The Game of Risk: Brokers’ Psychological Tactics

• “Now I don’t know who to trust and I don’t know what I can believe. They say they want to help me but with the stuff they keep on sayin’. I think those guys just wanna keep on playin’ [“Roulette”] (Springsteen)

“Risk” is a word you hear a lot if you invest. Ever stop and wonder why that is?

Risk is key to broker success. Large investment brokers have found ways to transfer risk onto the shoulders of their clients without their client’s knowledge. Some do it for commissions. Some do it so they can profit off their client’s ignorance.

Smaller investment brokers use risk as a way to milk clients for money too.

Financial advisors who sell mutual funds

My first visit as a client to a brokerage was quite long ago. I went to Charles Schwab’s old office near the University of California in Berkeley.

Schwab’s office was a bit plainer than Merrill Lynch’s in Oakland where I’d worked. But like Merrill Lynch, Schwab at that time, had no one at the front desk. I had an appointment. Again I had to go hunting for someone to tell me where to go.

Times have certainly changed since then. Schwab is now very business-like and their Berkeley office looks plush. So maybe what followed in my first visit to Schwab no longer happens, but I suspect something like it still goes on.

The financial advisor I found at Schwab took me into a tiny room with a table and gave me a form to fill out. I was informed I was taking a quiz to determine how much risk I would be comfortable tolerating. I did wonder what in the world this had to do with investing, but the advisor had disappeared. So I picked up my number 2 pencil and dutifully filled out the answer sheet.

The test was supposed to determine if I was in investor able to handle “low,” “medium,” or “high” risk.

Actually that test was intended to do other things too. (1) It set me in the position of “novice” and my financial advisor in the position of “teacher,” ( 2) It showed my financial advisor how much pressure he would need to exert to get me to buy any of Schwab’s products, and (3) it told my financial advisor how he would need to word his sales pitch for whatever products he was interested in selling me.

Face it folks! There is no financial product in existence that doesn’t carry a lot of risk!

Financial advisor as teacher or coach

Financial advisor as teacher or coach is an interesting and ironic idea. Goldman Sachs’ defense against accusations of shafting its clients is based on the idea of a broker as a “partner” instead of a teacher or coach.

Investors at large banks are called “sophisticated.” This means they are supposed to know exactly what they are getting into. “Sophisticated investor” is the excuse used by upscale investment bankers when their clients realize they’ve been sold a “white elephant” while being assured it’s a very valuable antique.

What makes an investor a novice or a sophisticated investor? How much do you have to know to graduate from one to the other? It seems to me that the main distinction between these two categories of investor is not really knowledge at all, but rather the amount of money you have to invest, i.e., over $1 million.

Do sophisticated investors have to go to school, get a degree or even take a workshop to be sophisticated? Do brokers give them a test to see how much risk they want to take?

Imagine that we all (rich and not so rich) were kids again, and we were in high school taking a class on investing. Do you think the teacher would give us a quiz to test whether or not we were afraid to take risks with money? NOT! They’d teach us what the real risks were.

Brokers and financial advisors warn everyone about risks, but they protect no one against risk.

Copyright © 2010 Nancy K. Humphreys