The S&P/ASX200 price index peaked in October 2007 at 6851, a remarkable 2.5 times its level five years earlier, in March 2003, of only 2693. The long bull market had started after ‘the recession we had to have’ in 1990, and for at least 15 years, financial planners could factor handsome ongoing returns from equity allocations into Statements of Advice.
The market index is now about 5000, 27% below its peak, and it is apparent that the strong market prior to the GFC disguised many shortcomings. As Jack Bogle, the highly respected founder of the Vanguard Group, said, “Never confuse skill with luck, especially during a bull market.”
With lower absolute returns from investment markets after the GFC, many market participants (including the funds management industry that I have operated within for the past 30 years) have faced greater scrutiny and criticism, and they will need to work harder and smarter in future to earn their keep.
This article focuses on financial planning and examines the elements of financial advice that are most valuable for clients.
Financial planning has grown rapidly in recent decades, with current estimates of 17,000 planners across Australia. The increase from a small base has been fuelled by:
- relatively complex tax and social security laws, especially concerning retirement planning
- the compulsory superannuation system
- a low interest rate environment causing investors to search for growth, where returns were attractive
- intergenerational transfer of wealth
- opening up of investment markets to 'the man in the street' as a consequence of more knowledge, media coverage, financial advertisements and high profile sharemarket listings (such as AMP, Telstra, CBA, GIO, Qantas, TAB, Woolworths, NRMA).
Prior to 2007, most investors who followed a planner’s advice would have been reasonably happy with the results. Advice fees, traditionally a percentage of the assets invested, were a relatively small proportion of the returns generated, and many financial planners received a handsome income. Happy investor ... happy financial planner … happy, growing industry.
But times have changed. To quote another legendary American investor, Warren Buffett, "It's only when the tide goes out that you learn who's been swimming naked."
Increasingly, investors are asking whether the fees paid, either directly or indirectly, to financial planners represent value for money, or indeed whether they need a financial planner at all. No doubt some planners feel this is unfair because returns rise and fall and this is not necessarily a valid reason to either criticise or praise a planner or their fees. Markets move quite independently of what a financial planner says or does.
But the poor returns prior to the 2012 rally were not the cause of the changes required in the financial planning profession, merely the catalyst.
So the question is: what type of financial advice is worth paying significant fees for?
Access to a wide variety of asset classes can be gained by anyone, regardless of whether they consult a financial planner. This is particularly the case today with a plethora of investment platforms, educational material, managed funds with low minimum balances and easy access to everything listed on the ASX through cheap online broking. Access to investments is not a planner’s competitive advantage, perhaps with some exceptions in the rarefied world of exclusive, private banking.
Similarly, the ability of a planner to select the best investment managers, and create an expected superior performance, is often overstated. In any case, this role is carried out by independent specialist research houses who give managers ‘star’ ratings for their investment skills. Advisers can access these services, and will develop familiarity and preference for certain managers, but last year’s league table winner is often next year’s laggard. In fact, most money is made or lost each year from being in or out of a particular asset class, not from who is managing the money within the asset class.
What about the planner’s role in selecting the correct short-term asset allocations? Again, history has shown us that it is virtually impossible for anyone to predict the winning asset class in any particular year. Peter Lynch, famed former investment manager with the Fidelity Group, has stated about market timers, “… they can’t predict markets with any useful consistency, any more than the gizzard squeezers could tell the Roman emperors when the Huns would attack.”
Further, Jack Bogle’s summary of market timing was less pithy but equally precise, “In 30 years in this business, I do not know anybody who has done it successfully and consistently, nor anybody who knows anybody who has done it successfully and consistently. Indeed, my impression is that trying to do market timing is likely not only not to add value to your investment program but to be counterproductive.”
It is not that knowledge of expected long-term returns from various asset classes is irrelevant and of no value to a client. It is important for a planner to advise what proportion of a client’s money should be invested in each asset class, with a ‘through-the-cycle’ perspective. But this should not result in regular switching, even as a yearly exercise, because of the volatility of different asset class returns over short time frames and the impossible exercise of predicting this with certainty.
The role of combining a client's investments together into a single, easy to comprehend report, showing consolidated performance, transactions, market values, income receipts, calculators, tax implications and so on was once a significant value-add of a planner. This is now done by administration platforms or software solutions which are increasingly 'all-inclusive', and available directly to the investor. Administration services and reporting tools have become a low value commodity. The adviser has a role to play in ensuring the correct platform is selected for the skills, experience and financial resources of the client, but it is part of the outfit to play the game, not the game itself.
There is some value in all the above, especially in the establishment phase of a plan, but what should be the greater focus of high quality, value-adding financial planning?
Simply stated, the value in good financial planning is understanding a client’s needs and setting and adhering to a realistic long-term strategy to achieve a desired outcome for that client. Doing this with first rate client service and a strong projection of trust and professionalism are the keys to success. It requires knowledge and skill, and is a lot more complicated that pontificating about the short-term merits of a particular manager, asset class or stock.
Setting strategy requires a good understanding of many aspects of personal finance, including:
- taxation laws, particularly those relating to capital gains tax and superannuation
- social security rules
- expected long-term returns and volatility from various asset classes
- estate planning
- asset and income protection
- the role of trusts, companies and partnerships
- personal budgeting
- family law, especially where assets require splitting
- structured philanthropy
This knowledge is worth paying for. Until investors understand the true value in financial planning, the relationship between financial planners and their clients will often become dysfunctional when markets are producing poor returns. The industry needs to move clients away from gauging success by the return appearing on their yearly investment statement, and much more towards the overall strategy.
A financial planner requires reward for execution and adherence to a sound, personalised strategy. Where the fee between a financial planner and an investor is fair and reasonable and sustainable value is being delivered, there is no justification for the criticism of fees during periods of poor returns. However, if the 'sale' by a planner to a client was all about sexy, quick investment returns, then the investor has every reason to complain about fees when investment returns are poor. This is not financial planning. This is speculating.
The financial planning industry must continue to advance into a mature profession that the public understands and properly values. We can look forward to such changes with enthusiasm. Good financial planning advice is an extremely valuable service and increasingly essential as the general population continues to age and the compulsory superannuation system works its way through a full life cycle.
