Overall costs of service. Investment costs present
some interesting issues. Various
distribution channels have traditionally used different disclosure methods. Because of these differences, many consumers
had little idea of the fees they paid.
Often, options that seemed low-cost were quite the opposite. There’s a sign in our conference room
reminding clients that:
“The cheese is always free in a mousetrap.”
On some levels, fees might seem
unimportant. One very smart attorney
explained this to me in football terms: who would you rather have as
quarterback of your favorite team, a star like Joe Montana or some lesser-rated
journeyman? Obviously, most of us assume
that Joe Montana in his prime was worth a lot of extra money. You always pay for what you get, my attorney
friend argued. It’s an interesting
point, but, again, flawed.
Investing isn’t very much like
football. There’s an abundance of
research suggesting that investment managers operate with much less skill than
quality quarterbacks. That’s not saying
they’re worthless, just that active management adds less value than you’d think
to most portfolios. In the main, a major
component of performance comes from general market movement, not the portfolio
manager. So why pay huge expenses?
Timing also plays a role in the
perception of fees. High fees are simply
more tolerable in period where markets are quickly rising. No one complains about a one percent (1%) fee
when the market gives their portfolio a twenty percent (20%) boost! Ask again after the market is down by twenty
percent (20%) and see how they feel. (A
good advisor may genuinely earn one or more percent in a down market by
reducing risks and protecting against a sharper correction.)
Of course, there are some parts
of the investment world where expertise plays a key role. Smaller sectors – say, developing markets or
very new companies – aren’t covered as broadly by the general press or
analysts. Managers specializing in these
fields may incur higher costs and reasonably pass them along to investors. Yet, how do we decide what deserves higher
fees and what doesn’t?
The Schwab Center for Investment Research did an extensive study of
mutual fund performance (June 1999, Vol. II, Issue I). They ran computer analysis on dozens of
factors that might contribute to mutual fund performance. Two primary factors emerged with strong
correlation – lower costs and recent performance. Good performers tend to repeat (sadly, so do
bad one) and, since costs necessarily reduce performance, lower fees mean
higher returns. They didn’t specifically
test this on other non-fund asset classes, but experience tells me that it’s
true.
Investment fees are changing
across the board. The Internet and other
resources have created a very transparent environment. Fees are no longer hidden, and savvy
consumers can easily locate helpful information regarding costs and value
provided in exchange for those costs.
Trading and other costs have fallen (and keep falling) while convenience
and ease of use keep going up. It’s a
terrific environment for do-it-yourselfers.
Providers that can’t measure up in this environment won’t survive.
Environmental changes spur different kinds of investment services
and fee schemes. From all this, some casual
observers are predicting the demise of investment professionals. I’m very skeptical (as you’d expect). Oh, there’s no question that our industry is
changing and that some professionals will not survive. As with any era of rapid change, traditional
methods often implode, just as new methods thrive. It’s a natural progression. Survivors simply adopt new and better ways to
serve their customers.
I’ve already observed one radical
new behavior among investment consumers.
The freedom to do something – virtually anything – includes the freedom
not to do something as well. Consider
the routine or mundane tasks often delegated to others: lawn service, oil
changes, laundry, maybe housecleaning.
Cooking (at least some portion of family cooking) slipped into this
category decades ago when low cost and convenience slammed the restaurant
world.
True, today’s consumer faces some
wonderful new opportunities in investing.
But, easy as it has become, it still takes time, concentration, and
energy to invest wisely. It’s a fine
diversion for some people (a hobby, perhaps), but it’s not for everyone. Is investment management where you really
want to spend your time, concentration, and energy?
Many smart, talented, and
extremely successful people are deciding not.
I’m talking with more and more people who are actively deciding to
delegate part of the investment management function to outside professionals. They want to stay involved to some degree but
not at an activity level necessary by themselves.
It’s never been easier or cheaper
to delegate. The same tools that lower
costs for consumers also lower costs for advisors. The same technology that brings quality
research to the home desktop also brings it to professionals. Good advisors provide more value and cost
less than ever before. Across most areas
of our lives, it’s more affordable than ever to hire outside help. It’s true around the house and it’s true
around the portfolio. Technology creates
better value.
The truthful answer about which options are best lies with the
client. Each client brings a unique set of
needs. Some clients need a lot of safety
and convenience; others need considerable expertise or reduced costs for active
trading. Chances are very good that the
same firm can’t serve both clients equally well. You have to understand the issue to reach
wise choices.
Excerpt taken from Million Dollar Management: Simple Lessons to Use Wealth Management Principles for Your Family Investments by Dan Danford (with Gary Myers), 2002
