When my niece was a little girl, she loved to eat sugar from the sugar bowl. No matter how many times she was told the damage sugar could do to her teeth and her health, she always came back with, “That’s okay, I still want it”.
Having a discussion with clients about fees sometimes feels like having the sugar discussion with my niece. You explain how yes, index ETFs and funds might be cheap, but because of their design, which is to provide a benchmark return less internal trading costs and fund expenses, they will generally under-perform their benchmark most every time.
“That’s okay,” they say, “I still want it.”
Influenced largely by the financial media, robo-advisors, and discount brokers, I feel investors are missing the essential point of investing. In my day as a financial advisor the first question a prospect would ask was generated return. Said differently, "how much money did you make for your clients?"
Today, for some, this burning question has been replaced with "how much are your fees?"
The challenge with the lowest fee model is that it does not matter what fee you charge, someone is likely to come along and find a way of charging a lower fee. Recently, a firm announced that not only will they have zero fees, but they will pay investors to put money with them!
I believe the reason the financial media harps on the fee issue and some investors adopt its mantra is a function of the prolonged bull market.
We are now in the 11th year of the longest ever bull market. This period has witnessed the S&P 500 up over 325%. As a result, outperforming a diversified benchmark and the concept of risk-adjusted return are simply not in vogue because we have not had the downside of a normal market cycle for a very long time.
Unfortunately, I believe that offering the lowest fee as the central premise may provide a serious disadvantage to your clients and ultimately to your practice.
When the bear market arrives, it is my view that the conversation will migrate from fees back to investment return. The conversation investors will have with you will be asking your return in the last bear market, not your fees as the market lost in excess of 20%.
I have seen this before.
When I started in this business as a Financial Advisor, no different than today, fees were a focus. We were in the bull market of the 1980s and the prevalent thinking was that no loads were going to take over the industry. Jason Zweig of the Wall Street Journal was vocal in saying how superfluous the financial advisor was in the investment process when there were no load options available with no commissions.
However, as the market crash of 1987, the recession of 1989 – 1990, the difficult bond market in 1994, and the global financial crisis of 1998 took hold, more investors started moving to load mutual funds because load funds came with a financial advisor to help navigate challenging times. Towards the end of the 1990s, Jason Zweig admitted that if the load fund came with a professional financial advisor, then the additional fees could be well worth it.
By 2000s, many of the staunch no load fund companies like Janus, Twentieth Century Funds, Mutual Funds Shares, Stein Roe, and others were converted to load funds. Even Fidelity changed their load Plymouth Funds to the Fidelity Advisor name.
When the bear market arrives, higher cost investments like alternatives and the cost associated with better active managers might serve investors as the focus shifts from fees to providing a degree of protection in the bear market.
When searching for a value proposition that veers away from the cheapest fees, look at Dunham’s innovative approach to fees. At Dunham, the manager makes more when they outperform their benchmark and gives up a substantial portion of their fee if they under-perform their benchmark – net of all internal fees and expenses.
Also, talk to us about the way we manage risk within investor’s portfolio. I believe that when the bear market hits, fair fees, having the right amount of risk in your portfolio, and a risk management system will matter most.
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