An understanding of how advisers add value allows self-directed investors to set themselves up for success.
The report outlines specific areas where advisers are adding this value including overtrading, a tailored plan and technology, tools and knowledge. They serve as pertinent lessons that self-directed investors can take to improve their financial outcomes.
The report calls out the period between February and April 2020 to demonstrate how advisers can add value as a behavioural coach. It quotes statistics from ASIC that showed 5,000 accounts were being opened daily during this period. These new investors only held onto their securities for an average of one day. It wasn’t much better outside of this period. A year prior, it was 4.5 days on average. 80% of these new investors made losses.
Financial advisers can add value as behavioural coaches and stewards of their clients’ investment goals.
Those that sold during March 2020 sold at the bottom of the market. As we all know, markets have recently set record highs—doing more than recovering those losses.
Overtrading and overconfidence comes from seeking wealth maximisation. That is a focus on maximising your money instead of having a clear goal in mind and working towards that goal.
An investment policy question connects your goals to the actual investments. In addition to specifying your goals, priorities and investment preferences, a well-conceived IPS ensures that you have a set review process that enables you to stay focused on the long-term objectives. This way, you can ignore short-term noise and avoid irrational decisions.
There are six steps to an Investment Policy Statement:
Documenting your goals might seem straightforward, but there’s more to this than meets the eye. Quantifying and prioritising your goals is paramount. If you do not quantify, you cannot measure success, and if you do not prioritise, you risk letting a lack of focus hinder you from achieving any goals.
The most successful investment strategies are straight-forward and succinct. For instance, a strategy for those embarking on their investment journey may be as follows: ‘To invest primarily in low-cost passive investments, increasing contributions along with salary increases. Begin with 80% in aggressive assets, and transition to 50% in aggressive assets by retirement’.
An investment strategy for retirees might be: ‘To invest in dividend-paying equities and annuities to deliver a baseline of income; regularly rebalance to provide additional living expenses. Target a 50% defensive/50% aggressive mix.’
The next step is document all of your current investments with their recent values.
Asset allocation is larger driver of returns than security selection. It is important to align your asset allocation to the goals you hope to achieve.
Remember that assets change in value. Your target asset allocations may be better expressed as ranges instead of a set figure to avoid over-rebalancing and incurring transaction costs. For example, you might have an 80% allocation towards equities, but on any given day that 80% could shift to 75% or 85% of your portfolio. Instead of 80%, express your equities asset allocation as 75%-85%. For major asset classes, stick to a range between 5-10%.
In your Investment Policy Statement, you must outline your investment selection criteria that will provide guidelines for the types of investments that you want to hold.
For example, if you use Morningstar’s research in your investment decision-making process, you could specify that your equity holdings must have at least 3 stars, or your mutual funds must all be rated Bronze or better. Defining criteria for selecting investing will keep you accountable and focused on what matters.
Implicit in defining an investment policy statement —from asset allocation to investment-holding specifics—is that you’ll periodically check in on your portfolio to ensure it is still on track to reach your goals.
In this section, you will specify how often you will review your portfolio. Understand yourself, and what works for you—if checking too often will cause poor investor behaviour (such as panic buying or selling), set a less frequent period for review.
This is the crucial last step to avoiding over-trading. It outlines the reasons in which you will buy or sell assets in your portfolio, and at what intervals. You may also buy and sell assets if current holdings do not meet your investment selection criteria anymore.
Your portfolio should be reflective of your own goals. The value that a financial adviser provides is tailoring your investments to you as an individual or family. Financial plans, are by regulation, created in an investor’s best interests by financial advisers.
This can be done by a self-directed investor and requires an investment of time. Many articles, including this one, are general in nature. I write about how a particular stock ticks all of our analysts’ boxes, but it is up to a self-directed investor to decide whether it is in line with what they are trying to achieve. General advice and information do not account for your personal circumstances and requires work from a self-directed investor.
Financial advisers do this work for you.
Morningstar is a proponent of goals-based investing. The four steps to construct a goals-based portfolio are:
Resisting the temptation to chase a popular or well performing investment that doesn’t align to your goals is challenging. Knowing how your investments are connected to your goals helps to limit poor decisions when emotions are heightened during periods market volatility. An investment in your own education is also needed to understand the foundations of investing and the attributes of individual investments.
One of the largest benefits that financial advisers offer is the access to financial technology and tools that can model financial scenarios. These tools allow them to easily determine the best path forward for their clients in a scalable manner. They can model out withdrawal rates, portfolio projections and age pensions. They can then adjust the variables to ensure that they are accounting for a variety of scenarios that may alter the outcomes of the client.
These tools can often be tens of thousands of dollars a year in subscription costs which the adviser can justify as they are using these tools across their entire client base. These tools aren’t as accessible for individual investors.
However, individual investors do not need to worry about a suite of clients. They only need to worry about themselves. They do not need scalable solutions because there is no scale. There are many tools available to retail investors that can help them manage their portfolio. Even without these tools, a spreadsheet can do some of the heavy lifting when it comes to the math behind an investors’ portfolio. For example, my colleague Mark LaMonica has recently put together a spreadsheet that helps to calculate the roadmap to generating $100,000 in passive income.
These tools give advisers an edge in terms of efficiency when putting together portfolios, but that is not to say that self-directed investors do not have edges themselves.
For example, Approved Product Lists. To operate as a financial adviser in Australia, you must be authorised under an Australian Financial Services Licence (AFSL). Some AFSL holders only allow their representatives to invest in a select range of products that fit a set of internally established criteria—limiting the securities an adviser can recommend. As a self-directed investor, you are able to invest in the securities that are best suited to you, without restriction.
I’ve outlined some free tools here for when you are just starting to invest. There are also a multitude of tools on Moneysmart and Noel Whittaker’s website for those that are further along in their journey.
Ultimately, an adviser’s job is to know what is best for their clients. Their job is to help you reach your financial goals, which involves meeting and maintaining qualification standards. Most self-directed investors are not full-time investors. They are establishing and maintaining their portfolios to reach their financial goals outside of their day jobs. It is hard work.
Self-directed investors may not have the same time to dedicate to learning and understanding the depths of the many aspects of personal finance—tax, estate planning, investments, structuring of assets. Financial advisers usually have a suite of trusted professionals that they team up with to manage these aspects holistically. In the same breath, self-directed investors are not usually fully self-directed. They will outsource some of these aspects to professionals—commonly estate planning or tax.
So, the question is—does the fact that you are able to recreate these advantages mean that you should not get a financial adviser?
Just like many aspects of personal finance it depends on your circumstances. Some individuals have no interest in managing their financial affairs and would rather outsource to a financial adviser. Others will decide that they do not have the aptitude or time to learn. Some are not in the position to afford the financial advice fees.
A large part of the excess returns a financial adviser provides is acting as a behavioural coach and ensuring that their clients make decisions that are in their best interests. More than anything this is a result of the structure provided by the financial advice process.
Some individuals will determine that they are not able to do that without a third party. Some will put the work in to learn about investing and set themselves up for success. Many people will continue to achieve poor outcomes by not bothering to define their goals and put an investment strategy into place and will haphazardly chase strong performing investments. A self-directed investor can achieve great results. It just requires work—and a willingness to do it.
By clicking subscribe, you agree to receiving editorial, events, product update and marketing emails from Morningstar and its related parties, until such time that you choose to unsubscribe or update your preferences via the link in the footer of our emails. You also agree to the Morningstar’s Terms, Privacy Policy and Financial Services Guide (AU).
