It is well understood that we live in a transaction driven industry. The problem for the investor is that the securities regulations that govern investment advice, instead of mandating that securities recommendations be suitable for the individual, protect the right of the industry to sell products without fully addressing the suitability of an investment.
There are five rules that should determine the suitability of an investment.
An investment that is recommended must relate to a) the actual size and timing of financial needs over time and b) the relationship between financial needs and total assets over time (both current and future disposition of capital) .
After relating the allocation to a given investment or set of investments based on financial demands on the portfolio over time, the investment must then be able to relate to attitudes to risk and investment preferences.
The recommendation must relate to all existing investments and the relationship that exists between these investments and financial needs at a point in time and over time.
The recommendation made must make sense given the price of the investment at the time and the risks the investment is exposed to over time.
Suitability can only be fully assessed with client interaction in the decision making process. This also means that education and communication regarding the basics of investment, the risks of investment, the managerís investment style and how portfolios are constructed, planned and managed to meet financial needs over time are key to agreeing suitability of transactions, products and recommendations.
In fact, the minimum industry standards (the know your client form) that govern the suitability of a transaction do not require compliance with any of the above.
This means products can be sold as one off solutions and invariably investors will end up with a collection of securities and products that make little or no sense. These products are expensive not just because they require incentives to be provided to the seller but also because of the various layers involved in developing and managing them.
In a transaction driven industry where products can be sold as stand alone entities the consumer is at risk of inappropriate products masquerading as appropriate product solutions.
It is an awkward situation that the only one responsible for making sure that they are getting good advice is the consumer and, the consumer is the least able to understand whether or not they are getting good advice.