The financial crisis of 2008 onwards has destroyed a significant amount of trust in the financial services industry as a whole. Restoring lost confidence is difficult and takes time, and there was no shortage of scandals beforehand, going back a good few hundred years at least.
On the other hand, a certain amount of trust is literally essential. Investors themselves cannot function without trusting the industry to some degree. No one knows everything, a lot of people know very little and there are new things to learn all the time.
The world inevitably revolves around a base level of trust
Human interaction in the broadest sense is not possible without a certain level of trust. Sociologists have demonstrated that the complexities of everyday life are simplified through trusting and relying on other people. Trust reduces the number of potential behavioral alternatives. Particularly in periods or situations of uncertainty, individuals need to rely on social systems.
The risk of trust and the prevalence of misselling of various kinds
The world of money and investment is intrinsically complex and uncertain, so how nice it would be to rely on brokers, banks and firms. Unfortunately and paradoxically, this very trust can raise the level of risk, because it is exploited by unethical individuals and organizations. Some psychologists point out that, strictly speaking, trust can literally be irrational. Yet, rationality is just what investors need.
What exactly is trust and how does it apply to investments?
In the financial context, trust entails positive expectations of responsibility, competence and accountability. Both legally and ethically, investors are entitled to expect and rely on precisely these qualities from those to whom they entrust their money.
Unfortunately, this trust is often misplaced. Not for nothing is there is a saying “trust is good, but control is better”. Investing money well is just not easy, and pure incompetence thus quite common. More seriously, the investment industry is characterized by fundamental conflicts of interest, which basically mean that some sellers do what is best for them rather than what is best for the client.
Furthermore, psychologists have established that human perception is, on average, not very good at detecting lies. Signals are often misunderstood, particularly when people are essentially nervous, in a hurry and want to get the matter out of the way. Simultaneously, sellers of dubious products will be taking great pains to seem honest and convincing. Sadly, many financial meetings are characterized by just such pressures and priorities.
Yet, the financial industry, in which there are so many products, many of which are also complex, inevitably forces people to trust and rely on others – on their integrity, judgment and reliability.
Therefore, the trick is to do two things. The first is to minimize the required level of trust and the second is to learn who you can trust and who you cannot. How does one do this?
The solutions – know the products and know the seller
If one is aware of the issue and dangers in the first place, some relatively simple precautions can be taken at both the product and personal levels.
Avoiding being ripped off at the product level
The better informed you are, the less likely you are to trust the wrong people and the less you need to really on them anyway. Nothing makes you more vulnerable to misselling and bad investments than not understanding what you are being offered and how the industry works. As the saying goes “do your homework”, read about what you are about to buy, ask the right questions, ask other people and generally leave as little to trust as possible.
At the personal level
Check up on the sellers through references, find out more about them and why exactly you should trust them. If other people recommended them, find out the reasons. Bear in mind too, that the same people may be trustworthy in one context and not in another. I know of one case where a broker did a great job for a wealthy client with whom he obviously bothered. But when a friend of his went to the same broker with his modest life savings, all his money was simply dumped into the stock market at the worst possible time.
The more independent the better – no matter how nice and even how decent people really are, they will be more honest about your investments when their own earnings are not linked to any specific products or asset class. This is an unfortunate reality of human nature.
More subtle signs of an honest advisor
The following are signs of good advice and a good advisor:
- Shows you various options (with varied levels of risk) and clearly wants you to choose sensibly and objectively
- Does not push at all, and particularly not one type of investment
- Clearly wants to tailor things for you, listens to you and reacts accordingly – beware the dreaded one-size-fits-all approach.
- Spends real time with you and is not in a hurry.
Diversification
This helps a lot in the context of trust. Not only having different types of investment such as stocks and bonds, but also ensuring that not all of your money is with one broker or firm further reduces the change of true disaster. Don’t trust any one person or any one investment totally.
Conclusions
Unfortunately, everyone has to invest money somehow, and this also means you have to trust some people some of the time. Given human nature with respect to money, this is the unfortunate reality of the situation. Literally no one knows everything there is to know about investments and new dangers appear all the time. However, you can at least minimise the risks of being ripped off by informing yourself and being very careful.
Brian Bloch - Brian is based in Muenster, Germany and works as a managerial and financial journalist, as well as doing academic editing for non-native ...
