Is Your Financial Adviser Making Money Off Your Bad Investments?
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I work at an insurance company. There are products that we sell all the time to commission-based advisers that we almost never sell to fee-based advisers. Why? Because those products aren't right for the customer, but with 5%+ commissions they sell like hotcakes.
Yes, there is such thing as reputation, but it doesn't come into play unless you play on the same power level as them. That is, if you are a wealthy person with connections then by all means, find a reputable financial adviser, they'll happily work in your interest. Such clients are scarce, after all, so they need to care. But if you're a Joe or Jane Random, salesmen have little incentive to offer you a good deal - they have hundreds or thousands people just like you every month, and none of you can do any damage to them.
http://www.investorclaims.com/Blog/2012/July/North-Carolina-...
http://www.adviserinfo.sec.gov/IAPD/Content/ViewIndvl/IAPD_I...
"When stated as a percentage of assets, average fees do look low — a little over 1% of assets for individuals and a little less than one-half of 1% for institutional investors. But the investors already own those assets, so investment management fees should really be based on what investors are getting in the returns that managers produce. Calculated correctly, as a percentage of returns, fees no longer look low. Do the math. If returns average, say, 8% a year, then those same fees are not 1% or one-half of 1%. They are much higher — typically over 12% for individuals and 6% for institutions...
Thus (correctly) stated, management fees for active management are remarkably high. Incremental fees are somewhere between 50% of incremental returns and, because a majority of active managers fall short of their chosen benchmarks, infinity."
https://blogs.cfainstitute.org/investor/2012/06/28/investmen...
Also, there are different kind of indexing strategies, e.g. one that is based on revenue and similar stuff..
I think advisers and index funds sit on two ends of a see-saw. If "everyone" ran to one side, the other would start to look more attractive.
We need investors who actively invest, by evaluating the companies, so that more money goes to good companies and less money goes to bad companies. The index represents the current batch of the top 500 good companies in recent times as decided by the active investors. The index is re-balanced as the preferences of the active investors change.
So, if there were no active investing, then investing would be completely pointless.
As an increasing number of low-intensity investors broadly invest in the entire market space, it overinflates asset prices and diminishes the efficiency of this market space, to a degree. It's hard for news to knock on VW stock prices, for example, if the index funds keep buying it like clockwork anyway. Of course, it's possible that this system increases information arbitrage, but the overall effect is that index funds become less efficient as more investors rely on them.
I'm not sure where the irony is in that; sure, it would be bad if every dollar invested in the markets was invested that way, but no one that I've seen has ever suggested that every investment in the market should be done that way; the closest argument I've seen is that individuals whose primary focus isn't personally, actively managing investments that just want good returns for, e.g., retirement and financial security should prefer index funds.
2) I have been having good returns (for over a year now) with 2 vehicles: lendingclub.com (P2P lending) and futureadvisor.com (which is in a space I suppose is called "computer-assisted wealth management"; competitors include Wealthfront, etc.) It's basically a financial advisor without the advisor, and thus, extremely low-fee. You get a person if you need a person, and they lean heavily on quantitative analysis to reduce their own investment-decision workload.
Comparing financial advisors to mutual funds is comparing apples to oranges. Many times, advisors will advise you to invest in mutual funds as a part of your overall portfolio strategy.
So you have to think about having a financial advisor versus not having a financial advisor. In my company, the advantage I have mostly seen has been high net worth clients looking for tax advantage investing strategy and protecting their wealth. There are probably other advantages that I don't see on a daily basis.
The cost is typically a large disadvantage. Advisors typically take a small percent on your investments even if you lost money. 1% of a hundred million dollars is a million dollars. Is the utility provided by a financial advisor worth a million dollars?
In a similar vein, you can also think of the advantages/disadvantages of mutual funds versus single stocks. The same goes for the advantages/disadvantages of actively managed mutual funds versus passively managed mutual funds.
I had an exit a few years back for a sizable, but not retirement-worthy, amount of money. My friend who was one the founders did make retirement level money and went the full financial planner route with a large investment firm.
I had begun to do a lot of research for where and how to invest, but before meeting with "his guy" I doubled down and consumed everything I could find. I ended up deciding that if I went my own route I would just go with Wealthfront for the simplicity of their strategy and the extras like tax-loss harvesting and immediate and near-real time account re-balancing.
I eventually did meet with the financial planner and his staff did their best to make me feel "special". The waiting room was modern and wood paneled, I was offered drinks and snacks, and when he brought me back to the war room he had another member of his team there and reassured me that I'd have their full resources at my command. This triggered immense skepticism off the bat, since a few simple calculations with their fee structure revealed that I was essentially a chump to them compared to my friend. We talked for a while and he led me through various investment options and I later left with a few personalized investment strategies in a nice leather-bound folio.
It took all of about five minutes of study to determine the proposals were a waste of time and an even larger waste of money. For a 1.5% management fee they would invest in high cost mutual funds -- the kind that even do kickbacks to the advisers, and provide me with a once a year re-balance of my accounts with no opportunity for tax-loss harvesting. I told him all this and that I was just going with Wealthfront instead and in a subtle but patronizing manner he told me I did not understand his value proposition.
Unless you are high net-worth I have a hard time understanding why you would ever go the planner route as opposed to just keeping a safety net and dumping the rest into a service like Wealthfront.
Maybe the fee is worth it to you to never have to think about it, but since you mentioned the 1.5% management fee, I thought maybe you might not want a fee at all :)
Tax loss harvesting has been significant for me over the last few years as well and that is not something I would want to deal with myself even if I just simulated Wealthfront's trades. It's also made harder once you start using their index tracking individual stock trade functionality -- they do the harvesting on a per stock level for that one.
It looks like they are essentially identical, except that Wealthfront charges more. I haven't examined them in too much depth, but is there a key detail that I'm missing?
While there is a .20% difference in fees at the 100k+ level, I am content paying Wealthfront's higher fee simply because I believe in what they are doing and I never feel like they are trying to screw me over -- directly or indirectly. Consider it brand loyalty at this point :)
I've also enjoyed their blogs both for engineering and investment. I like to point friends there first when they start looking to invest money somewhere.
Mutual funds certainly don't offer the "best" returns (generally).
This demonstrates why people need financial advisors, just like we need, say, auto mechanics. Most people don't have the time or inclination to learn about investing. Unfortunately, just like auto mechanics, many are out to make a buck off of client's lack of knowledge.
The information and internet age is making these types of markets more efficient.
The one thing you absolutely can control when investing is costs. Low cost index funds put you in a more advantageous position right out of the gate which means more money available to compound over time.
Do some managed funds or advisors beat the low cost index funds? Yes, but they cost more and you have to be fortunate enough to pick the one who beats. Keep in mind the one who beats also often changes year to year so you're stuck rolling the dice over and over.
Personally, instead of spending time researching which managed funds may do better than the rest I focus on companies instead. I have a small % of my portfolio in a brokerage account where I can directly invest in companies and ETFs that I think may do well.
1) To have a holistic, financial plan.
What I mean by this term is a truly comprehensive understanding a client's motivations, aspirations, hopes and dreams for their life and providing a plan on how to achieve this. Ultimately this approach comes from the belief that your money is there to help you live the life that you want. This holistic approach will encompasses all areas: protection, retirement, investment, savings, mortgage, tax, long-term care and inheritance. Not taking a holistic approach means that you miss out on the synergy offered when structuring a client's affairs with complementary financial products.
2) To ensure that your financial plan is appropriate for your current and future circumstances.
What I mean by that is that each client is different and that I believe there is no 'one size fits all' approach. Your plan should take into account your current arrangements, life's goals, attitude to risk and capacity for loss. The last two items are very important because some clients are risk adverse and as an adviser you must take this into consideration when you consider how best to reach their life's goals. For example if a client wants a pension income of x, and you can achieve that goal with less risk (and therefore less returns), then it may be appropriate not to chase 'market returns' for that client.
3) Access to specialist tools and knowledge.
For example we use psychographic risk profiling from Oxford University. In conjunction with that we use stochastic modelling for efficient frontier analysis of a client's entire portfolio and lifetime cash flow modelling tools. I would suggest that these tools, while absolutely essential to creating a good holistic plan, are out of reach for most retail investors. Furthermore there are many financial products that may be appropriate for a retail investor within a wider portfolio, but they are simply not marketed to the wider retail market (intermediaries only). One last point, we have a team that includes several domain experts covering different areas such as tax and pension transfers. I highly doubt that a typical retail client would understand, keep up with, and be capable of legally mitigating their tax.
UK Regulation Has Raised Standards
Post the UK regulator's (Financial Conduct Authority or FCA) shake up of the adviser market with the Retail Distribution Review (RDR), huge changes have occurred in how advice is given. Part of this is that from the beginning of next year commission from financial products will be switched off and adviser/product charging must be completely transparent. If UK advisers were to carry out the self-serving advice offered by US "advisers" they would fall foul of UK regulation and face huge fines and a ban from the industry.
Another interesting point is that the FCA now require evidence of ongoing servicing of a client or an adviser will be forced by the regulator to hand back all remuneration paid by the client to the adviser. Quite frankly if you are not demonstrating value to a client for the fee you charge you will likely loose the client anyway.
Closing Thoughts
Good financial advisers in the UK have already switched over to fee based business models many years ago and have been in line with best practice anyway. Raising the minimum standards, while painfully implemented by the regulator, has ultimately been good for clients who can afford advice. Unfortunately there have been unintended consequences and as a result it has made advice more expensive and inaccessible (that is another story).
Finally I would say that yes, there are bad advisers out there and you should be cautious. However there are good ones out there too and I truly believe in the value proposition that a holistic approach offers to clients.
(From http://www.bloombergview.com/articles/2015-09-30/spinoffs-ki...)
This is especially true if you don't have much money or can't write your own automated trading strategies.
The real reason to get an investment manager is access to interesting investments, for instance private debt which is the sort of thing you need some connections for. You'd only be thinking about this at rather large amounts of assets.
99.9% have no basic knowledge of Technical Analysis (TA) https://en.wikipedia.org/wiki/Technical_analysis thereby not applying it in basic investment decisions they advise on. TA is valuable even though it tends to break down in very bad markets.
Indicators based on statistical analysis can't be argued with in terms of their value in providing additional insight into the present condition of a stock or index. Think in terms of moving averages, a common application in TA. http://mathworld.wolfram.com/MovingAverage.html
(BTW: Wolfram and mathematica do not deal in astrology)
For example, indicators involved with technical analysis include, lagging indicators or those that show overbought or oversold conditions for stocks or entire indicies such as the Moving Average Convergence/Divergence ratios or MACDs.
https://en.wikipedia.org/wiki/MACD
If you are a financial advisor, you should be using these to make sure that when you advise on taking a postion in a stock for example, the stock has not spiked up 10% on the previous day. If the stock did spike the previous day or week and as a financial advisor, if you advised your client to take a position in that stock, you'd effectively be placing them in a position of risk as the stock is likely to retrace. TA indicators are very practical in this case. This is just one of many examples.
You're getting your robust methods of statistical analysis confused with astrology.
Moving averages have a function in statistics. But there is no evidence that they can be used to time the markets. If they could, it would be done algorithmically by hedge funds, closing the possibility.
Please show actual analysis of market data (i.e. recent published scientific papers) supporting your positions. Without those, it's quackery.
1. The existence of mathematica was quoted first.
2. Moving averages are a "lagging indicator", which I stated, not a predictive indicator which I did not state.
3. I develop hedge fund algorithms.
References to papers include this most important one: "Contagious Speculation and a Cure for Cancer: A Non-Event that Made Stock Prices Soar," https://www0.gsb.columbia.edu/faculty/ghuberman/research.htm...
Do the hedge funds know? ;P
On the one hand, your arbitrage argument makes sense. If there existed a simple strategy that made money, it would be traded out of existence.
On the other hand, I happen to know how the major quantitative funds allocate their money. It is a simple formula, with a number of small twists. (Yes, people will not believe you if you claim this. Rightly so.)
Now, how can these facts coexist? The answer is that the formula "sort of works". There are long periods where it doesn't work, and periods where the returns are phenomenal. If someone were to start a new fund, they would have a number of issues:
- It is just not quite believable that such a simple formula is profitable. What are those hordes of phds actually doing? (Squeezing a lemon actually). Surely someone else would have found it?
- Institutional investors have all sorts of issues with investing. It's done by committee. They need you to have a long track record. They want all the right boxes checked.
- What happens if you launch and you start with a fallow period?
- Even if a simple formula works, why does it work? Are you happy to trade something that you don't really understand?
Basic or simple approaches can be combined with others and be statistically/mathematically sound and robust.
Some work for periods of time, some don't, some stop working. Algorithms degrade over time and that's continued optimization is a must.
Case and point: LTCM and the story behind black scholes algo running up against a black swan.
I'd highly recommend watching this for the others reading this thread that really just are familiar with the whole space:
Black Scholes isn't an "algo". Sweet mother of god...
Example: If, at some point, the advisor looking at Google, which just spiked 10% from $80 to $88/share, passed it over, he did his client a huge disservice, because the stock is at $600/share, say 10 years later.
Technical analysis may be somewhat useful in short-term trading (speculating, rather), but its overall value has been way overblown.
For more sophisticated investing, you need a multi-factor model - a mixture of fundamental analysis, industry/macro indicators, and (perhaps) a touch of technical analysis.
I've also protected portfolios from showing close to zero gains by using basic stats and TA principles available to anyone, to avoid creating positions in overbought stocks. While also sometimes overweighting on stocks that they are keen on buying, that have either spiked down or have shown significant retracement, oversold, days before.
The only field where a sort-of technical analysis may be mentioned is HFT, but that's due to the fact, that HFT works on such a microscopic time frame that it is difficult to come up with conventional data used in financial analysis (example: correlation). So it's more of a tech arms race than anything else.
Just because TA uses mildly advanced math, doesn't mean it's any good. Just like it doesn't mean that heroin is good for you, just because the producers use sophisticated chemistry equipment.