Business Q&A: Here’s why you should negotiate with financial advisers

If Steven Blum has just one piece of advice for people wanting to be better investors, it’s this: Be a better negotiator.

Blum, a teacher at the University of Pennsylvania’s Wharton business school, believes investors need to be prepared to negotiate with financial advisers to avoid pitfalls such as high fees and being steered toward products they don’t need.

That means arming yourself beforehand with information about those products and services and how the adviser and firm are paid, among other things, says Blum, author of “Negotiating Your Investments,” published this year.

“What if you go to a car dealership and you say, ‘Well, I know absolutely nothing about cars?’ What happens to you? You spend a lot more money,” he said.

Blum was in Charlotte last week to speak to the Wharton Club of Charlotte. During his visit, he spoke with the Observer about his book and advice for investors.

For 21 years, Blum, 56, has been a lecturer at the Wharton School, where he teaches negotiation and conflict resolution. Blum, who is also a lawyer, says anyone can become a better negotiator. That's an important skill to have when dealing with financial advisers, whose interests don't always align with their clients’, he said.

“The history of this industry is sales-based. The historical roots are people selling financial products and ... stock brokers selling stock transactions for a commission, which is always going to have a big conflict-of-interest problem.”

For example, he said, the wealth management industry sells financial products created by the very banks selling them.

“And what is the markup? What is the profit margin on those commercial products?” he said. “The problem with wealth management as it tends to be practiced is that it is hopelessly loaded down with conflicts of interest.”

Such conflicts can end up costing investors lots of money, which is why it pays to do your homework first, he said.

Questions and answers were edited for brevity and clarity.

Q You advocate negotiating with financial advisers. What do you mean by that?

A If you’re going to be a good investor-negotiator, you’d better … learn what you need to know, just like any other good negotiation. If you’re going to negotiate about finance, you’d better know the basic finance. You’d better know what economists know. When I say negotiate, I don’t mean bargain or dicker. I mean a systematic way of thinking about negotiation as it’s taught at major universities in America. What I mean by that is do what an excellent negotiator would do if $1 million is on the line, because for most upper-middle-class families, several million dollars is on the line.

Over your lifetime, this decision of who you're going to work with and what decisions you're going to make guided by them has several million dollars’ difference, good outcome or bad outcome. Do your preparation. Figure out who they are, how they do business, what they do. Don’t go into a negotiation understanding nothing. You’re negotiating fees, you’re negotiating (investment) strategy, you’re negotiating outlook.

Q What's one good thing to know before doing businesses with a financial adviser?

A I advocate that you say to them, ‘Tell me every way that you make money, and tell me every way that your firm makes money.’ Now … if anybody's ever going to lie to you, that’s the moment they're going to lie. But if you've done some research and some homework, you may be able to suss it out if they're lying to you.

What you want is a practitioner and a firm who make no money in any way except for what their clients pay them directly, and it’s transparent, for their services. Here's a partial list of … the ways these companies make money: commissions … transaction fees … proprietary products. The obvious problem with transaction fees is if I make a dollar every time you trade, I’ll suggest that you should trade 1,000 times, whereas any economist could tell that's the worst thing you could do.

Q Is there anything a financial adviser might promise that should send up a red flag?

A The thing that should send you scurrying away is the assertion that they can beat market averages, that they can beat benchmark averages. The reason why that’s so troubling is because economists have (come) pretty close to proving they can’t. Of course, last year some people did. But that’s the playing out of random chance. It’s not talent. It's not skill. It's not anything that you should ever pay a penny for. So, what you want is an adviser who knows the science of financial economics and says, ‘What I can do is harness it for you and guide you through it, not beat it, not do better.’

Q What are some investments to avoid?

A First one is variable annuity products. They are never going to be the best investment for you, and sometimes they are a truly terrible investment. What they amount to is a contract between you and an insurance company, and you cannot possibly understand that contract. And if you try to take it to your lawyer, she won’t understand it, either. And it is being sold to you by someone who makes … more than he would make selling a different product. And you're handing over cold, hard cash for this promise you don’t understand. From a negotiator’s point of view, that's madness.

The second one is hedge funds. What a hedge fund really amounts to is handing over your money to an individual investment guru … who does with it whatever the hell he pleases. And when you ask … ‘What are you doing with my money,’ he says, ‘That’s proprietary information.’ So it's like putting it (your money) in a black box and waiting. They're totally opaque. Furthermore … hedge funds are insanely expensive. (Also), never, ever incentivize somebody else to gamble with your money.

Q What's a better investment, then?

A Economists are almost certain that they know the following: Diversified stock investments over very long periods of time, there’s every reason to expect those will be the best investments. But stock investments over short periods of time are nothing but gambling.