Many people who engage financial advisers on investments have some unrealistic expectations. How well a portfolio can perform depends 99% on the investor himself. So regardless of how good a financial adviser is, if the investor does not do a proper job, it is guaranteed that the portfolio will lose money on a long run. The following are some of my thoughts speaking from real life experience with clients:
- A financial adviser cannot control the date of engagement. Because the date of engagement is solely dependent on the client, it implies that the client is the one who actually decides the starting date of investment. 101% of the time, the client date of engagement is when the market is right at the peak. No financial adviser will advice the client to wait until the market crash because it may not happen for the next few years. In the meantime, the client is likely to either do it himself or go to another adviser within those few years to invest. Thus, the client will suffer for investing at the peak of the market. The main reason this is so is because the client solely determine the date of engagement. To me this is extremely frustrating. When market was at the bottom and when the world seems to be collapsing at the end of 2008, hardly anyone approaches me to do investment. Of course, nobody knew at the time that was a good time to invest but everybody did know that it was definitely not at the peak of the market cycle. Recently over the past few weeks, I received many interested clients who wish to invest their new money. Although I do not know next year’s market performance, what is certain is that when most equity markets have gone up by double digit returns in 2009, we are definitely not at the bottom anymore. The entry point now is definitely not favorable compared to a year ago. Since the starting date of investment is dependent on client’s market timing, most investors will not make money on a long-run – even if they would to engage a financial adviser.
- There could be some expectation that a financial adviser will provide accurate market timing information. Implied in this expectation is the ability to give absolute return. Financial advisers who promise to give absolute return are either engaging in churning (which is illegal) or their clients’ monies are invested in hedge funds. If these two are not the reasons, it means that the financial adviser is lying because it is not possible to time the market. There are many hedge funds that have historically provided good absolute returns. Sometimes their performance charts look so good that I get frightened by it. If the performance chart is a straight line with no evidence of volatility, something must be wrong. In recent thinking, I have avoided hedge funds primarily because the absolute return comes with a price. The problem is that the “price” is unknown. What price am I talking about? It is the price of greater risk. The problem with hedge funds is that risk is almost never disclose or quantifiable. So a person who buys hedge funds will be taking on risk that is unknown.
- For an investment to work, it is required to hold on a long term basis. The issue is that most investors are short-term sighted. Most of the time it is due to poor planning. For example, a person invests his CPF-OA but a few years later need to liquidate the investments because of the need to pay for the downpayment of a newly purchase property. This is one of the classic cases of poor planning. As nobody plans to make a property purchase overnight, the purchase should have been planned years ahead such as deliberate effort to save enough for downpayment or simply investing less of the CPF monies. I had a few of such cases over the past two years due to the clients’ poor planning. A financial adviser cannot do any magic since ultimately it is clients’ choice in engaging in poor planning.
- Most financial advisers will advice their clients to invest in high cost investment products such as structured products, unit trusts and ILPs. The costs of these products are extremely hefty. An expense ratio that is above 0.5% for investing in developed economies is considered too expensive. For emerging markets, a cost exceeding 0.75% per annum is considered very expensive. In Singapore, majority of the unit trusts have cost that is double or triple this cost. Despite the high cost, financial advisers have no choice but to recommend these because they could only earn commissions by recommending such products. For me, the prefer instrument is to use index funds such as ETFs. For CPF money, it is probably better not to invest because the universe of funds available for CPF investment is extremely few. The impact of cost is examined in the following articles: Is it true that Emerging Market is less efficient? and What Are the Sources of Profit?
Due to the above 4 reasons, most people who engage financial advisers to help them will be quite disappointed with the outcome. Financial advisers who wish to help their clients and prevent disappointments may wish to consider the following:
- Since the date of engagement is determined solely by the client, it means that the client determines the start date of investment. To reduce the risk of market timing, dollar cost averaging is the best the adviser can do to smoother the volatility.
- It is best not to promise absolute returns to clients. Since smart fund managers are clueless, it will be overly arrogant to say that the ordinary financial adviser has more intelligent compared with those with possess Masters and PhD in finances working in the fund houses. Prospects who insist that the adviser provide perfect marketing timing information are what we called “lousy prospects”. Such lousy prospects are likely to be more attracted to get-rich-schemes and Ponzi.
- To mitigate the risk of the client engaging in poor planning and resulting in premature liquidation of investments, it will be more useful to provide a more comprehensive planning for the client. This can help reduce the risk of premature liquidation since the adviser will now have a more complete picture of the clients’ mid to long term needs.
- If it is feasible, only recommend ETFs and index funds.
The above four points are only possible if financial advisers do not depend on commission selling products. Dollar cost averaging implies that instead of getting the commission in lump sum, the commission will have to be spread across a long period. So the initial commission is extremely low. Due to time value for money, the present value commission is actually lower when an adviser recommends dollar cost averaging. For point 3, offering a more comprehensive planning for clients is only practical if clients are paying for such service. You can do it for 1 or 2 clients per month for free but you cannot do it for all clients. For point 4, ETFs do not pay any commission. So if a financial adviser is relying on commission cannot recommend ETFs.
Therefore, the only way out is to be paid separately by the client.
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