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Jonathan Clements: After Cuts in Fund Fees, Advisors’ Fees Are Next

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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 — 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.

Please explain what you mean by: Understanding what clients “really want.”

If you know that your clients want to retire at age 65 and move to Florida, you don’t know anything about them. But if you know that at age 65, they want to move to Florida, work as a docent in a museum, travel to France because they love Impressionist painting, would like a chance to write a screenplay [etc.], now you know something about them. When you understand what your clients really want and make a better connection with them, you can help make that happen.

So do advisors learn this by sitting down and chatting with clients?

Yes. One of the hardest things to do in life is to listen. We all love to talk. Give your clients a chance to talk: When you meet them, spend 20% of the time talking and 80% of the time listening. It’s amazing what you’ll learn.

You write that people should think less about making their money grow more, and more about the “dangers that could derail [their] financial future.” How can advisors help with that?

The issue here is: It’s less about pursuing a few extra basis points of investment gain and more about reducing the risk that your financial life is going to end up in tatters. There are two principal ways financial advisors can help. The first is to make sure that clients’ portfolios are well diversified — not only across the global stock market but also including a reasonable allocation to bonds. The second way is to ensure that clients have the right insurance [coverage].

Do annuities come under that?

If clients are thinking about making money last through retirement, a combination of delayed Social Security benefits and an immediate fixed annuity could indeed ensure that they’re less likely to outlive their money. The longevity risk is a real risk.

Why do you single out the immediate fixed annuity?

Unfortunately, the term “annuity” has an extremely bad name. That’s mostly because of some really atrocious products, specifically, variable annuities with high annual expenses and equity-indexed annuities. But the plain-vanilla immediate fixed annuity is a great product. If you reach retirement age and want regular income and to hedge against outliving your money, buying an immediate fixed annuity could be a smart purchase. However, this is a product that financial advisors don’t tend to sell, in part, because the commissions tend to be very low.

What do you recommend in your book, “From Here to Financial Happiness,” when it comes to hiring an FA?

Don’t use an insurance agent as your principal financial advisor. Don’t use a broker who works on commission. Consider a robo-advisor if you have a fairly simple financial life. Look for a fee-only financial planner if you have more than $250,000 in savings and your finances are complicated. Consider paying by the hour.

That eliminates the numerous advisors paid by commission.

If you’re selling commission products, you have a conflict of interest: One, you have an incentive to get people to trade; two, you have an incentive to get them to buy products with the highest commission.

You write that most people should own “at least some stocks.” Individual equities?

I don’t think individual investors should have anything to do with individual stocks. They should be buying either stock index mutual funds or exchange-traded stock index funds.

Why shouldn’t they buy individual stocks?

Because of the undiversified risk. On top of that, owning individual stocks encourages bad emotional decisions. An individual stock is far more volatile than a fund. We know about the behavioral mistakes that people make with investments — and the more volatile the investment, the greater chance of making a mistake.

What investing strategies do you suggest in “From Here to Financial Happiness”?

One approach is investing in three index funds: a total U.S. stock market index fund, a total U.S. bond market index fund and a total international stock index fund. The other is to buy a single target-date retirement fund and focus specifically on the three fund companies that sell target-date funds composed of index funds: Schwab, Vanguard and Fidelity.

Have you changed your mind about anything you espoused in “How to Think About Money,” published two years ago?

The only thing is that I believe more strongly today is that people should have a truly globally diversified stock portfolio. The global stock market consists of nearly 50% U.S. stocks and 50% foreign stocks. Investors should aim for that global diversification. The caveat, of course, is currency [exposure] risk, which may mean limiting that by looking at bonds as a hedge.

What’s the biggest overall mistake people make when it comes to investing?

They aren’t saving. It doesn’t really matter how good you are as an investor. If you don’t have good savings habits, the investment returns you earn are never going to amount to much.

What do you recommend to remedy the failure to save?

Most of us have to trick ourselves into saving money. One of the great tricks is to take advantage of our inertia by signing up for automatic savings programs, whether it’s your company’s 401(k) plan or an automatic investment plan where money is pulled from your bank account every month and put in your favorite mutual fund.  Once we’ve made that sort of commitment, we tend to stick with it — because of inertia.

Why else is that “trick” helpful?

A lot of people will happily spend money that’s in their checking account; but if they get money out of their checking account and put it into a mutual fund account or a brokerage account, they tend to consider it off-limits and won’t spend it.

What do most folks overlook in their financial lives?

People tend to look at their finances too narrowly, and they don’t consider their finances over time. That is, they tend to think of their goals consecutively rather than concurrently: In their 20s and 30s, they try to buy a house; in their 40s, they try to pay for the kids’ college education; and finally, at age 50, they turn their attention to retirement, at which point, of course, it’s way too late to start saving for retirement.

Will robo-advisors will continue to make inroads vs. human FAs?

I think robos and human advisors can coexist quite happy. One doesn’t necessarily preclude the other. Robos are great for clients with relatively modest portfolios and simple financial needs. Human advisors are good for clients with substantial assets and complicated financial needs. But if all you’re doing is providing clients with mediocre investment portfolios and nothing else, then, yes, the robos will eat your lunch.

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