What's advice worth?
The value of advice
The media is rife with discussions of mutual fund management expense ratios (MERs). In particular, there is an abundance of criticism about MERs being too high. Good points have been made - putting the financial advice industry under scrutiny. I think most would agree that quality advice is valuable. But what's it worth?
For the purposes of this article, the terms MER and fees will be used interchangeably.
Current compensation system
The vast majority of financial advisors today are compensated through commissions generated on product sales. As noted in an earlier column, this is perhaps the largest shortcoming of the industry. It's not so much about how much services cost, but rather that payment for services is tied to the wrong part of the advisory process. The embedded nature of the compensation makes it more difficult for investors to know what they're paying.
Sliding capital markets and unhappy clients are now shifting the focus on fees and the industry's perceived conflicts of interest. Nobody bothered to think about these issues a few years ago when annual returns of 15 or 20 percent (and above) were being considered "the norm" by many investors. Now, in an environment where retirement accounts have been decimated, fees are under the media and consumer microscope.
This has potential to blow up in the industry's face because the realization of fees in actual dollars may be an eye-opening fact for many. That kind of surprise in the midst one of the worst bear markets on record is a bad mix for the industry.
Planning services and associated costs
I think few would argue that financial planning advice is valuable. Costs are truly all over the map. From the disgruntled advisor making 0.65 percent per year (based on the value of client portfolios) who quit in disgust , to investment counsellors charging a minimum of 1 percent, to advisors selling so-called wrap programs carrying costs of up to 3 per cent and above.
Why such disparity?
In my opinion, it comes down to the fact that the advice is tied to the product - as is the payment for the advice. Also, even fee-only advisors often charge their fee based on the size of the investment portfolio. But does it make sense that advice on investment, tax and estate planning is based on portfolio size? No, but the industry isn't set up to work any other way.
The weakness of this structure is that it's tough to nail down any uniformity in the value of such advice and for clients to judge whether or not they're getting good value.
Flying solo and associated costs
There's not doubt in my mind that most people do themselves more harm than good if trying to do it all themselves. Despite the compensation weaknesses of the advisory industry, there exist plenty of products for investors to use to implement their plans without paying for advice they don't want.
But quantitative studies in the U.S. from firms like Dalbar and Financial Research Corp. have confirmed that individual investors cost themselves several percentage points annually thanks to bad timing of buys and sells. Researchers Terry Odean and Brad Barber uncovered similar finding in their research of thousands of brokerage accounts of retail stock traders.
That's not even counting the lost opportunities to save taxes (while alive or for heirs after death) and the stress, anxiety and loss of family time resulting from having to keep up on all of these things.
Despite the value of quality advice, the focus on fees remains. And that's a good thing because advisory fees are high, in general. Also, there is a trend that is bound to lower fees going forward.
It seems to me that wealthier investors - i.e. those with portfolios of $500,000 and up - are growing tired of paying more just because they have more. I know because I hear from many of them. And this is the same crowd that everybody's chasing after.
While advisors need to earn a certain amount of revenue (and many do offer price breaks for larger accounts), these investors have a valid argument. For instance, consider the hypothetical case of two clients. Their situations are identical, except that one has $250,000 to invest, while the other has $500,000.
Under many fee schedules, the wealthier client would pay twice as much. Even with a progressive fee schedule, the client with the larger portfolio would still end up paying 1.5 times more. This doesn't make sense.
Given that individuals doing it themselves often cost themselves more than it would cost to hire an advisor (thanks to procrastination and emotion-driven decisions), a market for advisory services will remain.
However, given the maturing nature of the industry and the fact that one of the key benefits it delivers to clients (i.e. investment returns) is likely to fall, so must the price. It's a reality that the industry knows in the back of its mind. While it won't happen quickly, industry players will shift to position themselves accordingly.
Dan Hallett, CFA, CFP is the President of Dan Hallett & Associates Inc. in Windsor Ontario. DH&A is registered as Investment Counsel in Ontario and provides independent investment research to financial advisors. He can be reached at firstname.lastname@example.org
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