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Good Investment Advice is Not a Commodity

Recently I’ve heard a lot of chatter in the financial planning community dismissing investment advice as a cheap commodity; something that is easily accessible where no one provider can differentiate themselves or create any additional value apart from anyone else.

Now if these proponents are talking about lousy investment advice, they are right on the mark. But if they are talking about good investment advice, they are dead wrong.

There are several reasons why the commodity rationale is off the mark, but first you have the recognize what good investment advice can not do. First off, no matter what the financial media tells you, there is no systematic way to beat the market over time unless some element of luck crosses your path. So I would walk away from anyone who promises market beating returns, it’s going to create a lot of false expectations. Second, investment strategy should always be a sub-set of a financial plan to accomplish your goals. Developing a plan and the actions you take towards accomplishing that plan will provide far more value that the investment component over time. When investment performance dictates actions and overrides your overall need, that’s when you are eventually going crash and burn.

How does good investment advice add value? In several ways:

-Controlling Bad Investment Behavior: Behavior hurts people more than they think. Research has been coming out that indicates that we are physically and psychologically hardwired in a way that helps us in certain aspects of our lives to survive, but undermines good investing discipline; especially the emotional aspect of managing your own money. Fear, greed, over-diversification, under-diversification, speculation, borrowing on margin, chasing yield or blindly avoiding taxes are these types of actions that will destroy wealth over time. In a Dalbar study a few years back; from 1984 to 2003, equity mutual funds earned an average compound return of 10.2%. The average stock mutual fund investor earned 3.5% over that same time frame. The average person who invested $1,000 in stock mutual funds in 1984 would have $1,990 at the end of 2003 where the average equity mutual fund would have had $6,976, three and half times more. Emotion is a killer when investing and if you can remove it by delegating it, you may be a lot better off because it can avoid the big mistakes that can happen.

-Truly Diversifying: I rarely see portfolio’s that truly are diversified when I initially review them. A majority of stock portfolios are a combination of holdings or collection of ideas that when put together, could simply (and more efficiently) be emulated by holding an index fund that represents the Standard & Poor’s 500. And for people with portfolios such as this, they are just returning to pre-tech bubble levels. In contrast, if you had decent exposure in smaller and international stocks, your stock portfolio wouldn’t have lost nearly half their value and you have recovered your losses more than three years ago. For individuals in early retirement, this could have been the difference between maintaining the lifestyle that you want and running out of money during your lifetime. Just like sports, defense counts and in some sports, can actually score you some points. Diversification is a great way of playing defense in your investment strategy.

-Costs Matter: Costs count and people are very unaware how they can add up. To start, the average annual stock mutual fund expense ratio is 1.5%. Then there’s the cost between the difference in commissions and the bid/ask costs in stock mutual fund transactions, which is known as the spread. According to a Wharton Financial Institutions research paper by Edelen and Kadlic, it was determined that commissions and the difference in the spreads erode .8% annually. Then there is cash drag, the need to keep cash to cover ongoing redemptions. According to Vanguard, this erodes .4% of return annually. Finally there are taxes; according to Vanguard, taxes on average erode 1.6% of return annually. Add it all up and you get 4.3%. Most investors never realize how much cost can eat away at returns. Good investment advice is very cost conscious and the cost savings involved should more than pay for the price of advice.

Although these core themes seem simple enough, but people lack the detail, time or disciple to follow through on these. It isn’t sexy or exciting although it matters. But keep in mind, if anyone is telling you that investment advice is a commodity, they are either:

Not interested in investing, thus downplaying its importance or a vendor trying to sell a turn-key investment service to a financial advisor.

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