Why the likes of Money Week, Hargreaves and others play on our emotions and this is a danger to DIY investors…….

In the first of two new blogs I want to consider the danger of emotion when it comes to DIY investing, and in the second blog I want to highlight the one thing that many DIY providers do not deliver as part of their service.

In all my blogs, and tweets I have always said that DIY investing will work for some people, and likewise advice will work for others. The danger is that we have a swing so strongly towards DIY investing that we have a danger that people are entering into a very difficult world where emotion can be dangerous. We have of course seen this before, not in investing but with DIY in the home.

A raft of TV programmes, books etc made us all believe we could be DIY experts. As we gained confidence we thought we could do the electrics and plumbing, for some there was no doubt they had a natural talent but for a larger proportion it led to disaster and extra cost. We now have a reverse trend where perhaps the more basic DIY is still being done but the more complex work is going to the experts.

To some extent this is happening in investing and for many it will end in disaster. Let me talk about emotion, there are two emotions which the likes of Money Week and Hargreaves play on. The first is making money, and the second saving money.

Let me take the first one, a lot of the marketing we see in the likes of Hargreaves will talk about if you had invested x in a particular fund over a particular time it would now be worth y. This plays on emotions, all we see is the end figure and we want some of that. Did we not see this with the tech bubble and others? The savvy DIY investor will do one of two things with Hargreaves mailings; bin them without reading, or perhaps take the tip and research it further and then decide whether it fits with their plan. The less savvy investor will almost certainly invest in that fund. We know that very few DIY investors actually monitor their investment, and therefore if that investment doesn’t deliver what it did in the past those investors will be disappointed.

Of course Hargreaves are about selling a product so selling on emotion is part of the process of getting people to invest. Money Week is not about selling a product (but it is about selling their magazine), it is about giving information to people about investing; effectively it provides ideas and highlights opportunities. We have seen a couple of times that their journalists do not like financial planners and believe that you can make money on your own. This fits well with the aim of the magazine but it forgets that unless you really understand investing you will not understand what constitutes good returns.

So for example it will show the top performing shares for the previous week, and the worst performers. Emotion will say I want some of that but now may not be a good time to invest. Take two examples of shares I have purchased – Apple I purchased at around $400 and sold at around $500, sounds like a shrewd investment but at one stage the shares were around $700 and I allowed the noise to distract me and believe that the shares would only go one way and that is up. Another share is Lloyds; I have purchased these shares at 20p, 30p, 40p and 50p. Even at 70p I think they are very cheap. I was buying the shares when people were saying not to, and now people are starting to take interest. In reality people won’t really start taking notice until they are perhaps nearly £2 a share and paying dividends. Now an adviser can’t normally advise on shares but the point here is about emotion. I have two things in place, a return I expect to get from these investments and a point where I will bail out. Over time if I can get somewhere between 5 to 7% a year on my investments over a long term time horizon I am happy.

So the emotion of greed (making lots of money) is played on heavily and it looks at the past and not the future. Hargreaves and Money Week may give you ideas but ultimately it is your own research, and your own plans which should determine whether those ideas are good or just worthless marketing hype!

The second emotion is that of saving money, so looking back at my previous example. If I fit my own kitchen, do the electrics and plumbing how much will I save? Perhaps £2,000 or £3,000 or perhaps more – of course I could do some of it and perhaps get some help and still save a considerable amount. When the budget is tight this is a strong emotion but reality needs to kick in – firstly do I have the time to do this and secondly do I have the expertise?

Investing is the same Hargreaves and Money Week will make you think that you should ditch your adviser because they take high fees. The premise is that if you are paying your adviser 1% a year then this is reducing the returns on your investment and actually if effectively you pay yourself that (i.e. going direct you don’t pay it) then you will make a lot more money. There will be people who do make a lot of money going direct and they are likely to be those people who are confident about investing, they understand about financial planning, they understand about goals and they understand about emotions.

So the point of this blog is this – headlines like “ditch your adviser” are playing a dangerous game and one that could in time reverse the so called decline in people seeking advice as they search for financial planners to sort out the mess they are in. If you are confident to go it alone, then what I am saying about taking what Hargreaves and Money Week with a pinch of salt will make sense, if you are just starting out then consider this carefully. And ultimately if you are not sure then that is where advice comes in, you can swim against the tide – there is nothing wrong with that and actually you may find investing in a financial planner is the best investment you make. If you want to go direct then patience, planning and research are key to success.

SPECIAL NOTE: Any reference to a share is not a recommendation to buy and careful research should be done before making any decisions. Past performance is not guide to the future and investments can fall as well as rise.  

Thought for the week – which is better for the client a fixed fee or a percentage fee?

I recently came across a blog where a financial planner disclosed they received 3.5% up front for single premium investments. They were less committal on their on-going fee but I suspect this was in region of 1% a year.

I also read an interesting piece claiming that a percentage fee was fairer for the client than a fixed fee based on the amount of work done.

In this blog I am not going to say what is right or wrong but I want to set a challenge on what is fair for the client.

If we consider accountants and solicitors the work they do is normally specific, so you have an accountant and you go back to them each year (or more frequently) and engage them to do specific tasks and pay an hourly rate for those tasks, or an agreed fixed fee. A solicitor will operate in the same way.

There is a strong argument that all financial planners will move to this model but herein lies the challenge, I have indicated (possible controversially) that financial planners should control all aspects of the financial planning model (or certainly be seen to be). The “be seen to be” is for example outsourcing the compliance to a network and outsourcing para planning but the key aspects i.e. the financial planning and investment strategy are controlled by the adviser firm.

This is important because the financial planning aspect is very much about a point in time, so for example it will be at the start of the journey and then through the cycle. It is difficult to put a time on things but say initial work is 20 hours and the financial planner charges £100 an hour that would be £2,000 up front. If the client pays a percentage as an annual retainer on say £100,000 that is £1,000 a year. So what do they get for that, this is the service for the financial planner to articulate; in reality this works out at 10 hour’s work a year……..

When considering it this way the percentage fee actually seems fairly cheap if the proposition is articulated correctly. But what is that proposition?  It is effectively reviewing the plan perhaps twice a year and making recommendations on the basis of those reviews. It may actually be hard to argue that it is worth 1% a year.

So how can valued be added? I believe that where the financial planner owns the investment strategy then they can add value, and the hourly rate doesn’t work because there is so much unseen work.

This is where a percentage fee works well but the financial planner needs to articulate what that proposition is. So this is, for example, how often the portfolios are re-balanced, how they manage those portfolios and what information they share with their clients. If financial planners are going to charge for it they must be prepared to share what they are doing otherwise there will be no recognition of what they do.

So what is right an hourly fee or percentage?

1. It depends on the proposition and what work goes on behind the scenes that perhaps the client might take for granted
2. If financial planners don’t own all aspects of the proposition then it may be harder to articulate the value in paying a percentage fee
3. If they do own all aspects of the proposition then they must be prepared to share what they do with their clients so that they can understand it, and truly value the proposition

The debate will go on but ultimately I hope that the regulatory bodies don’t force us down one route because the right route depends on a number of factors and cannot be boxed into one corner…….

The biggest threat to financial planning – part 2

I recently highlighted changing demographics and debt as being one of the biggest threats to financial planning. In this blog I want to expand on the way our economy is changing in such a way that we need to change to reflect this.

In a recent presentation the presenter indicated that 54% of the UK population have no savings or investments and that this would increase. Only 22% of the population are “active” risk based investors.

If we unpack the 22%, this is split such that 3.4 million are pure self-directed investors, 5.4 million are both self-directed and advised and 1.5 million are entirely advised. It is anticipated the self-directed market will increase significantly over the coming years, and the advised market will shrink.

Before I explore further how I think the advised market can reverse the trend I want to pick up on a couple of points. Firstly the presentation indicated that 80% of self-directed risk based investors are actually not active – this is a warning sign for the future and secondly there is demand for advice but people don’t want to pay for it and I think a lot of this is around how it is packaged to investors.

Where now for the advice model?

There is a greater desire for the advice model to be seen more as a professional vocation similar to accountants and solicitors. This is very much the US model but I believe this will take many years to attain the same status in the UK (although some financial planners are already seen in that way by their clients).

So there are clearly challenges for the advice model and in a shrinking world the question is how do financial planners thrive – clearly financial planners can go down the self-directed route or phone / internet based advice route but for face-to-face advice how do they survive?

1. I would argue that as financial planners move towards a more professional vocation the concept of financial planning becomes a commodity, i.e. everyone does it
2. Cost is a battle ground but shouldn’t be, this is because many people don’t understand the value of financial planning and the service they receive

If we take these two points then to survive financial planners need to own all parts of the strategy including the investment proposition. If they don’t then they need to reduce their fees to reflect a reduced service, some are doing this but many are not.

Picking up on the investment strategy, nearly 50% of financial planners outsource their investment strategy. This will increase for two reasons, a drive to push down costs (although in reality the cost to the client goes up) and because of the audit trail needed to run an investment strategy.

The danger is this – as the investment strategy is more and more outsourced there becomes consolidation in the market and there are fewer and bigger brands meaning the investment investment strategy is not unique to the business and becomes a commodity like financial planning, and ultimately the financial planner is not in control of the investment decisions that deliver the client’s goals.

Investors might not see this now, but they will in the future and they will demand lower fees to reflect this outsourcing. The end result is that margins are squeezed further unless financial planners take control of all aspects of the service proposition.

Reversing the trend

As the market contracts and shrinks, the financial planners who shine will be those look forward and don’t build a business on the past. Financial planning is about road maps and accepting paths will change, it is also ultimately about taking responsibility for the engine that drives the client along path. Only by doing this can the financial planner offer a point of difference, charge and articulate a fee to reflect that difference and ultimately provide a level head when the rest of the world appears to be going crazy (i.e. peace of mind).

Conclusion

The world is changing, debt and demographics are shrinking the pool of those who can invest and perceived cost is driving investors to the self-directed market. This provides opportunities especially in a shrinking advised market but financial planners need to accept that they need to be seen as being in control of the whole package if they are to charge a fee that reflects this, if they are not in control of the whole package then they need to reduce their fee to reflect this and think carefully as to how they articulate what they do.