Continuing the conversation with Neil Cowell of Vanguard, looking at how clients can get the most from a great financial adviser. If you haven't already, check out the first and second posts.
3. Minimising costs
Costs create an inevitable gap between a market return and what the investor gets out of it. By ensuring a client has access to asset allocation and the different asset classes, at a low cost, an adviser can add real value. Vanguard's reasearch shows that there can be as much as half to three-quarters of a percent per annum difference to a portfolio just by ensuring that costs are kept down. Compounded up, that's a lot of money.
I often hear the argument that if you compare funds and one is half a percent more expensive than the other, but the higher-cost one has outperformed over a set period of time, that people are happy to pay the difference because they're benefiting from it.
That's a valid point, but achieving that alpha over time is hard to do, with only a minority of fund managers beating their market consistently over time. The risk of choosing the wrong manager is why I believe that for most investors, simply choosing a spread of investments across a broad market index at low cost is a good outcome.
4. Behavioural Coaching
We talk about behavioural coaching and the adviser being like an emotional circuit-breaker. This benefit, keeping their clients in their seats at times of market difficulty, is a significant value factor that an adviser can add, over and above what clients would do left to their own devices.
There are two potential areas of danger for clients who are investing on their own. One is that today's money goes after yesterday's high-performing funds – people chase past performance despite all the warnings. There's clear and compelling evidence that last year's winners often don't repeat that success.
We see money coming out of the bottom quartile and going into the top quartile, and year on year those top performers don't repeat the act, causing a vicious circle of people chasing the money, which is a questionable strategy.
Secondly, it's often the case that they invest too late, so we see funds and fund houses describe their fund performances over a period of time, but which may not be a time when individuals were invested in it. These two things combined can, according to the Vanguard research, detract from performance to the tune of between 1.5 and 2% per year.
I found that during the credit crunch the markets were bleak and half what they are now, and a lot of people were worried that they'd lose money as the market dropped. I advised people not to bail out, and if they had, they would have crystallised that loss.
In the final post in this series, we'll look at the last three areas essential to adviser alpha.