Active Can Be Fiduciary; The Value of an Advisor

Every time I look at the comment letters, and see where articles list of supporters and opponents of the DOL fiduciary rule, I flinch when I see the Investment Company Institute on the “no fiduciary” side of the table.  In general, I think mutual funds are the fiduciary profession’s allies—and are certainly the investment vehicle of choice for most advisors.

The ICI’s position comes from an ambiguity in the interpretation of the fiduciary rule.  Some legal experts seem to believe that if an advisor recommends any actively managed investment, particularly one with an expense ratio above the tiny expense ratios of Vanguard funds or index ETFs, then this is not a fiduciary act and could be prosecuted.  Many advisors seem to feel similarly; they think the DOL is basically pressuring them into abandoning actively managed funds when they make recommendations to clients.

We—the profession and the public—need a much clearer interpretation on this subject, but I think in the meantime we can make some very strong inferences.  The fiduciary rule basically extends ERISA standards that already cover qualified plan recommendations to qualified plan rollovers and the new investment recommendations for the rolling-over client’s IRA.  It is worth noting that the Department of Labor has never exercised any negative opinion about the many actively managed mutual funds being offered in the nation’s 401(k) plans, and the people managing those platforms as fiduciaries are theoretically held to the same standard as those that now apply to advisors recommending rollovers.  So why would anyone think there would be a problem with researching the universe of active managers and recommending those who you believe, in your professional judgment, to be earning the (somewhat higher) expense ratio that they charge?

I totally agree that index-hugging funds that are charging 1% or more expense ratios, and those funds that are buying the recommendations of advisors with commissions or under-the-table payments, are not fiduciary recommendations.  The mutual fund industry is going to have to adjust to actually providing active management at a reasonable fee, and I think that transition is well underway.  If the ICI gets clarity, or promotes the reasoning I’ve offered here, then it should recognize that an anti-DOL stance means it is representing the most questionable elements of its membership—funds (I would argue) that are going to have to get with the fiduciary program or go wherever the dinosaurs went.

Meanwhile, in the initial article in this issue of Inside Information, I promised that I would provide a more passionate articulation of the value of financial planning advice—which I think is superior to adding up all the nickels, quarters, dollars and time you’re saving clients with your advice and expertise.  I wrote this a couple of years ago, and I think it’s still relevant and potentially valuable to you as you talk to prospects and clients.  It goes like this:

When I travel and speak around the country, at chapter meetings and national conferences, I find that very few advisors understand how important their work really is to the lives of their clients.  There is, in my humble opinion, an enormous gap between the value that financial planners deliver and their perception of the value they deliver.

Why should this be?  I suspect that many of you feel blessed to be in a profession that helps people and offers great psychic rewards–as well as the financial rewards.  Advisors have actually told me that they feel like because the work they do is so rewarding, it cannot possibly be valuable.  (No, this is not logical, but trust me, somewhere in the back of your mind, this argument is playing itself out.) 

And also, I think, the giver of services always has trouble evaluating the value of them in the client’s life.  It feels like your daily activities are normal work, and so you expect the results of what you do to be normal too.

So let me help you think through the value of what you do for the people you take on as clients.  I’m going to list the value of a planning engagement in reverse order, starting with the ordinary conveniences that you offer your clients, and ending with the services that can transform their personal sense of well-being and fulfillment–forever.

1) You help your clients keep track of–and make more efficient–their financial affairs. 

I think it is hard for an advisor to recognize what it’s like to be a naturally disorganized or financially naive person.  So let me draw you a picture. 

The typical person I talk with outside the planning profession had a will drawn up–some time ago.  He’s not sure exactly when and has a mild curiosity, now that you bring it up, about what it says, but who knows where it is now? 

There’s an insurance policy in a drawer somewhere, and it may be term or it may be a cash value contract; all he knows for sure is he writes a check to the insurance company every year, and if you give him a few minutes, he might be able to find last year’s check register and tell you how much he paid. 

The auto insurance policy he happens to own is way more expensive than the lowest rate available in the market, and the homeowner’s policy hasn’t been updated since the Clinton Administration. 

Refinance?  He’s either paying 5% or 6% or maybe 4.25%, and what are the rates like today?

But at least the portfolio is diversified.  He owns six different small cap value funds, all managed (he tells you proudly) by different fund companies. 

You might be tempted to laugh, but people who don’t do financial services for a living find all these things incredibly complicated and confusing–and they prefer to focus their attention on work, home, family, the things they feel are really important.  They KNOW they’re leaving money on the table, overpaying and not getting the returns that the market offers.  They know that their disorganization and lack of financial awareness costs them money; what they don’t know is what to do about it. 

When you sit them down and put everything in one place, and show them how it all works, you are taking away the anxiety that comes with normal disorganization, and replacing it with a sense of peace that, at last, the paperwork is being attended to and the decisions are being made with a degree of competence.  Plus you can probably save them money on some of the things they were overpaying for.

This is incredibly valuable to their sense of well-being and personal confidence about life, not to mention the money saved. 

And it is the least of what you offer your clients.

2) You help your clients create an organized, diversified portfolio, and you stand between them and the dysfunctional emotional decisions that everybody makes with their own investments.

My favorite presenter at financial planning conferences is Roger Gibson.  One reason I like him is that he wows audiences even though he has a sincerely nerdy personality with none of the flash of a born motivational speaker. 

Another is that he demonstrates magic.  He shows planning audiences that if you knew in advance how to pick the one asset class that offers the highest rate of return over the next 10 years, a diversified portfolio that blends three lesser-returning asset classes would still generate more terminal wealth. 

This, of course, is the magic of a smooth investment ride; any portfolio that experiences big negative years will produce less terminal wealth than a comparably-performing mix of investments that takes a smoother course to its destination. 

Advisors can get their clients a higher rate of return than they would get on their own simply by taking a portfolio put together under the influence of a succession of salespeople touting hot this or that, and putting it somewhere near the efficient frontier.  Chances are, over ten years, this alone will more than pay your planning fees.

But there’s much, much more, that relates to today’s market environment.  Left to their own devices, many–perhaps most–clients will panic and sell at or near the bottom of a market storm, and then return, years later, when they get caught up in the buyer’s frenzy at or near the top.  Terry Odean, a professor at Berkeley, has taken a lot of customer data from two big discount brokerage houses (Hint: one was based in San Francisco), and found that those people who traded most frequently experienced the lowest returns. 

There have been numerous studies, by the Morningstar organization and others, that shows that investors experienced much lower returns than the markets or the mutual fund industry were delivering–because of their trading habits.  One credible study estimated that more than 70% of all day traders lost all their money in the late 1990s DURING THE BIGGEST BULL MARKET PERIOD IN AMERICAN MARKET HISTORY–a time when the markets were delivering more than 20% a year.

The point here is that you don’t have to time the market or find above-market-return investments to add tremendous value to your clients’ financial lives.  Today, even if your clients fully participated in the downturn, if they will also participate in the recovery, then they will greatly outperform the average investor in the marketplace. 

The difference between the returns your clients get and what the average investor gets, measured in terminal wealth dollars, is probably many many times what you charge. And it is only an  incidental part of the value that you offer.

3) You help your clients get into the habit of saving (and investing) a portion of their income.

You know the statistics about the savings rate in America (the 2004-2008 numbers hovered around 0% of income, spiked briefly after the Great Recession and are now back in the 1% range again).  But the keepers of these statistics don’t tell you that they probably overstated the actual rate, because they didn’t include things like increasing credit card balances or home equity loans–so that when people put money in their savings account, and at the same time ran up even more debt, it counted as an increase in their savings.

The well-kept secret about the investment markets–which you know but probably don’t always communicate effectively to clients–is that a person’s savings habits have much more effect on his/her  terminal wealth at retirement than the rate of return on the portfolio. 

People who save 10% of their income will have far more terminal wealth over 30 years than people who save very little but get an extraordinary rate of return.  And when market returns have been negative, as they have recently, it is possible to rebudget, save more, and recover the same overall level of wealth despite the losses.

The problem for most consumers is that there is no voice in their environment advising them to pay themselves a fair percentage of the income they earn.  Instead, they are bombarded by messages which make powerful arguments to do the opposite: to buy this, that or something else. 

When you become that voice speaking out in favor of saving, and help organize clients’ lives so that the money that goes into an investment account is treated as one more expense that has to be paid every month, you provide an incalculably valuable service. 

One advisor once told me the story of a schoolteacher who came to him early in her career, and got in the habit of saving a percentage of her income every month.  At age 60, she decided to retire with a portfolio in excess of $1.5 million, and her fellow teachers asked her where she had gotten the money.  They were still working to pay their bills.

The difference between a lifetime of paying themselves vs. spending whatever they make is, over time, the difference between the cheerfully desperate-looking greeter at a Wal Mart store and a person who retires on his/her terms, a retirement of travel and leisure.  Can you put a price on that?  Certainly it will be far greater than whatever fees you decide to charge. 

And this is far from the most valuable service you provide.

4) You help people identify what is important in their lives, and prioritize their goals.

There are no statistics on this, but I have yet to find a person, who is not working with a financial advisor, who has taken the time to identify what he/she really wants out of life. 

If you think about it for half a second, you realize that this is an incredibly sad, tragic situation.  The vast majority of people in our advanced, prosperous society have not taken the time to figure out what they really want out of the all-too-brief time they will spend on this planet.  And because they don’t know their destination, you know they will never reach it.  They are, in a very real sense, doomed unless acted on by a powerful outside force.

If you ask questions in your initial interview which help your clients recognize this deficiency in their lives, and lead them to identify their most personal goals and desires, then you have given them a gift that is priceless.  It is worth more than all the money there is, which (I am guessing here) is less than you charge.

5) You help people turn seemingly impossible goals into a routine that can achieve them.

I am constantly amazed that financial planners have the most powerful tool in the world in their hands, and they are so familiar with it that they don’t realize how valuable it is.  After years of running retirement planning spreadsheets, you have mastered one of the truly magical lessons of life: that any enormous goal can be broken down into manageable, monthly increments, and achieved by routine and persistence.  You save X amount of dollars every month in a portfolio that gets something close to what the market offers, and you will retire with a sum of money that seems impossible to you now. 

I have only seen the power of this expressed once, in an old episode of the TV Western series called Bonanza.  The series focused on the Ponderosa ranch–which, as nearly as we could tell, encompassed most of the state of Oklahoma.  There were four characters, and in this particular scene we had two of them: Ben “Pa” Cartwright, and his burly, muscular, not-too-bright son “Hoss.” Pa was going out of town for a few weeks, and he was leaving Hoss in charge of a ranch the size of some Third World countries, and Hoss was nervous about his ability to manage such an enterprise.  So his father decided to teach him an important management lesson.

He picked up a large bundle of sticks and put them into this son’s muscular hands.  “Hoss,” he said, “I want you to break these sticks.” Hoss took the bundle of sticks in his arms, and his muscles bulged, and he flexed and strained, and you had the feeling that if anybody on the planet could break this bundle of sticks, it was this cowboy.  Finally, Hoss gave up, and gave his father an unhappy look of defeat.

“Pa,” he said, dropping the sticks at his father’s feet, “I just can’t do it.”

Ben Cartwright was unfazed by this failure.  He picked up one of the sticks from the ground and handed it to his son. 

“This time,” he said, “break them one at a time.”

This is the magical, powerful lesson that financial planners have learned, that the rest of the world still doesn’t have a handle on yet.  You have the ability to identify client goals, put the financial numbers to them, and then break them down into the individual sticks.  Clients who have goals that they don’t believe they can achieve are put on a schedule that will get them there as a matter of routine.  Put another way: you make it more likely that your clients will achieve their most meaningful and important goals–in most cases, FAR more likely.

What’s the value of this?  It, too, is probably more than you could possibly charge.

6) You help people bring the focus of their lives from retirement to the present.

Truthfully, I don’t know if you offer this service, but if you don’t, you will before long.  Ten years ago, there was little understanding of the downside of retirement; that it meant more than just leisure, that it often represented the elimination of a feeling of usefulness, a lost of stature and self-esteem for the life-long worker.  As Mitch Anthony has memorably put it: when you retire and golf is your most meaningful activity, then golf suddenly becomes your work.

Today, many advisors have a clear recognition that retirement is a huge, dangerous transition, and that all-too-many people will unknowingly retire to lives of emptiness and meaninglessness.  And so they are no longer doing retirement planning.  Instead, they are offering career counseling, helping their clients transition from a job they dislike to meaningful work that they can do and enjoy as if it were play. 

I think Jim Johnson, who practices in Sacramento, put it best.  “We help people leave high-paying crappy jobs,” he said, “for crappy-paying great jobs.” And of course he works out the financial implications of it, so that the change in lifestyle is not traumatic.

Helping people move from work they dislike to work that is fulfilling and empowering is enormously valuable, and the bonus is that they can continue to do what they enjoy and escape the meaninglessness and emptiness of a retirement that puts them on the sidelines.  They can cut back and still remain relevant. 

Can you put a value on this?  Let’s agree that it’s probably greater than your current fees would reflect.

Of course, this is not a comprehensive list.  When clients come to you, within a year, perhaps sooner, they begin to enjoy a certain peace of mind about their financial affairs.  They are educated about esoteric financial issues–life skills that are never taught in our dysfunctional society.  They feel like they have an ally who is on their side in a world that would take their money and steal their time for everybody else’s agenda.  They have somebody who will take care of their spouse and heirs when they’re gone. 

This list also doesn’t include specialized services like charitable planning, divorce counseling, creating special needs trusts for a disabled child or the value of having been nagging into buying disability insurance and long-term care coverage and now, suddenly, the policy is an important source of income.  It doesn’t include the comfortable knowledge that they can call you for advice on virtually any financial or economic subject, and you’ll give them an answer that is not tainted by a sales agenda.

The point, however, is that the services you offer have enormous value, and many advisors I talk with are shy about the fees they charge and almost tongue-tied when it comes to describing the value they offer their clients.  If more people understood this list of services, and the benefits that each of them offer to their personal and financial lives, I suspect that every person in the world would be clamoring at the doors of the nearest independent financial planner. 

But today, they are not.  Why not?  Because many of you are not delivering that message effectively, and with total confidence. 

Let’s say it out loud, with confidence: that nobody in the world makes as much of a difference in peoples’ lives as a well-educated, caring, ethical financial planner. 

After watching the profession for the better part of 35 years, I can say with total sincerity that nobody’s work is as important or valuable as yours.  If you are having trouble charging enough to live a prosperous life, then you don’t really understand the full value that you provide to your clients.  If you are having trouble convincing people to work with you, or if you are not attracting new clients to your door, then you are depriving people of a chance to master the challenges and opportunities of their all-too-short lives.

Master the ability to communicate these services, and their value, and you will instantly move into the elite ranks of the planning profession. 

More importantly, you will help to raise the awareness level for consumers in your community, helping them to see that there are life-changing services available for mere money, delivered by idealistic professionals who may, with help, learn to  charge at least a fraction of what they’re worth.

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