Executive Summary
Notwithstanding its risk and the painful volatility of the past decade, stock investing is still a cornerstone of financial planning advice. However, investing in equities - even just a little bit - is not for everyone. Some aren't interested in the risk; the trade-off just isn't worth it to them.
Of course, financial planning advice has much value to offer beyond just how to allocate an equity-centric portfolio. There's just one problem... financial planning advice may still be so equity-centric, that people who don't want to take investment risk just don't use a financial planner at all, as a recent Journal of Personal Finance revealed!
The inspiration for today's blog post was a brief article by Jason Zweig in last week's Wall Street Journal entitled "Who Needs Financial Planners, Anyway" discussing a recent article entitled "The Demand for Financial Planning Services" by Sherman Hanna in the Journal of Personal Finance.
The good news of the article was that, in analyzing data from the Federal Reserve's Survey of Consumer Finances, it appears that approximately 25% of households utilize the services of a financial planner (as of 2007), up from 21% of households a decade earlier, and representing a total increase of almost 7.7 million households that started working with a planner (although notably, the research refers to financial planners, but it's not clear whether the data really makes a distinction between comprehensive financial planners and the general category of financial advisors). Given some of the criticisms of financial advice only reaching a limited number of the affluent, this can be viewed as a very positive trend on the expanding reach of financial planning.
However, in further analyzing the data of who consumes financial planning services, a disturbing trend also emerged: one of the key factors in determining whether a household is interested in seeking out the advice of a financial planner is its willingness to take investment risk. As the results show, 28% of families willing to take "average" levels of risk use a planner, and 33% of families who are comfortable with "above average" risk use planners. But amongst those who aren't willing to take any risks, the use of financial planners is a mere 11% (and this is after controlling for age, income, net worth, and other factors). In other words, there appears to be a strong self-selection bias occurring here - people who are comfortable taking risks as stock investors seek out financial planners, while those who are not comfortable with stock risks tend not to seek out a financial planner at all (despite the other value that planners can provide).
Unfortunately, these results suggest to me that overall, financial planning is still too equity- (and therefore risk-) centric in the advice that it gives, and as a result carves out and excludes a material portion of the population for whom its advice doesn't feel relevant or appropriate. Given the trend for the increase in the use of financial planners - even though it's been an incredibly difficult decade for equities - it would appear that financial planning is making some progress in convincing the public of the value it has to add beyond investments, as the percentage of households using a planner is on the rise even though I doubt the tolerance for stock investing has climbed over the decade. Nonetheless, it still raises the specter that financial planning as a profession could be in serious trouble if the stock market has even more protracted difficulties and the general public sours further on equity investing.
Personally, I do still believe there's a value opportunity in investing a portion of one's net worth in equities for the long run, so the point of this post is not to bash stock investing. But we as financial planners do need to take a good, hard look in the mirror. Why is it that we'll suggest whether to spend 20% of our income on a car, or only 5% on a car and save the rest, is a "personal values" choice, yet investing in a purely fixed income portfolio is "never" appropriate for anyone because every client needs and deserves the long-term returns that equity investing provides (even though sometimes it doesn't actually provide those returns over a relevant time horizon)?
Why don't we have more discussions with clients about how to achieve financial success by investing in a portfolio of TIPS, that provide some real return while also hedging against inflation, providing as close to a risk-free accumulation strategy as any available? Yes, it would mean clients have to spend less and save more because they won't participate in equity returns... but so what? Isn't that just part of the trade-offs and personal value decisions that we should help every client evaluate? And sometimes, equities don't actually deliver the expected returns, and the TIPS portfolio could even be the superior path, not merely the steadier one!
I realize that some people will probably use this discussion as a chance to stab at the AUM-based financial planning business model, but I don't necessarily think it is the culprit. Our tendency for equity-centric advice generally appears to span all business models; I've seen similar equity-centric advice behavior ranging from hourly planners to wealth management firms. Some business models may face this conflict more than others, but the equity-centric nature of our advice is, I believe, a learned behavior from our curriculum and our culture as planners, not merely a consequence of one particular business model.
So what do you think? Have we as financial planners indoctrinated ourselves into a "cult of equity investing" that is making itself unappealing to anyone who doesn't want to adopt our own equity-centric views? Are we as financial planners projecting our above-average risk tolerance tendencies onto our clients, and not doing a good enough job of providing advice truly based on their risk tolerance? Have we bet our profession on the long-term growth of the stock market?
The role of a half-decent financial planner is to explain to clients what, if any, “risk” they need to take to achieve their most important goals in life without fear of running out of money.
If a client wants to invest 100% in TIPS, so be it; if he can do all he wants with his life in so doing, then good for him! Our most significant role is to help those who think they can achieve this outcome with this strategy – but can’t (the majority, probably…)
If such a client still insists he wants 100% TIPs then of course that is what he gets in his portfolio – together with guaranteed failure. But it is always the client’s money, not ours.
Not “every client needs the long-term returns that equity investment provides” but most mass-affluent people do. And it’s our role to educate such clients in the potential that having a share of capital markets affords them (notwithstanding the rubbish returns of the last 10 years, although, of course, that’s but a long-lunch in the context of equity investing!)
Risk comes in many forms. The worst risk is running a lifestyle that sees you run out of money before life. If equity investing helps reduce this risk, everything else is relative.
It’s been almost twenty-five years since I passed the CFP exam, but I seem to remember that there were more subjects covered than just investments. I realize that consumers may think of investments and insurance when they think of financial planning, but that’s due to poor marketing on our part. Properly presented, we can, and explain the value of the other aspects of financial planning.
Michael,
Great dialogue, thank you. Help me clarify something.
Are you suggesting that equities are not the only way to achieve high rates of return? Or that high rates of return are not the only indicia of success?
If the former, then I think there’s still a hidden assumption, namely that money buys happiness and the more money (risk-adjusted of course), the more happiness. I must not have met too many of the SSRFP, because that’s what seems to me to be the operative belief of most planners.
I was suggesting the latter idea; that until financial planners can conceive of the possibility that lower returns might co-exist with greater happiness for a given client, they will be stuck in money-centric views, with equities being the generally “obvious” choice (rightly or wrongly).
I think clients contribute to this view–way too many insist on measuring their planners by “how much money did he make me” and not much else, though that may also be because no one ever asked them a better question.
Perhaps I really am being narrow here, and the SSRFP crowd is bigger than I thought. I will stand happily corrected if that’s the case.
Michael:
Great topic. I think the reason it appears that Financial Planning only appeals to risk takers is because consumers are unfortunately unwilling to pay for a through high quality financial plan so the planning process becomes a small part of the thrill of seeking investment returns. Thus an evolutionary bias occurs where a consumer on the margin chooses a firm that implies they can produce above average equity returns (and the firm implies that equities are superior to fixed income) by doing a.u.m. and then the firm offers to do a financial plan on the side. So a bearish pro-fixed income investor has less chances of meeting the typical financial planner. A bearish investor may simply fool himself into putting all his money in a bank account and refusing to talk to financial planners. It is the potential thrill of getting the equity risk premium of stocks over bonds plus attempting to beat the market that motivates consumers to seek out a planner.
The consumer needs to take responsibility for dragging his feet on the need for obtaining the more dry parts of financial planning. The foot dragging results in a warped industry where too much emphasis is placed on equity investing and not enough on other parts of financial planning.
Great topic Michael, and I have to agree with the statistics and that we have been biased to MPT and the long term return on equities when also doing shorter term planning. I don’t think we’ve done a very good job convincing the public of our value, though it does go beyond investment management, though too often not much, as proven by how much time is spent in front of a computer vs with clients. Bonds have outperformed equities for the last 10-30 years or so, and there is no assurance it can’t continue until the global economies get back on track, which is pretty iffy at this point. Plus, Wall Street hasn’t cleaned up it’s act either. We still see more of the same ridiculous incompetence and highly leveraged risk taking by banks, MF Global, with help from legislators clamoring for less regulation, not more. No wonder the Occupy Wall Street movement is gaining supporters. They have some valid points and there isn’t a level playing field when flash traders can front run the public with their computers closer to Wall Street. I’m not against stock investing, but see why the public is fed up with and distrustful of our business when many of us are happy with business as usual, and another good reason for a fiduciary standard. Enough ranting for now, but the situation only seems to be getting incrementally better to me. We need a new paradigm and what Socially Responsible Investors have been working for for decades now, full disclosure, transparency, fairness and for the good of all, ethical behavior, etc. Is this really too much to ask?
At last a discussion that suggests that there is an alternative to stock investing. Hildy Richelson and I have written 5 books on bonds, with the last two suggesting that investors should invest all their money in what we call “plain vanilla bonds”, high quality bonds with no story about them. Our book is called Boonds: The Unbeaten Path to Secure Investment Growth, Bloomberg Press, 2011. It is in its second edition. The first edition was an award winning and best selling book in 2009. A study has been done by Robert Arnott in 2009 concludes that bonds outperformed stocks over the last 10, 20 and 40 years. Rob asked, “what is the long run?” A more recent study noted on Bloomberg in the last few months concluded that bonds outperformed stocks over the last 30 years. We have been shouting in the wilderness for the last 25 years suggesting that bond investments had great value without any agreement. With more than $200 million under advisement, we can suggest that there are more than a few investors who value bonds, sleep well at night, and are quite pleased with their investments and lifestyle. Kudos to you Michael for raising this important topic for discussion.
Michael:
Judging from the number and quality of the responses, you have once again asked the right question. Hope to see you in Denver again soon.
I think the underlying issue is indeed behavioral. On the one hand, we deal with self-described “risk seekers” whose tolerance for risk is actually near zero. At the same time, most have limited resources and little chance of success as long as spending and saving habits remain ingrained. And, apparently, we have not been that successful, e.g., see the recent FPA white paper, indicating that according to us half our clients are likely to fail.
So a new paradigm is definitely needed. But “fiduciary standard” (and the conventional methods that likely will flow from it)is more likely to be a stumbling block than a solution.
Ray
Hi Michael
My view is that it’s the public confusion around what is a financial planner that led to the survey results. I believe the public generally equates financial planners with broker-based financial advisors that primarily recommend equities.
I just blogged about this topic as well, although with a focus on the consumer rather than other financial planners: http://blog.pwjohnson.com/?p=506.
Artie
When your financial needs become more complicated, you might find that you are in need of advisors for guidance, and made decisions based on separate conversations and different points of view. However, choosing a financial planner, who can develop appropriate strategies for your unique circumstances, while creating organization and focus to your financial puzzle is the main thing.
The options are there for all levels of risk, it isn’t as black & white as it appears.