The greatest challenge in managing your financial life is choosing the guides, experts, and providers in whom you will place your trust. How can you identify who has real knowledge as opposed to a working vocabulary of the conventional wisdom? When you finally find an adviser with genuine expertise, an even more vexing problem remains; will she use that know-how to advance your goals instead of her own? These two questions make up the larger query; whom should you trust?
Economists have long known the answer, at least in a general sense. People tend to act in furtherance of their own interests. Of course, they are limited by their own perception of them. Nevertheless, you can confidently place your trust in someone whose interests are best promoted by rewarding that trust. The opposite is also true. It is seldom wise to expect trustworthy behavior from those whose interests call for something other than keeping the promises they have made to you.
Thus, a restaurant cannot afford to use stale meat for fear of word spreading all over town. The bus company won’t persist in allowing unskilled drivers to take the wheel. And the local tavern can (presumably) water down the booze only so much before even an inebriated clientele begins to notice.
This “reputational effect” tends to police many corners of the public marketplace. For the most part, one who lies, breaks promises, or fails to uphold client needs develops a “bad rap” and cannot get new business. But that is not always the case. There are some situations in which reputation fails to regulate behavior. One involves transactions so complex that it becomes difficult to know whether the provider has acted faithfully or not.
The power of reputational effect to keep business providers on the straight and narrow path begins to fail with goods or services that are very complicated or difficult-to-understand. We have few ways of knowing whether the surgeon is really talented or if he simply has a good “bedside manner.” Our insight into the relative skills of lawyers or accountants is quite limited. Even our auto mechanic may be able to convince us that an adequate job was somehow “brilliant.”
In those areas where our observations as lay people are inadequate to form useful judgments, we rely on regulators. These may be governmental, industry self-regulatory organizations, or even not-for-profit watchdogs like Consumer Reports. We must have confidence in these bodies, though, and believe them to be incorruptible.
Where complexity or specialized knowledge makes it almost impossible for most folks to know if they are being cheated, the role of the regulator is vital. In such situations, no “invisible hand” or market mechanism can come to the rescue. It is these areas of public life where the overenthusiastic swing toward “deregulation,” “free markers,” and laissez faire has done real damage. Where we need strong regulation, we need it badly.
Notwithstanding the hope that government and other regulatory bodies may someday come to their senses, the private citizen still must face up to the individual challenge. In your financial life, you must figure out who is worthy of your trust. It is a duty you owe to self, family, and descendants. Ignore it at your peril.