The Home Depot Revolution in Investing?
"You can do it - we can help" has brought in a fundamental
change in attitudes towards home improvement. Before the time of
Home Depot, an average person would not dream about making major
home improvements without a professional. The Home Depot
revolution has changed it forever. Now you can visit your local
Home Depot and a knowledgeable "specialist" will help you meet
your home improvement needs.
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.
Client Dissatisfaction
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.
Emerging Alternatives
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.
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.