The massive investor shift to indexing and growing popularity of robo-advisors and other low-cost options won’t put active fund managers out of business anytime soon — but managers are indeed fearing for their future.
So says Jonathan Clements, a Wall Street Journal personal finance columnist for 20 years, author of eight finance books, and director of financial education for Creative Planning, the country’s leading independent RIA.
The investor advocate and champion of indexing, who is a favorite of financial planners, allowed a few other interesting observations as well: The “plain-vanilla immediate fixed annuity is a great product.” “The boom in index funds has been a boon for advisors.” And, not unexpectedly: “Don’t use a broker who works on commission. [They] have a conflict of interest.”
Clements’ most recent book is “From Here to Financial Happiness: Enrich Your Life in Just 77 Days” (Wiley-Sept. 2018). The revised international edition of his bestseller “How to Think About Money” (Harriman House), is being released today.
London-born Clements’ sharp financial insight is a result of his unusual dual perspective: He covers finance; at the same time, he’s a member of the financial services industry. After writing for The Wall Street Journal for 18 years, he joined Citigroup for the next six as director of financial education for Citi Personal Wealth Management. He then freelanced for the Journal for more than a year and has continued as an independent writer.
Clements joined Creative Planning — part time — because of its “very heavy focus on indexing in portfolios,” he says. He is on the investment committee, writes client letters and speaks at the firm’s annual conference and other events. CP manages about $33 billion in client assets.
In the interview, Clements offers advice for advisors on ways to improve client relationships, including adding more value and changing clients’ financial misbehavior.
The founder of HumbleDollar.com — serving up a blog, guide and newsletter — Clements structured his “…Financial Happiness” book as a day-by-day guide to putting one’s financial house in order. He also provides details for creating a globally diversified portfolio of index funds.
ThinkAdvisor recently interviewed Clements, on the phone from his office north of New York City. There’s no question that the Cambridge grad has all the answers about personal finance. He also has one about financial advisor personal finance. Question: Will index funds cause FA fees to come under pressure?
Read on for that answer and other highlights from our conversation:
THINKADVISOR: How have investors’ attitude about the market changed since the financial crisis?
JONATHAN CLEMENTS: The shift out of actively managed funds and into index funds is staggering. The latest numbers I’ve seen from the Investment Company Institute show that among funds focused on U.S. stocks, over the past 10 years there have been net outflows from actively managed funds totaling $1.3 trillion and net inflows into index funds focused on U.S. stocks of $1.6 trillion. That’s wild!
What, then, is the future of actively managed funds?
Over time, actively managed funds will manage less and less of people’s money. But that doesn’t mean we’re reaching any sort of crisis point. There’s all kinds of hoopla in the press and on social media that too much of the U.S. stock market is in index funds. That’s absurd. The vast majority of money in the U.S. stock market is still actively managed. All this nonsense is an attempt by active managers to drum up business. They’re not anywhere close to extinction — but they sure are afraid.
What do you see happening eventually?
I suspect that we can get to the point where 95% of the U.S. stock market is indexed and still have a highly efficient market. But we’re so far from that point it’s not even worth considering.
You write that people can suffer “slow financial death” because of costs and fees. How should FAs handle a client who says they’ve heard about that and therefore wants low-cost investments?
Listen to the client, and then buy her some index funds! It’s not complicated! If you get [clients] out of actively managed funds, there’s no longer the risk that the funds they own will be duds.
How is the popularity of indexing affecting advisors?
The boom in index funds has been a boon for financial advisors. Low-cost index funds are a gift to them. The question is: Are advisory fees going to come under pressure? I think the answer is yes.
What will be the impact?
Advisory fees will come down! If I were a financial advisor, I’d be looking to add as much value as possible because that’s the surest way to ensure that you’re not going to lose clients and have to cut your fee down the road. Advisors who focus only on client portfolios run the risk that they’re going to lose clients to robo-advisors and other low-cost alternatives, which means they’ll either lose assets or will be pressured into lowering their fees.
What’s the financial advisor’s mission?
An advisor’s job has three parts: helping with the investment portfolio, with other areas in the client’s financial life and with behavioral change. It’s the latter two where the good advisor can make a huge difference. They can certainly improve the client’s portfolio; but they won’t deliver on the promise so many of them make, which is that they’re going to outperform the market averages.
Why should advisors focus on those two other parts?
We spend countless hours researching mutual funds and individual stocks — and the net results are a loser’s game. We spend all this time blathering on endlessly about the market. But it’s of so much more value to both individual investors and financial advisors if [advisors] focus on other areas of personal finance, like helping to straighten out estate plans, minimizing taxes, buying the right insurance, claiming Social Security at the right time and so on.
What benefit will FAs have from that?
If an advisor educates clients about the unlikelihood of beating the market but explains the value that can be added in those other areas, they’ll have much better relationships with their clients and do a lot more good for them.
What are the top three “mental mistakes” about investing that people make?
Lack of self-control, having too much confidence and being too quick to change their minds when markets [tumble].
Please talk, then, about the significance of FAs changing client financial behavior.
That’s at least as important as having special knowledge that clients don’t have. Clients don’t want to look bad in the eyes of the advisor; so if the [FA] says, “You should sign up for a 401(k) plan and commit to putting in 10% of your income,” the client will do that because they don’t want to face awkward questions when they next meet with their advisor.
What’s another way FAs can improve the relationship with clients?
In many ways advisors behave like psychologists: They need to understand what clients worry about and what they want from their financial lives. To the degree that they understand what their clients really want, they’ll have a better relationship with them, clients will trust [the advisor] more, and [he or she] will be able to do more for them.