The “Value” Question Is Pushing Advisors Into Dark Places

Complex recommendations

The portfolio recommendations he received were overly complex and inconsistent with sound investing principles.

The larger firms pushed alternatives, with one telling him he could “sometimes” achieve market returns “with a fraction of market volatility.” They didn’t mention the downsides of alternatives, including illiquidity, lack of transparency, higher fees and more difficult tax reporting.

Another firm claimed most of its alpha was generated in alternatives, noting that endowments and other institutional investors shun public markets in favor of alternatives.

They neglected to mention the evidence showing the underperformance of endowments compared to benchmark indexes, primarily due to investments in alternatives.

Since endowments have longer time horizons and different liquidity requirements, using them to tout the benefits of alternatives to an individual investor was dubious.

While reasonable people could debate the merit of alternatives, this article by John Rekenthaler, director of research at Morningstar, is thought-provoking. The article's title says it all: “Alternative Investments Have Been Useless Since 2007.”

Another told him investing in a bond index fund was a bad idea because they include companies with the most debt, without differentiating between bond funds or discussing the availability of short-term Treasury bond index funds.

Even a robo-advisor failed to deliver an uncomplicated portfolio.

Its portfolio consisted of six ETFs. It had separate ETFs for dividend-growth stocks, emerging markets, foreign-developed stocks, and U.S. stocks. It could have just recommended one all-world stock fund.

To its credit, the ETFs it recommended (which included both a municipal bond and a TIPS ETF) were all low-fee.

Fees

There was a lack of transparency on fees from all firms. I asked the investor if he knew how much he would pay to one of the larger firms over a decade. He said he had no idea. I told him to run the numbers using this calculator.

He did so and reported he was “shocked.”

One firm sent him the Vanguard study on the value of an advisor.

I asked how he could determine value without understanding the impact of fees on his returns. He had no response.

Violating your fiduciary duty

The following conduct violates your fiduciary duty:

• Presenting one-sided or otherwise misleading data;

• Hiding the impact of your fees on returns;

• Not giving clients the option of paying fees outside of their portfolios; or

• Unnecessarily complicating your recommended portfolios to justify your fee.

A fiduciary advisor would have begun the discussion by suggesting a simple portfolio, using index funds or those I cited at the beginning of this article. Any other recommendation would need to be positioned in terms of advantages and disadvantages relative to that solution. All fees would be disclosed transparently.

If that is not how you would have worked with this prospect, then you are not a fiduciary.

Dan coaches evidence-based financial advisors on how to convert more prospects into clients. His digital marketing firm is a leading provider of SEO, website design, branding, content marketing, and video production services to financial advisors worldwide.

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