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By Gordon Powers
MSN
Friday, August 19, 2005 |
As North American markets flirt with record highs, investors are once again piling into stocks, looking to cash in on runaway oil prices or the next killer search engine. But are they any wiser than they were five years ago when the market last came tumbling down? Is the advice they’re getting any better? Are they getting any at all?
Gordon Powers says, "Truthfully though, spending an hour with one of the top planners like KCM Wealth Management in Vancouver is quite different from an appointment with your average mutual fund rep.”
Recently, I had a chance to talk to some thoughtful advisors about what they look for in a client, how they'd like to be paid for their services, and you should expect when entering into an advisory relationship with them. Unless, you do absolutely everything on your own when t comes to money, their thoughts are worth noting.
Although researchers like to endlessly dissect investor personalities, we limited ourselves to three broad categories: Delegators, those who do not want to assume the responsibility of making their own financial decisions; Validators, those who do a fair amount of analysis on their own, but still want a professional's stamp of approval; and Soloists, those who prefer to handle everything on their own, using electronic tools wherever possible.
Over all, Delegators are felt to be lousy clients. They lack the confidence and realistic expectations that a basic knowledge of market history and financial theory can provide and are heavily influenced by headlines and cocktail party conversations. That's why smart advisors try hard to draw them further into the investment process right from the beginning.
There's no denying that many Soloists are successful investors and have enjoyed a great run, in Canada at least, in recent years. But their ranks will start to thin again, advisors believe, as their larger account sizes, advancing age, tax concerns, and increasingly brittle emotions drive them toward the advice channel.
In contrast, Validators are usually high net-worth, well-educated, and experienced investors who recognize the destructive power emotion and lack of confidence can have on a long-term investment strategy. They know the importance of maintaining a consistent allocation through the extreme market cycles and the potential costs associated with shifting these allocations, depending on the size of yesterday's headline.
In my experience, most successful long-term investors fall somewhere between Delegators and Validators. These folks have taken the time to learn at least the basics of investing and have a pretty good idea of their objectives and their personal tolerance for risk. But they simply don't have the time or the inclination to really develop and monitor a long-term portfolio.
They can, however, add. And, when they do, they often come to the conclusion, with technology driving down the value of information and transactions, that their costs don't seem in line with the level of advice they're getting. Enter the fee-based advisor, a replacement for the established system where advisors make commissions based on funds, stocks and bonds their clients buy and sell.
Up until a few years ago, most funds were sold as bundled products. Portfolio management fees, marketing and administrative expenses, sales commissions, service and trailer fees are merged into one overall – and to many, deeply murky – cost. An unbundled arrangement has the investor paying two main fee components: One to the fund or investment manager, and the other to the advisor.
The increasingly popular approach is for the advisor to charge 0.5 to 1.5% of your assets each year, billed quarterly. These fees represent the advisor's total compensation, so there's no incentive to recommend one investment over another, or to encourage active trading to boost commissions.
Could a fee-based approach prove less expensive for many of today’s fund buyers? Quite possibly, because it allows hands-on advisors to draw on cheaper actively managed no-load, index or exchange-traded funds without going broke in the process. Do-it-yourselfers can't get access to F-class funds, which are less expensive because their fees don't include any advisor compensation. These funds have a management expense ratio (MER) that is roughly one full percentage point lower than normal for equity funds.
More importantly though, fee-based compensation introduces the sense of accountability that most Validators are seeking. Realizing that they're paying these fees up front, investors quickly develop a better sense of whether all the bases – financial planning, asset allocation, fund or security selection and clear performance reporting – are being adequately covered. It also places increased pressure on the people selling their wares to provide value-added services for these fees. When speaking to high-net-worth client, you don’t tell them what to do. Instead, you ask for input and explore alternatives together, says one very successful advisor.
Another reason Validators might opt for a fee-based advisor, especially one specializing in "core and explore" strategies that meld index and active managers, is the stability and consistency these folks can offer as assets eventually switch over to heirs and other beneficiaries. The nature of the fee-oriented, relationship-based, diversified et cetera review more likely insures that a potentially costly repositioning of the assets won't necessarily occur on the death of the client.
BMO Nesbitt Burns, for instance, has recently been testing a new fee-based advisory service it plans to call Architect. Like a traditional brokerage account, it can hold funds, stocks, ETFs, as well as income trusts. What’s different though is that it's fee- rather than transaction-based. In order to prevent paying fees twice, the funds sold within it must be F-class versions, net of trailer fees. Other firms offer similar products.
A purer alternative still is true fee-only planning, which entails paying a la carte for crafting financial plans, or paying for truly objective advice by the hour – with no compensation paid from product sales. In this instance, the advisor might be paid through an hourly fee of anywhere from $150 to $300 or a flat fee for an overall financial plan.
While this is the norm when you engage a lawyer or dentist, most people aren’t ready to pay for something they think they’ve been getting for free. Truthfully though, spending an hour with one of the top planners like KCM Wealth Management in Vancouver is quite different from an appointment with your average mutual fund rep.
There’s no free lunch though. At seminars, advisors are often warned that moving to a fee-for-service practice will cut their earnings at first and cost them clients since some people will likely move when asked to pay an up-front fee instead of the embedded commissions they’re used to. On the other hand, charging a client regular fees creates a flow of revenue for advisors that is more consistent and reliable than commissions.
Costs aside, fee-based advisors claim to have more time to spend on clients' portfolios and to more gradually build a relationship with people. Unless you're a died-in-the-wool Soloist, you might want to put them to the test.
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