On Sunday I caught up with Rational Reminder, one of my favourite podcasts on sensible investing and financial decision making. At the 18 min 40 sec mark of Episode 142: What is Financial Advice? one of the hosts, Ben Felix, considered a question recently asked of him.
“If you’re telling me index funds are the smartest investment and they’re super easy and low cost for me to access on my own, why do you still have a job?”
It’s a great question! Why would I, a financial adviser, still be relevant? You can listen to the whole conversation via the episode link above, but I thought I’d paraphrase some of what was said here.
Ben starts by making a bold statement:
“Investing has been solved (for most people).”
A large proportion of the general public incorrectly believes ‘financial advice’ is a predictive ability to choose the best investment. But the empirical data will tell you around 90% of actively managed investment funds do not beat their target benchmark over 10 years, after charges. Trying to beat the market with actively managed funds is, in most cases, a losing strategy. Buying low-cost index funds, which track a relevant benchmark, and not deviating from the plan, is the investment solution most investors should choose. The odds move in your favour over time when this is adhered to.
Gone are the days of calling your stockbroker or wealth manager on account of their being the oracle of investment information. The internet has made access to investment research easier than it’s ever been. The 2008 Financial Crisis tested (unsuccessfully) the claim of active managers and hedge funds to produce superior returns even in down markets, and regulatory change in the UK has made the full cost of investing overwhelmingly transparent.
Why buy a discretionary share portfolio, or active investment fund, costing +1% per year and often much, much more, when a portfolio of index-tracking funds will in many cases meet the same objective, with a better chance of higher returns over time, often at a tenth of the cost?
Considering this information, if an adviser continues to promote financial advice, and their own value, as your investment problem solved by solely picking the best funds, you should run in the other direction. Fund selection can still be important, but it only plays a small part in the overall advisory value proposition and is certainly not the lead character.
So, if the ability to choose the best investment isn’t ‘financial advice’, what is?
Ben believes it lies in a good understanding of probabilities and base rates rather than relying on predictions, technical competence in financial planning, and understanding human psychology. These skills can be applied to the following areas when helping people arrive at high-quality financial decisions:
Goal Formation & Quantification
Before investing, you need to know why you are investing. Personal goals often influence how you spend your time, who you spend your time with, the job you take, how much you save, what you spend, how you invest and much more.
Our financial lives are intertwined with how we want to live, both now and in the future. So, thinking deeply now about why you have a goal rather than arbitrarily setting retirement at age 60 for example, is essential. Why do you want to retire at 60, or 62, or not at all? Wanting to retire at age 60 because you want to redirect time to local community issues and developing your long-held passion for writing is a meaningful goal. Adding more detail such as wanting to spend 3 days on community, 2 days on writing and weekends on the coast with your spouse even more so.
And once you’ve formulated a meaningful goal, how much is it going to cost to make it happen? Is it realistic? How will you achieve it? What will you have to sacrifice now and in the future? Are you prepared to follow it through and how will you track success over time?
Ben hits the nail on the head when he says:
“Without stepping back and scrutinising the goal, it’s a recipe for a misallocation of capital. You might end up spending time, relationships, working hours, or money, on stuff that doesn’t align with a meaningful life.”
The opportunity cost of skipping the goal formation and quantification process could be huge!
It’s a topic unto itself but good financial planning will help you discover and formulate meaningful goals, help you explore the reality of making it happen and keep readjusting the finer details through to goal completion. It’s not a one-time job. It’s a continuous process.
Asset Allocation
Asset allocation (the mix of your assets allocated to equities, bonds, cash) is probably the most important determinant of expected investment outcomes. A more aggressive portfolio has higher expected returns (but a more uncertain outcome) over a more cautious portfolio, which has lower expected returns (but a more certain outcome).
Nevertheless, without the aforementioned goal formation and quantification, how can you know how to allocate your financial assets successfully? The correct asset allocation and expected return are chosen both because of what is needed to underpin your financial goal and your comfort in taking investment risk.
I mean, even if you do have a high-risk tolerance, why allocate to a high investment risk portfolio if you can achieve your goals without having to do so? Likewise, why be conservative if expected returns could lead to goal failure or inflationary loss?
Good financial advice will help you understand and choose an asset allocation suitable to your goals, financial circumstances and comfort with risk.
Asset Location (Financial Products)
Which financial products should be used to implement the asset allocation strategy and purchase of index funds? What suits your stated goals? A Self Invested Personal Pension? An ISA? A JISA? A General Investment Account? So many to choose from and each with its own set of pros and cons. It is only at this point do we get to what is traditionally called ‘financial advice’ and the selection of investments within products.
Tax Planning
But overlaying all of the above, every step of the way is tax. Given a set of goals, asset allocation strategy and financial product mix, there is always going to be a consideration for tax. Regular use of annual allowances, spouses in different tax bands, wealthier families with Inheritance Tax complications, business owners and Capital Gains Tax consequences. These all need to be considered and it’s honestly amazing to me how many really smart people don’t even do the tax basics. Simple, regular tax awareness could easily negate a significant cost with some oversight.
And these are just some of the building blocks of financial advice.
There are also less obvious considerations such as the time spent dealing with stress. Not the actual task of implementing a plan, but the time spent dealing with the stress of knowing you have to implement a plan. I have multiple experiences with clients who came to me with financial problems they’ve been sitting on for years before making contact. YEARS. Years spent thinking about or avoiding, a subject that I’ll happily take off your hands and resolve. How do you value that?
Anyway, I’ll leave it there for today as I’m already well over 1,000 words. There is so much more to appreciate but do go and listen to the Rational Reminder podcast Episode 142 from 18 minutes in, and subscribe to them for more enlightenment, if you’re so inclined!
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