Investment Focus | Issue 2
Nothing in the World is Free
“Nothing in the world is free…The sooner you know it, the better you’ll be” Clifford Coulter (Jazz Artist)
I was reminded of those lyrics when I recently saw online ads for free financial planning and free “no cost” ETFs. Can something as important as financial planning be offered for free? How can a company afford to offer free investments?
The financial and investment world has been ultra-focused on fees in the past few years, which was warranted given that Canadians paid some of the highest fees in the world. However, when cost becomes the primary factor in decision making, we can end up with unanticipated problems.
I believe it’s critically important to understand the price you pay for things, to know what you own, and to understand why it’s important.
Understand the Price You Pay
The airline industry was deregulated in 1978. That brought competition and innovation. The result was more airlines entering the industry, more routes and cheaper pricing. Then in the 1990’s when technology created an online real time marketplace for buying airline tickets, the industry hit a tipping point: the race to the lowest price.
According to Captain Sully Sullenberger in his book, “Highest Duty: My Search for What Really Matters,” to stay price competitive, airline carriers began hiring post-secondary graduates at entry level wages and trained them to get their commercial pilots license. Prior to 2013, the FAA required 250 hours of flight time to become a first officer. Today, commercial pilots can fly as a first officer with as few as 200 hours of flight time.
So, what do you pay for when you buy an airline ticket. By the time US Airways Flight 1549 flew into a flock of geese in January 2009, Capt. Sullenberger had logged over 20,000 flight hours. The passengers had paid for Sully’s experience and the quality of the aircraft. Even though we have the benefit of technology today, I want an experienced pilot in the cockpit in case there is a problem. Understanding the value you receive for the price you pay can be crucial for your safety.
Technology and Modern Business Models
In the last decade, the financial services industry has gone through a lot of change. Technology and modern business models have given investors direct access to the market. There are now tens of thousands of options for investors with even the most modest level of assets. These solutions come in the form of robo-advisors. These robo-solutions are getting many investors started at a younger age and are teaching them the importance of saving and being disciplined. However, robo-advisors are not a replacement for a full-service financial advisor.
Robo-advisors provide the basic building blocks of investment management which are asset allocation, security or fund selection, and portfolio construction. Robo-advisors that deliver investment-only management (no financial planning, ongoing service, or guidance) have set prices at about 0.33% which pays for annual statements, online access and a 1-800 number to call with questions. In addition to the 0.33%, the investor also has to pay for the underlying costs of investments.
Certified Financial Planner
In the case of a full-service financial advisor, many focus on goals and objectives that take time, planning and ongoing co-ordination to accomplish. If a financial advisor is a Certified Financial Planner, they must have had 6,000 hours of professional experience or 4,000 hours of apprentice experience to be a candidate. The exam process can take up to seven years to complete and in 2019, the pass rate was only 60%.
It’s interesting to think that prior to 2013, the airline industry only required 250 hours of experience to fly a plane when the Financial Planning Standards Council requires 24 times that amount to sit for that exam. Planning is a complex and specialized experience personalized for the individual. The following topics cover the various areas of financial planning:
Source: Russell Investments
Planning and Ancillary Services Advisors May Provide
How many hours of meetings, preparation and follow-up would it take to cover these topics appropriately? How could a company offer this for free? More importantly, what is the cost of not instituting an appropriate plan?
Know What You Own
It’s important to know what you are getting for the price you pay. In the investment world, many investors are buying low-cost investment solutions to save money on fees.
But before we get teased by “free,” there are a lot of questions that must be answered when it comes to investing…
- Do you understand what you own?
- How much risk is in the investment you own?
- What is the return expectation?
It may be fair to say that many investors don’t completely understand the amount of risk they are exposed to during given points in the market cycle.
From December 2007 to December 2018, investors withdrew more money from mutual funds than they put in. All the while, a hypothetical $100 constantly invested in the index more than doubled in value. And those who chose to stay in cash during that period would have missed a cumulative return of more than 200%. You can visually see a pattern of investors buying high and selling low. These mistakes can be very costly over time.
Source: Russell Investments
As mentioned in the last Investment Focus post, there was a record $83 billion in losses in December due to investment outflows of over $125 billion. At the end of Q1 2019, the S&P/TSX was up 12.42% (Q2 end it was up 14.38%).
These numbers reinforce the importance of knowing what you own and the importance of a financial advisor as a behavioural coach and risk manager. Helping clients avoid pulling out of markets at the wrong time and sticking to their long-term plan is one way we believe advisors provide substantial value.
Understand Why It’s Important
In Malcolm Gladwell’s book “Outliers,” he dedicates a chapter to what researchers have come to identify as the 10,000 hour rule. The rule states that for an individual to achieve a level of mastery, they must dedicate 10,000 hours of practice to the subject. To put 10,000 hours into perspective, most people only work 2,000 hours per year.
So any professional working in a field for more than five years would be considered a qualified expert. In my mind, five years isn’t a lot of time – however, many investors are taking on responsibility themselves with little-to-no experience.
And when it comes to delivering value, we see that planning, managing investor behaviour and helping clients keep more of their after-tax wealth are key ways advisors are able to contribute value. We believe wise advisors educate investors on the products and services they receive for the price they pay. We also believe it’s important for our clients to understand the value they are receiving and the process we are providing in helping them achieve their outcomes.
The Bottom Line
Goods and services are priced as they are for a reason. The most important thing to discover is WHY they’re priced that way. Sometimes, a bad purchase based on price is a learning experience. However, some bad decisions based on the price of a good or a service can leave irreparable damage.
Next time a deal seems too good to be true, remember your due diligence. Take the time you need to assess both what can expect and what you SHOULDN’T expect from your investment and investment platform.
Second Quarter Returns
Source: This newsletter is an adaptation of an article by Joe McNally, Regional Director at Russell Investments, June 3, 2019.
About Dan Lambert
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