Investment Advice
Key Points:
• “Investment advice” refers to any recommendation intending to influence the investing decisions of its recipient.
• Investment advice ranges from the informed suggestions of financial professionals to the wacky ideas of friends and relatives. Be sure to vet the sources of investment advice, and trust only the most qualified advisors.
• Due in large part to the stock market crash of 1929, the government has established regulatory bodies that hold registered investment advisors to strict legal and ethical standards.
• While investment advisors are often portrayed in mass-market films as fast-talking, egocentric individuals, this stereotype is generally inaccurate. Due to their strict regulatory overseers, registered investment advisors must always act in their clients’ best interests.
The term “investment advice” refers to any recommendation intending to influence the investing decisions of its recipient. Investment advice tends to revolve around a specific product, or series of products, and presumes to evaluate the extent to which the product(s) in question would be healthy or unhealthy investments. While investment advice is most commonly — and most credibly — administered by registered investment advisors (RIAs) whose regulatory overseer, the Securities and Exchange Commission (SEC), ensures that their guidance is transparent and honest, investment advice can come in many other forms, as well. Anything from a blog post to a conversation at a backyard barbecue can constitute investment advice if the ad-hoc advisor intends to sway the ad-hoc advisee one way or the other.
Particularly when administered by RIAs, investment advice can be extremely influential. Throughout the history of the stock market, there have been certain periods in which this power of influence was wielded unjustly, as in the case of the stock market crash of 1929, which precipitated the Great Depression. This disaster gave rise to sweeping regulations which keep sources of investment advice in check. Primarily, these include the Securities Exchange Act of 1934, which established, among other things, the SEC; and the Investment Advisers Act of 1940, which laid out an exhaustive set of rules delineating what investment advisers/advisors are and are not permitted to do vis a vis investment advice. RIAs are still held to the standards set out in these acts of legislation.
Due to the fact that investment advice can be administered by amateurs — who, of course, are not subject to the strict regulatory requirements of the SEC and others — people should exercise extreme caution when seeking and acting on investment advice. In general, it’s best to run all serious investment questions by professionals, and take all advice with the caveat that it’s just advice, not guarantees, about what the future will hold.
The best investment advice tends to come from human RIAs, but there are many different types of investment advisors out there. These range from the most limited — free resources that anyone with an internet connection can access — to the algorithmic — robo-advisors who synthesize clients’ preferences into a simple, managed investment portfolio — to a kind of hybrid model, where human beings are on call to answer questions about algorithmically generated investment portfolios. Of course, given the option, one would certainly prefer to benefit from the input of an RIA with decades of investing experience, but not everyone who wants to invest well can afford this.
When soliciting the services of an RIA, be sure to ask the advisor about their qualifications and/or certifications. Many professionals who provide investment advice have sought and attained certifications, like Certified Financial Planner™ professionals (CFP® certificants) and Chartered Financial Analysts® (CFA® charterholders). These certifications are the products of extremely long and strenuous working, training, and testing processes. As a result of attaining these certifications, these advisors are qualified to provide guidance on an extremely wide range of financial matters, often making them the most credible sources of investment advice.
The Genesis of Investment Advice Regulations
There were many drivers of the stock market crash of 1929. Investors indiscriminately engaged in speculation and buying on margin, in which stocks were bought en masse, using loans, in hopes of generating a short-term burst of profit. The constant, rapid-fire buying caused the market to soar for a short while, but as the buying was not correlated to anything of actual value, the soar was accompanied by a plummet shortly thereafter. Also, similar to the subprime mortgage crisis of the late-aughts, many loans were administered by the Federal Reserve without sufficient due diligence to determine whether the borrowers would be able to pay them back. Again, this catalyzed a short-term swell in the economy, which was undermined when the bills came due and borrowers were unable to pay.
Additionally, insider trading, in which individuals with exclusive access to information have a much greater likelihood of profiting off of certain investments than outsiders without access to the same information, went largely unregulated at the time, which undermined public confidence in the stock market, especially after its crash.
President Franklin Delano Roosevelt’s administration created the SEC so that overseers would be able to prevent this kind of irresponsible investment activity from again running rampant and hurting the lives of millions. The aforementioned legislative acts, the Securities Exchange Act of 1934 and the Investment Advisers Act of 1940, outlined strict regulations over who could legally call themselves investment advisors (widely spelt “advisers” at the time), what kind of advice they could give, how they could advertise, and more.
Selected Regulations Imposed on Investment Advisors
The Investment Advisers Act of 1940 (IAA), which is still the document to which most modern advisors adhere, introduced a host of new regulations into investment advising, including the following.
Who They Are
In the IAA, an investment advisor is legally defined as “anyone who for money is engaged in the business of providing advice, making recommendations, or furnishing analyses on securities, either directly or through publications.”
The terms used in this definition are applied broadly. “For money” can refer to any type of compensation. “In the business of” does not mean investment advising has to be the advisor’s primary line of business — if it’s any level of business at all, they qualify, and must abide by regulations. The last phrase, about advice, recommendations, and analyses, encompasses any statements regarding market trends, instructional data, advisor selection, and information about securities or other investments.
Prohibitions
Among the many actions the IAA prohibits are “misleading omissions of material facts” (lying by way of telling partial truths), insider trading, and investment advice that does not hold up to the suitability standard. That is, all investment advice provided by advisors must reasonably be deemed suitable by an expert, otherwise it qualifies the advisor for fraud.
Advertising Limitations
The IAA contains extensive restrictions on how investment advisors may advertise their services. For example, it prohibits them from advertising about successful investment advice, unless they’re willing to include all of their investment advice from the previous year in the same advertisement. They are also not permitted to include client testimonials about successful investment advice in advertisements. Generally speaking, they are not allowed to produce advertisements which in any way suggest that their advice is uniquely excellent, or that they are right more of the time than they actually are.
The IAA is a rather lengthy document that includes many more stipulations, but these are the most relevant to know for the purposes of individuals soliciting the input of investment advisors. The key takeaway is that the irresponsibility that led to the collapse of the stock market — canceling out $45 billion of wealth in 1929 dollars, which equates to more than $800 billion of today’s dollars — led the government to assume great responsibilities of oversight.
Common Examples of Investment Advice
The pervading stereotype of investment advice features a high-octane, fast-talking broker insisting that their advisee would be insane not to buy or sell the company stock in question. Typically, in the stereotype, the broker is not acting entirely in the advisee’s best interests — if at all. Popular mass media like The Wolf of Wall Street and Wall Street are to blame for these inaccurate stereotypes. In reality, the most common forms of investment advice tend to be much more sedate, and much more geared toward steady, long-term portfolio growth.
Many advisors encourage their advisees to begin investing as early as possible in order to take advantage of compounding. That is, the sooner they open an investment account, the more quickly it will begin to grow, and the higher it will ultimately reach. Advisors also typically caution their advisees against attempting to predict or beat the market, as these practices typically prove unsuccessful, and end up resulting in more losses than gains.
There are numerous other forms of generic investment advice that typically accompany the guidance of investment advisors and other financial planners. Of course, advisees should understand that they have the final say over the way their portfolios are allocated, and they should not take investment advice as gospel by default. The advisor-advisee relationship functions best with total transparency and open lines of communication. To get the most out of the investment advice they receive, advisees should be prepared to ask lots of questions to develop a thorough comprehension of their portfolios.