A similar fundamental shift is currently unfolding in the investment industry. In the traditional model, an individual who lacked time or knowledge relied on an investment advisor for help with investing. Now, more and more people are devoting their time to learn to do it themselves, rather than rely on the investment advisor. This new breed of empowered individual investors is hungry for knowledge about investing, and as time goes by, they will seek the "specialists", rather than hire the professional. The investment community should embrace the new paradigm as it will likely lead result in more business as well as greater degree of professionalism and integrity.
What has prompted this quiet revolution? For starters, the benefits achieved doing things the old way. According to Tiburon Strategic Advisors, a consulting and market research company, almost three-quarters of "high net worth" investors are dissatisfied with their financial advisors on some level. Only 30 percent of clients declared being fully satisfied with their advisors while nearly half of the respondents have given recent consideration to changing their primary financial advisors.
And what of those clients who are "less than high-net worth"? Anecdotal evidence supports the conclusion you have probably already arrived at, namely that those clients are even less enthusiastic about the service they receive. Even more so than is the case with high net worth clients, these clients have an all too intimate knowledge of the investment motto "financial products are sold, not bought".
The Emperor Has No Clothes
Statistics on the returns "enjoyed" by clients suggest that their dissatisfaction is justified.
Over a ten-year period, Dalbar's well-known research divided mutual fund investors into two groups; Do-it-Yourself investors and Sales-Force Advised Investors (i.e. investors who used advisors). During this time period, the first group had a return of 79.5% while the latter had 96.4%.
Those return rates sound fairly impressive, until one considers that during the same period, the S&P 500 index had a return of 384.5%.
Although the Dalbar research was conducted between January 1984 and June 1995 and was never repeated in the same format afterwards, one could question whether the results would be different now.
What those results lead us to conclude, of course, is that investment advisors were not able to add significant value in terms of higher returns -- although they could potentially have added value by saving clients’ time, managing their anxiety and providing investment education through client service.
Conflicts of Interest
It is widely known that a number of forms of client-broker relationships are still plagued by conflicts of interest, where recommended products are not the most optimal for clients. For instance, broker advisory services may be presented as free-of-charge but the embedded costs could be quite high (e.g. a client with a portfolio of $100K could be paying as much as 2.5% in trailer fees for this "free" advice). Furthermore, the client may be made to favor financial products that are better for the company the broker represents rather than the most suitable for the client.
This has not gone completely unnoticed -- every year the industry has to pay billions of dollars in lawsuits for scandals as well as selling products that were unsuitable for clients in the first place. Unfortunately, unlike Home Depot, the investment industry is not yet prepared to offer up (without a fight) refunds for products that did not meet clients’ objectives.
In addition, many clients express a view that the investment industry is paying insufficient attention to its fiduciary duties (i.e. putting clients’ interest first), while it is pursuing asset gathering strategies (i.e. maximizing its own returns). For example, John C. Bogle concludes in his ten-year research that the returns generated by mutual fund conglomerates (i.e. asset gatherers) lag significantly behind their competitors. Mr. Bogle, of course, was not referring to return of conglomerates’ own capital, rather the returns on capital entrusted by investors. As a Chartered Financial Analyst, I feel that in order to effectively deal with these challenges, we should first acknowledge that they exist and then move decisively to rectify them.
The developments noted above have led many people to think that discovering what works in investing is not just for a small group of professionals, but something that everyone can do. The dot-com mania brought in the new group of people known as day traders. Unfortunately, the great majority of day traders lost money as markets headed down, but the phenomenon proved that large groups of people are indeed willing to venture into capital markets en masse. At the same time as dissatisfaction with the traditional investing model grows, new alternatives (both in terms of technologies and financial products) are gradually emerging, which are eroding investment advisors’ influence more than ever before.
Nowadays, with a click of a mouse, an individual investor can create an efficient portfolio (with a little help) that reflects his or her personal circumstances. And, recognizing the value of strategic long-term investing, many companies have created products that focus on tax and cost efficiency such as ETFs and life-cycle funds, as well as various types of software and Internet-based solutions that offer all-encompassing investment options. These ‘so called’ investment auto pilots are not without fault but offer simplified solutions to many investors that are confused and no longer trust that the investment industry is looking out for them.
People are starting to realize that it does not require a lot of money, time or "expertise" to learn a sufficient amount of knowledge to achieve results comparable with the top 25% of all investors. What it does take is strategic investing that minimizes costs, taxes and follows simple portfolio optimization while considering investors’ personal situation. To prove the point, indexing is growing in popularity as more individual and institutional investors recognize that it is very hard to beat the market consistently.
Some members of the investment community feel threaten by the upcoming changes as did many contractors when the popularity of Home Depot was growing. However, the Home Depot model actually expanded the size of the home improvement business and benefited the providers of excellent services. Similarly, the investment professionals who add value and whose interests are aligned with their clients will also benefit from the new paradigm.
So, as millions of baby boomers have discovered the joys of dry-walling, the new breed of independent and empowered investors will enjoy learning about investing and taking responsibility for their losses and gains.
The revolution has just begun.
Derek Polcyn has been involved in capital markets for over 12 years. He worked as an investment analyst at several large North American financial institutions for over 7 years and taught finance at college. Derek is an investment coach at InvestWELL Financial, a company that is passionate about educating people to be independent and successful investors.
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