If you're not yet acquainted with Charlie Munger, Warren Buffett's right hand man for decades at Berkshire Hathaway Inc (NYSE:BRK-A)(NYSE:BRK-B), stop reading this, jump online and order a copy of Poor Charlie's Almanack.
I'll wait. (While I'm waiting, a disclosure that I own shares of Berkshire.)
You're back? Good. Let's keep going.
Munger is perhaps the highest profile high-level polymath I know. (I'm sure there are others, but this isn't a competition. Suffice it to say the man is bloody smart, incredibly well-read and possesses an uncommon common sense.)
He also has a sharp wit, and is very funny.
Munger has said many, many things worth repeating (did I mention you should buy the book?), but in this case I want to highlight one of the things he's better known for: his view on incentives.
Tell 'em what you said, Charlie:
"Show me the incentive and I will show you the outcome."
and…
"Never, ever, think about something else when you should be thinking about the power of incentives."
Oh, and:
"I think I've been in the top 5 per cent of my age cohort all my life in understanding the power of incentives, and all my life I've underestimated it."
It's worth taking those three, in order.
First: incentives matter. Sometimes, they're all that matter.
Think about a CEO with a good moral compass. Her bonus, performance review and her future employment are being judged against this year's result.
Now imagine that CEO is confronted with a choice, 6 weeks out from the end of the financial year: to cut the price to get a deal done, now, or get full price for the same deal in 3 months' time.
What do you reckon she does?
No, she doesn't say "Screw the future, who cares!"
But she finds a way to convince herself to do the deal. She rationalises it. "A bird in the hand is worth two in the bush", is one way. Or, for the more aggressive CEO: "I'll do the deal now and back myself to find another deal in future to make up for it".
It feels rational. It feels acceptable. Hell, she even tells herself it's a better outcome for the business. And believes it.
Second, incentives matter, more than almost anything.
You can put whatever 'rules', 'ethics training' or 'policies' in place (yes, they're in air quotes for a reason), but if you set up a scheme of payment or advancement that runs counter to those, it'll be the incentives that win.
Take the recent Westpac AUSTRAC palava that ended up in a $1.3 billion fine. I ask you: do you think there might have been different outcomes if past board members and previous management were incentivised to do things that made such an outcome all-but impossible?
How much could compliance really have cost? $10 million? $100 million?
Conversely, there were incentives for increasing then-current-year profits, and keeping the 'cost to income' ratio down.
Lastly, Charlie's warning: Despite incentives being his Mastermind subject, Munger is humble and realistic enough to know that even he has underestimated the power of incentives throughout his life.
Which suggests, almost by definition, that you and I are doing the same.
Think about how long it took for the tobacco industry to come clean about the damage of smoking.
And how long it took for politicians to actually want to accept the same thing.
And yes, consider how hopelessly conflicted the financial services industry is.
Think about the kickbacks a planner used to get for recommending certain products.
Think about the incentives that still exist for the planner's dealer group or network.
Think about the fact that a recent ASIC study found that bank-related planners tended to – surprise, surprise! – think their own bank's products were best for their clients.
Think about the fact your planner, adviser or fund manager takes money from your portfolio, rather than asking you to hand over the cash or give them your credit card number. Imagine how our behaviour would change if the latter was required rather than the former.
Think about the fact that your stockbroker makes money not on whether your investments are profitable, but on how many trades you make.
(Yes, even the online guys. And yes, even the new ones.)
Think about how 'free' brokerage is being paid for (hint: you're the product in one way or another).
Now, think about the alternatives.
Who's going to create financial products that are genuinely in your interest, given the motivation to instead create products that let them make money from you.
Who's going to create a new brokerage that actually encourages you to develop good financial habits?
Who's going to create a financial product that – rather than making it easier for you to borrow from the future – encourages you to actually not buy those jeans?
Which financial products are aiming to lower costs, rather than increase them?
Which companies, hiding behind slick marketing schemes, are going to come clean about the only-slightly-tangential benefits of 'ethical' investing?
Hint: if they existed, the industry wouldn't spend millions on marketing – and incentives! – each year!
A pipe-dream?
Yep, it is. It's not going to happen.
So it's up to us.
You and me.
We need to be alert to the tricks, sleight-of-hand and conveniently opaque information.
We need to know we're being sold to, at least as much as we're being helped.
We need to remember that the incentives of others usually don't align with our best interests!
At The Motley Fool, we charge for our advice. It's an annual fee.
If we're not helping our members, they don't renew.
We're not perfect. We make mistakes.
But our incentives are aligned with yours. Because if you don't like us, you just walk away at the end of your term.
We have no incentive to get you to overtrade.
We don't take our membership fee from your portfolio, and hide it on page 3 of your annual statement.
We provide our scorecards, in full – every single winner and loser, ever – to members of each of our services.
To be clear, there are some wonderful stockbrokers, financial advisers, fund managers and bankers.
And there are some terrible people in the 'investment newsletter' industry that we're part of.
But it's important that you keep Charlie Munger's words front of mind in any and every interaction with the financial services industry.
Don't be scared off, but please, be careful.
Fool on!
