Issues
Since costs, inherent conflicts of interest and unmet high expectations are three major issue facing retail investors, let's briefly examine each one and then find out how I am addressing them.
Costs
Successful investing is hard enough with all of its uncertainties, so why do investors keep on making it harder on themselves by not controlling the one thing that they can control with certainty - costs?
Take the chart below showing a modest $1,000 annual contribution increased by 3% every subsequent year. After 40 years at a 9% return the portfolio would have grown to over $500,000. But after a 2% fee reduction netting a 7% return, the ending value is only $310,000. The portfolio value has been reduced by nearly 40% because of the black magic of compounding costs.
Conflicts of Interest
Look no further than the incentive system. In few other industries are incentives as misaligned as they are in the financial services sector. The majority of compensation schedules are based on either commission or a percentage of assets under administration. Some may even charge an additional performance fee for what they should be doing in the first place - performing.
So we have a situation where retail investors that are looking for objective guidance that is in their best interest being served by those who aren't rewarded for doing it. Instead, the incentive system rewards those that recommend the least suitable and costlier of suitable products or for spending time acquiring new clients and their assets at the expense of serving their existing ones. Neither of which has anything to do with the clients' best interests. This is not exactly confidence building.
High Expectations
Creating false expectations only leads to eventual disappointment. More than money is at stake in advisor-client relationships. It is about feelings and hope as well.
It makes little sense to risk more than one has or needs to in order to pursue what one doesn't have and doesn't need. Successful investing is a marathon and not a sprint. To benefit from long term compounding, survival is paramount. Rather than hoping for the returns that an investment will provide, one should first consider the consequences if wrong. Consequences should come before probabilities, no matter how favourable the probabilities appear to be.
I felt so strongly about about this that I wrote a research article published in the US based Journal of Financial Planning for CFP® professionals on this very subject entitled Investment Risk From the Client's Perspective¹. You can view it directly from their archives or here.
But it doesn't have to be this way and in the next section I'll describe what I am doing about it.
(CFP Flame logo)® Certified Financial Planner® and CFP® are certification marks awarded by Financial Planners Standards Council under a license agreement with the CFP Board of Standards, Inc.
¹Linked with permission by the Financial Planning Association, Journal of Financial Planning, December, 2005, Fred Kirby, Investment Risk from the Client's Perspective.