Financial Fuel Economy

I was never a mechanically-minded kid.

At the start of year 9 in school, all students were required to choose from a list of elective classes.  The options were woodwork, metalwork or typing.  Every other boy in my year 9 class chose woodwork or metalwork.

I chose typing.

This wasn’t due to any foresight about the future of computers and how handy typing would become.  This was in 1985 – before email.

Despite my natural aversion to “Manual Arts”, I remember one day our photography teacher who had a VW Kombi van, taught a few of us how to remove a distributor cap and clean the spark plugs.

Even for those that are mechanically-minded, working under the hood of a vehicle these days is not so simple and no longer the domain of a backyard mechanic.

Which is why it still strikes me as strange that in the world of investment, where things have also changed so dramatically over the years, that some financial advisers are still spending time trying to build share portfolios for their clients.  It’s akin to a backyard mechanic working on a 2018 luxury vehicle.

I mean it’s not as if these financial advisers are not trying to deliver good investment outcomes for their clients. 

It just isn’t realistic.

Teams of investment professionals who spend their entire work day managing investment portfolios have an incredibly hard time beating the market.  If you want proof, take a moment to review the SPIVA® Australia Scorecard from Standard and Poors.  It makes for troubling reading.

So why would a knowledgeable and well-intentioned financial adviser even try to custom-build direct share portfolios when the odds are so stacked against them, or should I say, stacked against their clients?

Don’t get me wrong.  Having a portfolio of direct shares feels good.  There is a sense of comfort that comes from owning shares with which we are familiar – the banks, Wesfarmers, BHP.

But that is just a phenomenon known as familiarity bias and it plays no part in the investment outcome.

Building custom portfolios with direct shares when you are competing with the most sophisticated trading and investment management techniques used by PhD qualified investment professionals, who do nothing else except manage portfolios, well …. it just doesn’t make sense.

You end up with a less diversified portfolio which is consequently higher in risk and to make matters worse, it requires significantly more ongoing management by you and/or your adviser.  It is why this approach is expensive to provide to clients, even though the extra management for a higher fee does not reliably deliver better investment outcomes.

So, let’s get this straight.  Having a portfolio of direct shares means paying a higher fee for a higher risk portfolio with less reliable investment outcomes.

It’s just nuts!

Financial planners and advisers have enough to do staying current with superannuation legislation, changes in tax and pension rules, not to mention helping their clients build and preserve wealth through effective cash flow planning, debt management, insurance protection and estate planning.

Highly sophisticated investment management techniques have moved way beyond the capabilities of even the most technically-trained financial adviser.

After more than 60 years of modern portfolio theory, we know what drives returns over the long term. And we know there’s little benefit to be gained by trying to outguess the market.

This is not a controversial statement.

The problem is much of the financial services industry has a vested interest in making it complicated and adding multiple layers of fees to the process in order to sell products that people don’t need.

So what we do is offer a single globally diversified solution with built-in rebalancing and that cost-effectively targets higher expected returns for a given level of risk.

These world allocation vehicles are designed for us by Dimensional Fund Advisors, an institutional manager that bases its approach on Nobel Prize-winning research based on the information in market prices.

On the surface, these are sleek and simple solutions. Underneath, there are thousands of stocks and bonds invested in multiple equity and fixed interest strategies that systematically identify differences in expected returns among securities. The focus is in reducing turnover, keeping costs low and rebalancing each day to keep the funds on target.

Think of it like a compact, extremely reliable and highly fuel-efficient hybrid vehicle with computerised control systems. What this means for the client is they get to where they want to go at low cost and without taking any more risk than is necessary. The time saved on all the complicated rebalancing, picking stocks and market timing we can spend instead on the clients’ own lives.

“Old spark plug” by Ben Loomis is licensed under CC BY 2.0

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