show I would write an article saying you've got to be looking at low cost investments because you get what you don't pay for in the words of John Bogle. And if you could, you know, reduce your cost by 80 or 90 basis points, that's another way of saying you can reduce your expected return by 80 or 90 basis points without any change in the risk that is empirically robust.
00:40:37 John
Well, we've known it for 30 years, but when you try to say it to the public, the industry, which of course makes its money by using active management, will find some excuse to not allow you to say it and and still sanctimoniously insist to the world that the that the industry is independent. So it's it's not as independent as you think it is.
00:40:55 Sam
Interesting.
00:40:57 Sam
What is 1 practical tip you would offer listeners keen on applying your insights when you?
00:41:03 John
Are speaking to your advisor.
00:41:06 John
I think you should.
00:41:09 John
Find the courage to ask for proof. So when the advisor says I think you should do.
00:41:14 John
This.
00:41:16 John
Why is a fair question and and then asking, you know, a second and a third time and and why is that? And is there evidence that supports that? So I did that with my second book Stand up to the financial services industry.
00:41:27 John
Me. I put about 30 different 30 or 35 different questions in the book to help people.
00:41:33 John
Ask those questions. It's it's a real problem here in Canada. First off, we're very polite. We don't like to ask questions, we just. But secondly, many people work with an advisor because they don't really know what questions to ask. So I I tell them what questions to ask, but then the third thing that I do is I say, and these are the answers you should be looking for. They should bind with. It won't be verbatim.
00:41:38 Sam
MMM.
00:41:54 John
But this is what you should look for, because people a don't wanna ask, don't know what to ask and even if they.
00:41:59 John
Passed wouldn't be able to discern if if they were being *********** in the answer they were getting, or if they were getting something which was viable and and robust. So I think for investors to have a better relationship with their advisor, no one cares more about it than than them their. It's their money they have every right to ask and they should try to hold the advisor accountable to explain what's being.
00:42:20 John
And by the way, you should also try to explain what you own, understand what you own at any rate. So why this product? Why this strategy? Help me to.
00:42:28 John
Dan.
00:42:29 John
Why? Why? Why we don't do it this way? Why don't we use that product and hopefully the advisor will be able to give you an advance with an answer that gives you comfort so that you can move forward with confidence so that you can take his or her advice next time when.
00:42:41 John
When the going gets tough.
00:42:43 Sam
That's a great point and I would say the corollary that you implied in there is obviously the advisor should be ready for those types of questions and have that evidence and be proactive in terms.
00:42:55 Sam
Providing that evidence, et cetera. So if the client isn't going to ask the questions that they're providing, the answers in the data. In any case, I think that having a more educated client or investor can only be helpful in the longer run.
00:43:10 John
We strongly agree. So the other thing that I would add if a lot of your listeners are going to be pretty smart and a lot of your advisers that listen are gonna be pretty smart. What they might want to do if they want to become more informed with regard to behavioral, behavioral, economics and and the advice that you give is you should maybe read two or three books about it if you're interested. If you're just want to read for fun.
00:43:30 John
You could you could. You could think of.
00:43:32 John
A book from Dan Ariely's predictably irrational. There are three, three more really good books that I would recommend thinking fast and slow by Daniel Kahneman, a Nobel laureate misbehaving by Richard Thaler, a Nobel laureate, and and irrational exuberance by by Robert Schiller, a Nobel Laurian. So I think if you want to read.
00:43:49 Sam
I know.
00:43:53 John
Books from people who who really understand personal finance and who could bring it home, and one of the things I really love about those books is these guys are really not only are they very, very smart, they're very compelling as writers. It's easy to read.
00:44:05 John
It's fun. It's sort of like a John Grisham novel. Like, it doesn't have to be really, really onerous. And if you are interested, I think it's the sort of thing that it's you can read and actually have fun reading it.
00:44:17 Sam
This is great and I echo all of those book recommendations that you made. They are great.
00:44:22 Sam
John, this has been fantastic. If people want to find out more about you or your approach or your podcast, where do they?
00:44:30 John
Go. You can send me an e-mail. I'm just in the middle of getting a a website built so I don't have a website right now. So First off, the podcast is called Make better wealth decisions.
00:44:39 John
And you can reach me via e-mail at Jade, Gooey at designed securities CA so designed with an Ed securities dot CE. I should say awesome.
00:44:48 Sam
Awesome, John. Thank you for joining us today on the future Ready Advisor Podcast.
00:44:54 John
Hi. Pleasure, Sam. Thanks for having.
00:45:00 Sam
In this episode, I talked with John, the Gooey about the optimism bias and the financial advisory industry.
00:45:08 Sam
My three key takeaways from this episode are #1 the optimism bias, and financial decision making. John highlighted the optimism bias as a common pitfall where individuals believe negative events such as market crashes or personal setbacks won't happen to them this mindset.
00:45:29 Sam
Can lead to poor financial planning and risk management, making it crucial for advisers to challenge such assumption.
00:45:37 Sam
#2 the challenge of setting realistic expectations, financial advisors often promise high returns to attract clients, but John emphasizes the importance of managing expectations realistically.
00:45:50 Sam
With lower projected returns on investments, advisors need to focus on delivering value through tax optimization, estate planning and behavioral coaching rather than chasing unrealistic performance.
00:46:04 Sam
#3 the role of technology and evidence based advice technology is a valuable tool in helping advisers assess risk tolerance and capacity more accurately. John advocates for a more evidence based approach to financial advising, noting that misguided beliefs in the industry, such as the reliance on past performance.
00:46:26 Sam
Can lead to poor decisions, he encourages. Advisers and clients alike to question assumptions and seek proof in their financial strategies.
00:46:35 Sam
You've been listening to the future Ready advisor. If you enjoyed the show, please leave a review on Apple Podcasts or a rating on Spotify, or share your feedback wherever you listen. Be sure to follow the podcast so you never miss an episode. For more insights on how to keep your practice future ready, visit.
00:46:55 Sam
Www.samsivarajan.com you can find the link on the show notes. There you'll find free tools and resources along with exclusive bonus content from these podcasts. Thanks for tuning in and I look forward to sharing more strategies with you in the next episode.