| The financial industry must continue to ask
itself, "Why does the public needs us?"
I know this question makes many financial advisors feel
uncomfortable. But if we do not continue to ask ourselves this question, we could find
ourselves out of a job. Why?
Whether we ask ourselves this question or not, others are
asking it.
This perennial question of, "Why does the public need
stockbrokers and financial advisors" has been raised again by three professors in
their paper, "Assessing the Costs and Benefits of Brokers in the Mutual Fund
Industry."
In this paper, professors Bergstresser, Tufano, and
Chalmers uncovered why consumers pay advisors to choose mutual funds for them. What they
found does not reflect well upon the financial advisor community.
Do Financial Advisors Help Clients Choose Better or Better
Performing Mutual Funds?
Most financial advisors tell clients that their chosen
funds will perform better than direct purchase mutual funds. Unfortunately, Bergstresser,
Tufano and Chalmers found the reverse to be true.
They found that investors suffer by paying on average 3.6
percentage points in front-end load fees, as well as higher annual marketing costs in the
form of 12b-1 fees. They also found that the financial advisor recommended funds
underachieved as compared to the direct purchase mutual funds.
In a recent year, not only did investors pay about $15
billion in sales charges and 12b-1 fees, but they spent an additional $24 billion on
management fees. Think about this, these investors spent nearly as much paying advisors to
find the funds as they did to the money managers to manage the funds. With this being the
case, financial advisors had better do a great job finding funds for their clients.
Did they?
Investors who bought directly from the mutual funds earned
almost a half a percent higher than those that had advisor recommended funds. If you took
out index funds, the gap was almost two thirds of a point.
But wait there's more!
These differences were calculated before accounting for
12b-1 fees. When included, funds bought directly beat advisor recommended funds by almost
a full one point.
So Why Do Investors Use Financial Advisors to Pick Their
Mutual Funds and Investments?
The average mutual fund investor is higher educated and
wealthier than the average consumer. So it can't be because they don't think they're
capable of doing it themselves.
I believe one of the authors of the study to be charitable
when he hypothesized that advisors bring a service to their clients by taking the emotion
out of investing. Though when you look at the data, it appears that investors using
advisors chase short-term returns as much a self-directed investors. And yes, it was found
that advisors are as likely to chase short-term returns as anyone.
This study uncovered yet more unflattering details. It
found evidence that brokers usually recommend funds with higher loads. So not only do
advisors generally not pick the best mutual funds, they also recommend under-performing
funds with a preference to higher sales loads. It doesn't take a rocket scientist to
figure out why too many advisors do this.
The question is, what as an industry are we going to do
about it?
What You Can Do as a Financial Advisor to Change How
People Perceive You
Every change starts with one person.
How much research are you doing for your clients? Whether
consciously or unconsciously, are you recommending funds with higher fees? Are you
providing service equal to the amount of extra fees a client pays for the funds you
recommend?
Only you can answer these questions
We are in the information age.
Studies like "Why does the public need stockbrokers
and financial advisors" are going to come around, become distributed and get
publicized more often. You might as well get used to it.
As financial advisors we need to step up to the plate and
start doing the right thing by our clients or we're going to find ourselves out of
business, one advisor at a time.
The public does not mind paying fees. What they do mind is
an advisor not disclosing the fees. If we think we are worth the fees, then as financial
advisors we should feel no need to hide the fees. Instead, we should fully disclose them
and explain to our clients why our advice is worth it.
The public knows that we do not have a crystal ball that
enables us to find the best performing mutual funds going forward. But the public does
become suspicious when all the funds we choose have higher than average expense and sales
charges.
There is an ever so slowly growing trend toward full
disclosure vs. casual disclosure by advisors in the financial industry. Another movement
gaining speed is that of formal fiduciary relationships with clients. Both these movements
assure a long and profitable partnership between advisors and their investor clients.
I hope you join me as part of this trend of full disclosure
and fiduciary responsibility, for everybody's sake. |
