What's the point of Financial Advice?
You’ve reached a level in your career where disposable income is in abundance, you have a young family, a home with a healthy Loan to Value, a good retirement and healthcare plan at work, and you still have that brokerage account of index funds you continue to build which has served you well. But you feel unsettled. You’ve heard colleagues at work talk about reviewing family finances with their Financial Advisor. What are you missing? Your index funds are tracking global market growth, your retirement plan containing target date funds takes care of itself at a low cost, and you continue to pay down your Mortgage - you're in good shape. Why would you pay fees to an advisor to tell you the time on your own watch. What are the measurable benefits?!
Let’s consider three common misconceptions:
1.) Financial Advice is about investing money and selling products.
Despite the resurgence of the mullet hairstyle, we’re not living in the 80’s. Financial Advice has come a long way since then, and advisors are more qualified, many to Chartered, Certified Financial Planner® and Fiduciary or Consumer Duty Standards. Investing and financial planning have combined, commission-based products have declined, and the industry, across all types of advisers, has become highly regulated, focused on long-term relationships and positive client outcomes. As a successful, affluent family seeking advice, you can expect:
A discovery process based on you and your family’s circumstances.
Personal risk assessment based on the capacity for loss, emergency funds, and your personal attitudes.
Goal-based cash flow modeling to establish how and when you'll reach specific goals such as retirement or funding a college education for your children.
Tax-effective investing based on asset diversification linked to your goals.
Company Stock Incentive Plan review.
Insurance and Healthcare evaluation in conjunction with your workplace benefits.
Estate Planning and Will review.
A regular bespoke review and rebalancing process to monitor your circumstances and goal progress.
2.) Financial Advice is expensive.
Obviously, this depends on who you work with, but the Caveat Emptor principle to deploy is: how much time is my advisor and their firm putting into managing my family's money and personal financial plan? If you’re paying 1% per year just for advice, how much is that in monetary value, and what are you getting? How much is this advice fee relative to the total fees you pay? Warning signs should flash if it’s more than 60%. Ask the advisor to break down the Total Expense Ratio you will pay so you can understand the value and compare it to competitors, but be aware some firms won’t publish total expenses as underlying investment and platform costs may be charged by 3rd party firms.
Time-based advice is becoming popular, but it’s important to understand the merits and drawbacks of this, including the retainer model and the time roundups built into contracts, both being popular amongst time-based advisors. You can easily calculate costs in the context of your needs by comparing them to the standard, asset-based fee model.
3.) Financial Advisors are always looking for new clients.
This might be true of a new advisor starting a new practice, but when engaging a reputable firm operating under a fiduciary or consumer duty standard, it becomes less relevant. 150 family relationships are the maximum for most individual Advisors to enable them to provide the best, bespoke service within their time and capabilities. It’s also important to break down the support functions an Advisor has behind them within their firm.
The Gold Standard
Financial Advice is about trust to structure, protect, and grow your family’s assets proactively with you as your life circumstances unfold. To achieve this, a good Advisor must focus their time on client relationship management as a quarterback, which means they will work with a team to support them with investing and financial planning, and administration/operations. The best advisor firms with the largest volume of client referrals work to a fiduciary or consumer duty standard, have strong account platform technology, Certified Financial Analyst® and Certified Financial Planner® teams actively working behind their individual advisors, and possess the ability to adapt their model to meet bespoke client needs. As Artificial Intelligence starts to take a more significant role across all global markets, it is these firms that will take advantage whilst maintaining strong personal connections with their client families.
Is our Tracker Fund obsession limiting investment returns?
Many believe that Warren Buffett said it best. Investors seeking retirement savings should consistently buy a tracker fund - a passive investment fund that replicates an underlying stock market index. For those feeling bewildered about which stocks to buy, the cost-conscious, or not wanting to engage with an adviser, this message has become commonly accepted. So, as Monty Python might say, what have active fund managers ever done for us?
Since 2010, global Exchange Traded Fund (ETF) assets have grown by eight times. Significant inflows have caused investors and the financial advice community to rethink their traditionally active fund approach. Depending on their overall asset allocation, the many investors who made the shift from active funds probably found it worth it. Major stock market index ETFs have outperformed most of their active fund rivals whilst giving passive investors significant cost savings. Financial advisers have relied on the same to provide clients with better value, whilst some have benefitted from higher ongoing advice charges due to the lower effective costs.
The active/passive fund debate continues, with both sides relying on performance and charge data to structure their arguments, but it isn’t that simple. Investors and advisers must dive deeper into the details of both arguments and their relevance to global economic and market cycles to take advantage of the benefits both active and passive strategies offer, particularly as we shift into a new economic phase.
But how did Passive investing take the fight to Active?
Until recently global interest rates were maintained at historic lows because of a collapse in inflation following global economic stimulus in 2008. This created a surge of growth stocks- the larger companies with higher earnings and lower dividends but steadier long-term growth prospects who can typically borrow more and have done so at extremely low rates of interest. Think of tech companies today, like Apple or Meta. Most major stock index ETFs predominantly hold large growth stocks due to the capitalised construction of their underlying index driven by the relative size of each company.
The Credit Crisis put banks and financial firms under the microscope. Investors were justifiably upset about the collapse of the mortgage and real estate markets in 2008/9. US legislation in the form of Dodd-Frank (2010) created oversight, and despite its partial repeal in 2018 by the Trump administration, the anti-banker, anti-commission culture cultivated and spilled into the US advice industry, particularly those representing wire-houses (banks and brokerages) in the U.K. The Retail Distribution Review (2013) addressed the professional qualification and the commission focus of the advice market, which caused adviser numbers to decrease. Regulation created a cultural shift. Investors turned away from advisers towards lower cost and self-investing; Vanguard, one of the largest global ETF firms, flourished, and Nutmeg and Betterment were established. The terms independent and fiduciary became staples for new advisers in global advice markets, and the independent and RIA markets in the U.K. and U.S. began to take asset share from the private banking adviser community, staking a larger claim into the well-established High Net Worth territory.
Buffett’s tracker fund argument is reflected in behavioural finance and the Nobel Prize-winning Efficient Markets Hypothesis- it’s impossible for anyone to beat the market consistently because common information that might provide an advantage is already priced in. So, why would any investor question this logic? Firstly, Buffett addressed American investors and referred to an S&P 500 tracker fund. For global investors such as those in the UK, the situation is more challenging given the relative size of the UK stock market, currency constraints, and particularly as we enter a new market cycle reflected by higher inflation, interest rates, and market volatility.
As we are acutely aware, interest rates are rising, and whilst 4%+ rates may arrive but not stay, it’s probable by 2024, they won’t return to the levels we’ve enjoyed in the past 14 years. This scenario makes growth investing more challenging and, with a rise in market volatility, reverts focus to how strategic investing used to be: active, bottom-up, and value-based, a skill few investors can successfully pull off consistently, but we haven’t needed to consider since pre-2008 thanks to the growth stock wave. Warren Buffet, Peter Lynch, Ben Graham, and Sir John Templeton are/were famous value investors who became investing heroes of their time, seeking out intrinsic value within unloved companies and holding them until their time in the sun came, but their skills were much less relevant through the growth wave.
The ETF universe has moved on, too. There are index funds for just about anything investors can think of, including value stocks and actively managed passive funds, such as Cathie Wood’s Ark Fund. Despite getting burned in their global growth ETF during the first half of 2022, an investor can gradually re-adjust their weighting towards value stocks but stay passive by investing into a range of value index funds, blending styles to accommodate their strategy. Given their passive nature, using an ETF to deliver a value strategy is difficult to define as strategic, particularly during volatile times, as traditional value investing should be, but that said, you could do worse by including Vanguard’s Value Fund in your allocation.
What’s the answer as we aim to balance strategy, the costs of investing, and, if relevant, advice? Firstly, don’t be obsessed by ETFs simply because they are cost-effective. Getting caught in a style or a tracking error trap is more likely without proper research. Investment styles typically ebb and flow into relevance depending on the economic and market cycles; moving forward, it's, therefore, good to be agnostic, blend styles across your portfolio, and recognize the past 14 years have been unusual. A good adviser should be able to manage and adjust fund investment styles across their client’s portfolios as market conditions evolve. Secondly, as part of a good due diligence process, focus on assessing active fund manager talent, and, if necessary, be prepared to blend your or your client’s portfolios with ETFs and active funds, known as a Satellite Approach. You or your adviser should be capable of creating and maintaining this strategy, but if you don’t feel comfortable as a self-investor, the passive world may be more suitable.
When should you use an ETF over an active fund? Generally, and as directed by the Efficient Markets Hypothesis, ETFs should be used to reflect your allocation across the most efficient growth-orientated markets, such as US, UK, and EU equities where commonly known information is heavily priced in, and active managers are less likely to outperform (known as achieving alpha). Your active fund allocation should reflect less efficient markets such as Asia, Emerging Market equities, and high-yield bonds where inefficiencies are present and information is less priced-in. This provides opportunities for fund managers, particularly bottom-up value investors.
