How Do You Know Whom You Should Trust? Here are Four Criteria to Find Out.

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Trust is the key to all successful human relationships.  In our lives we have to trust others.  From the moment we are born, we are hard wired to trust others because without their help, we would never make it.  At some point in our lives, however, we regrettably learn that we can’t trust everyone.  It might be the kid that never returned the toy we loaned out, or the parent that never honored the promise made to us.  That’s when we start to get hardened and wonder who we can trust.


Figuring out who you can trust ranks amongst the most important decisions we are continuously making throughout our lifetime, as trust is the basis of every interpersonal relationship.  If trust is strong, the relationship will work.   If trust is weak, the relationship will fail.  This is true in love, family, friendship, and also in business.  Trusting the wrong people can cost us our happiness and our money.  On the other hand, trusting the right people and being trusted in return can put us a long way toward a rewarding life.


Trust has arguably been one of the more interesting topics for us to research and write about at Carden Capital.  We have distilled research from a number of respected researchers from the fields of psychology and sociology.  As a result, three main themes, or rather character traits, appear to be prominent in helping us assess how much trust we should place in someone:


Reliability: Does someone do what they say they will do, on time, consistently?  Or are they constantly missing the mark and making excuses for broken promises and a lack of reliability?


Truthfulness:  Does someone tell the truth, bend the truth, or outright lie?  Are important facts omitted?  Do they ask others to be complicit in their lack of truthfulness?


Trustingness:  Does the person you are evaluating tend to trust others?  While it’s perhaps not entirely self-evident, empirical research and our own genetic wiring have taught us that those who tend to trust others are also more likely to be trustworthy.


While we agree with the research written on this subject, we believe there is one more exogenous factor that needs to be evaluated when addressing trust, namely, incentives.  Trust is much more sustainable if there is good alignment of incentives.  If incentives are aligned, people with a strong moral compass, and those with a weak moral compass, can generally trust each other.  If the incentives are not aligned, trust breaks a lot easier.  If the incentives to the contrary are big enough, anyone will eventually betray us.


Consider this extreme example: If the waterboard comes out, eventually you’ll crack and give up those secrets. Why? The incentive to do so has become stronger than your previous commitment to the contrary. The same dilemma holds in business. If the money is big enough, chances increase someone will do the wrong thing. That’s why we believe when examining trustworthiness in others, we should not only consider their personality, but also whether or not they share the same incentives with us.


In our business, money management, trust is the most important part of a successful relationship.  Next to our health and meaningful relationships, money is the most important thing we have.  Therefore the wise thing to do is to place your money not just with someone you trust, but also with someone who has a proper alignment of incentives with you.  Otherwise the results could, and likely will be, to your detriment.  The absurd part about trust is that once established, it can hold our mind hostage, even in the face of factual evidence to the contrary. Remember the story of the faithful spouse that got cheated on repeatedly but never fully faced the facts?  In business that is why great salespeople can be dangerous.  They are experts at building and subsequently exploiting trust.  Not all salespeople exploit trust, but we see this happen in our business quite regularly, especially if the incentives are not aligned.


Most non-finance professionals are not familiar with this, but the regulators have created two vastly different business models in our industry, which pretty much look the same to the unsuspecting general public: (i) Broker-Dealers (BDs), and (ii) Registered Investment Advisors (RIAs).


Allow us to indulge you. Those two business models are very different from each other and therefore create vastly different alignment of incentives with you, the client. The broker-dealer gets paid whenever you transact (buying or selling a security).  The RIA is paid a fee by you for managing your money but is paid nothing when you transact.  Some firms double dip and act as both (hybrid BD/RIA – arguably the worst for clients).  You might find it surprising that almost all of the large brand name firms in our industry are broker-dealers or hybrids, directly pitching their employees’ incentives against yours.  Ever wondered why they are so profitable?


From a regulatory perspective, the broker-dealer is only subject to a “suitability standard.”  This means they can sell you any financial product as long as it is deemed suitable to the client.  Suitable can mean a lot of things, but commonly it means the product with the highest commission to the broker.  The registered investment advisor is subject to the “fiduciary standard.”  This means the advisor must place their interests below that of the client and act in the client’s best interest.


So if you think about it this way, the registered investment advisor is subject to both the carrot (ongoing management fees) and the stick (regulatory penalties) to make sure that they do the best job for you in order to retain your business.  The broker-dealer is subject to neither.  The hybrid broker/advisor will generally try to sell you the product with the biggest commissions and then try to justify it so he can continue earnings advisory fees on top of the commissions he already earned.


There is only one business model that puts the client first, and that is the registered investment advisor. Carden Capital is a registered investment advisor.


If you think this distinction is not important, think again.  We know some very nice people who have been taken advantage of by their broker/advisor.  Next week we’ll share a few stories and some empirical evidence to demonstrate the difference in more detail.


Enjoy your weekend.


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