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What financial advice is worth paying for?

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.

 

5 Comments
Peter Horsfield
March 12, 2013

Thank you!!! At last some truth to the fees and values debate between clients and advisers.

The problem is the financial planning industry was built on product sales. Starting with insurance then managed funds, then superannuation and more sophisticated products as the world and laws became more complex. Unfortunately the advisory industry has trained advisers into believing they provide all these products and services to their clients as well as continuing to be an expert, not just in one field but now many! The result that naturally has evolved is that less value can now be delivered to the client due to the adviser's knowledge and capacities being stretched, since they are now responsible for multiple complex disciplines.

As soon as adviser's realise.. (As Chris has correctly pointed out) that their most valuable asset to the client is ensuring 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.

Let me give you an analogy to assist. let's say its Grand Designs!

Imagine you wanted to build your dream home.. The goal generally is to move in and reside in the dream home rather than the process of the dream home build, correct.. however the process of finally residing in your dream home may take three alternative paths.

1. You could decide to build the dream home yourself. You become the electrician, draftsman, plumber, carpenter, brick layer, tiler, council planner/approve, and client. You learn and do everything yourself. It takes time, you learn skills to to yourself, you can save money (or not) but eventually you get to reside in your dream home.

2. You are the project manager. You have an idea of what you want your dream house to look like and you then hire the electrician, plumber, carpenter, draftsman, council/ approve and yourself as the client. Again this is another approach however this time you have hired specialists and you must organize and orchestrate the build so that it rolls out efficiently, on time, under budget etc... Again using this approach you can get some of the work done for you however the challenge is in efficiently project managing everything when it may not be your strength. However the end result still is that you get to live and reside in your dream home.

3. You hire the architect/project manager. They discuss with you your visions, aspirations, costs, time frames, expectations and then once agreed engage their team of experts to build your dream home. Generally the headline cost may seem excessive however if you were to factor in your own time, loss of earnings (due to distractions), relationship issues etc... that are symptoms when creating ones dreams it has been found hiring a professional architect/ project manager and team more often than not saves money rather than adding to ones expense.

You each of us we will draw our own conclusion as to which path we feel there is the most value.

The financial planner who can lead an manage a team of specialists, is someone who can deliver immense value to the client, as they will have a deep understanding of where the client needs and is working to be, and they will liaise, manage and organize the process where professionals can contribute in an efficient and proactive way to give the client the greatest chance of success in achieving their goals, save the clients time, heighten their trust in their adviser and ultimately be advice worth paying for.

Peter Horsfield

Steve Romic
March 04, 2013

There appears to be agreement that structural (or strategic) advice is worth paying for as we generally accept that financial planners have expertise in this area.

The rub is in the investment piece and the jury is out whether financial planners have sufficient investment expertise to justify charging (ongoing) fees. They certainly do not, according to Paul Keating in his article “Where did SMSFs come from, and where are they going”; unless I am misreading the meaning of “falling prey to financial planners”?

Institutional wealth management firms that dominate the market control the investment piece for more than 85% of financial planners and the ongoing portfolio management fees are already imbedded in their investment products. In this case, advisers probably shouldn’t be charging ongoing investment advice fees. Rebalancing or adjusting portfolios by following a strategic asset allocation (SAA) model with an approved product list (APL) doesn’t really cut it. Perhaps such fees are better described as “ongoing portfolio review & financial counselling fees”?

The SAA/APL approach is also followed by a large part of the IFA market. However, a growing number of IFAs are shirking managed funds in favour of a direct stock picking and/or ETF approach. The proof is always in the pudding… but I generally question the extent to which such IFAs hold themselves to account ?

Anyway … what is investment expertise ? Does it refer to security selection; manager research; asset allocation modelling; risk management; portfolio construction … or all of these ? Also, what’s the required level of expertise to warrant the payment of ongoing fees and who sets the standard ?

I question whether it’s realistic to expect investment expertise of financial planners. To be highly competent across the strategic advice, relationship management and business management in addition to investment management is probably out of reach for most.

Perhaps the obvious conflicts around the investment piece will be addressed by regulators down the track … FoFA-Part II – the elephant in the room !?

Philip Carman
February 16, 2013

As a Financial Planning/Advice practice of over 31 years' experience we abandoned the nonsense of the "efficient market" theory and also the conventional wisdom associated with Modern Portfolio Theory 12-13 years ago, in favour of our own, less conventional, but wiser strategy.

Our clients who have reached their financial goals (ie after working hard have saved enough - or soon will have - for their retirement) NEVER have more than 30% of their financial assets "at risk" in "growth" assets. They have 70% in cash and the 30% in a tightly risk-managed portfolio of theirs and our best ideas, including some gold and any stocks they and we fully understand. That's not many! We may use a managed fund or two, but only for dollar cost averaging into the market OR when we/they have no better ideas, and then we prefer index funds in most cases.

When it comes to property - we don't use managed property, either listed or unlisted - instead preferring the more sensible "your own home; your next home and your business premises (if applicable)" strategy, which allows plenty of property, but only that which is of direct benefit to the client. No need to speculate on property if you stick to our rule...

You may ask what we do for those who haven't yet reached their financial goals... We teach them to work hard, save 10-15% of their income; be debt free asap and learn to live better on less. That way they, too will reach their goal before they cease working. Of course we protect them with the necessary insurances but we NEVER do geared investments, especially margin loans over shares. Those who need it can't afford it and those who can afford it don't need it.

Our value proposition to our clients is that we teach them the (simple) rules of risk management: stop losses to protect the downside and profit points to take profits on the upside AND we teach them to do as much as they are willing/able to do for themselves, so that they aren't totally dependent upon us... That may sound counter-intuitive but they LOVE us for it and yet most still pay us to do it for them while they get on with their lives, but they now know what it is we're doing and THEY can take over if/when they wish.

For super we use the only platform that allows the client to transact on shares, managed funds and even term deposits and we teach them how to do THAT, too - but we do it for them if they prefer. Larger balance may use a SMSF, but we find this platform (netwealth) so good that only those with more than $600,000 in super would warrant even considering a SMSF.

The point overlooked by most is that ADVICE should be just that - NOT instructions, Our clients actually instruct us AFTER we give them advice and THEY have chosen whether to take it or not. Hence, for the past 22 years we have charged fees for service and advice and those fees are paid up front whether the advice is taken or not. Remember - we're selling advice - NOT investments!

We also do planning for their estates and insurance, etc and we act as family counsel in all things financial, to the extent that the client wishes AND we vary our fees depending on the degree of service sought and that can vary year by year, at the CLIENT's choosing.

We invoice our clients annually and they pay US to work for THEM - no commissions are taken or any other incentives from any third parties. Clients know that everyone works for who pays them and are only too willing to pay if you make a proposition to them that clearly puts THEM first. We offer charges by either an hourly rate, a fixed annual rate for agreed service and/or some capital charge for assets under advice, but that is always a minor portion and explained carefully in terms of our costs of insurance for risk based on capital under advice, etc.

We have no idea why most planners haven't joined us in the real world of fees for service by annual invoice (they say they can't do it, but every suburban accountant/ or lawyer can...).

Scott Barlow
February 15, 2013

In terms of providing "advice", planners have esentially two streams (i) strategic, and (ii) investment. Most planners differentiate their practice from their competitors through their strategic advice. When it comes to providing investment advice however, they all look the same. Same platforms, same approach to portfolio construction (strategic asset allocation), same buy-hold strategy, same household funds management names, same traditional asset classes...and so on. Long after the value of the strategic advice is forgotten, clients will measure the "value" of their planner through his investment advice.

If advisers want to add value that is worth paying for, when it comes to investment advice, they must be able to consistently demonstrate that their advice/process/solution adds some additional return after all fees.

Unfortunately this is extremely difficult to do. As actuarial firm Rice Warner/Deloitte has shown over more than 15-years (!) not even the largest implemented (asset) consultants, with all their global reach and resources, have been able to demonstrate they add value in excess of the retail fee hurdle charged to ordinary superannuation savers. What hope has the average adviser then?

The reason is because the strategic asset allocation method, used by every industry super fund, every retail superfund and 99.9% of all financial advisers...contains a host of performance damaging "constraints" that make it impossible to add value!

Financial planners must abandon this method because it is failing investors and advisers alike. Here's what our industry leaders are saying:

“The strategic asset allocation (SAA) model used by many investment funds is fundamentally flawed. The approach must change. The assumptions we make are wrong. There are a large number of constraints in SAA. ” – Greg Cooper, Chief Executive, Schroder Investment Management Australia

“We believe the standard investment process employed by most Australian superannuation funds needs to evolve..[because]..the process is failing. ” - Sean Henaghan, Head of Multi-Manager & Investment Solutions, AMP Capital

“[Daniel] Needham [Chief Investment Officer, Ibbotson Asia] cited career and peer risk as a reason for the herding of balanced funds into typical 70/30 equity-bond portfolios, which may ignore the current market conditions and underlying risk of those asset classes. He called for a risk-based approach to asset allocation. ” – I&T News “Dominant Asset Allocation Approach Flawed”

“Strategic Asset Allocation should be abandoned....because it is flawed to its core, always has been, and would never have gained credibility amongst investment industry participants if they had not been so easily seduced by the ‘efficient market’ view of the world in the 1980s and 1990s. ” – Dominic McCormick, Chief Investment Officer, Select Asset Management.

“Most consultants and research houses still promote SAA to some extent, even though their faith in it is rapidly fading. After all, it is hard for them to openly admit that what they have been promoting to their clients for several decades is rubbish.5” - Dominic McCormick, Chief Investment Officer, Select Asset Management.

Evolving to a risk-targeting method of portfolio construction was a recommendation of the Cooper Review into Superannuation. This method evolves the asset allocation paradigm by ignoring traditional peer and benchmarking constraints, freeing the portfolio manager to utilise an extended list of asset classes, instruments and manager strategies that are unavailable to ordinary investment managers. All of the different asset class and risk exposures are summed to a single measure to give the effective equities exposure (called Net Equities Beta). This measure avoids the unintentional tendency to conceal the exposures to equity-like risks behind nonsensical asset class labels. With greater visibility, and through the ability to bias investment selection to genuine net value-adding investment 'opportunities', the portfolio manager is better able to manage the risks in the portfolio and to deliver excess return sufficient to beat the retail fee hurdle.

Financial planning regulators are increasingly guiding Advisers to demonstrate a clearer connection between their product recommendations and their client’s investment goals and objectives. The risk targeting method provides ordinary investors with a portfolio solution that prioritises those activities that enhance diversification allowing Advisers to deliver superior return outcomes better aligned to their client’s objectives and with the portfolio protection benefits they have come to expect.

John Mitchell-Adams
February 15, 2013

Chris - sage advice indeed, thank you! No mention however of the financial planner managing the expectations of the client! As a client I know that in the past I have expected too much and then when delivery or returns/results fell short I blamed the planner. Not fair I know but if my expectations had been managed more effectively I believe the outcome would have been better for both the planner and myself. I look forward to future such articles.

 

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