MCA Financial Advice

Financial Advice adding Value

We currently operate in an environment where emerging trends and changes in the financial industry characterise and question the roles of its participants, which are then examined based on their merits and contribution on a large scale, in this case, the financial advisor. Creating a financial plan enables you see the bigger picture when it comes to setting long and short-term life goals. This is a crucial step to take towards securing your financial future. When you have a financial plan, it’s easier to make financial decisions in order to meet your goals and objectives. A Certified Financial Planner (CFP® professional) can secure your financial wellbeing, give you peace of mind and help you to reach these goals and objectives. 

Considering the contribution of intermediaries, it is argued that technological changes may disrupt the role of financial advisors via the concept of robo-adviser, which has recently been introduced in South Africa. However, the role of the financial adviser is one that will always hold value irrespective of technological or legislative changes. This is proven through the Gamma study (conducted by Vanguard and Morningstar), which is a measurement of the additional value-add that a financial advisor performs for his/her clients. Investor emotions and decisions are usually based on human bias approaches on a large scale, ranging from movements in the markets, social, political, and economic factors that will potentially have an impact on their financial situations and end goals. Holistic financial planning as well as understanding client personalities are services that add a lot of value to an individual’s financial position. This is accompanied by psychological skillsets (behavioural finance) that ensures that individuals do not make impulsive decisions of which will negatively affect their financial objectives. It is important to stick to one’s financial plan irrespective of temporary speed humps along the road.

Research

Studies have found that the gamma effects are more clearly measured in diversification benefits and a savings discipline than increasing returns, and therefore, the benefits of having an adviser significantly increased savings rates and total non-cash investments. As a result, being better diversified allows investors exposure to more funds and asset classes. The study also found that investors who have a relationship with an advisor up to 4 years will have 69% more assets than those who do not seek advice, and a further 290% more assets for those who have had an advisor for 15 years and longer. The most profound benefits as a result of the above is higher income at retirement and overall better financial literacy. In addition, suitable investment vehicles, liquidity management, after-fee and especially after-tax returns, play an equally important role in adding value for a client.

The studies that proved most significant were conducted by the Morningstar study, which focused on more efficient retirement income; and the Vanguard study, which included the benefits of educating and coaching clients.

Both studies have provided measurable value-add, through having a financial advisor, in order to prevent individuals from making detrimental knee-jerk decisions that could hinder structured financial plans.

The ideal measurement can be found in the comparison between the advised versus the unadvised scenario. The below graph displays value-add benefits that a financial advisor can generate should the respective aspects (mentioned above) optimally structured:

Source: Vanguard, Morningstar, Glacier

The study was conducted in the United States, however, these are factors that impact individuals in South Africa in the same manner.

Investment Plan

There are certain aspects that are integral to a successful investment plan (adding to 1,7% of the Advisor Gamma)

1. Asset Allocation– Considering both Pre and Post-Retirement planning, much focus must be placed on one’s risk profile, financial goals, and investment time horizon. Time horizon will assist in determining which asset class you should allocate the dominant portion of your investment. The longer your time horizon of your financial goal (Eg//Pre-Retirement), the more you should allocate towards equity and property and less towards bonds and cash. Equities are considered riskier in the short term while less risky in the long term. Proper asset allocation will help you to determine the correct mix of Equity, Bonds, Property, and even cash based on your time horizon to achieve your financial goals. It is also recommended that a portion of the above assets are to be invested Offshore (roughly 30% of one’s portfolio) to take advantage of sectors in the market that our local stock market does not provide. In Post-retirement, is a more challenging task. The question of how much to allocate offshore is always a challenge in SA, and is best left in the hands of qualified professionals.
2. Fee Optimisation – The correct investment vehicles for the individual’s specific circumstances are very important, adding a possible 0.75% annually of total investment plan gamma – here, the best cost-benefit ratio must be provided for the investor.
3. Investment Vehicles – In SA, there are plenty of vehicles to choose from which offer different benefits and which are suitable for different individuals and life stages. The recently introduced TFSA (tax-free savings account) is more applicable to some than others. When applied properly, this vehicle can supplement retirement very meaningfully.
4. Return Sources– The last component of investment plan gamma is return sources – placing funds in investments that grow with capital gain or dividends rather than interest investments – as exceeding one’s annual interest exemption could place a heavy burden on one’s tax liability.

Risk & Tax

Risk and tax focuses more on rebalancing and income strategies, regarding funds invested in, which is crucial in making the decisions and can add up to 1.05% in gamma p.a. Choosing the most optimal income withdrawal/annuity income strategy is the second benefit and can add up to 0.7% of the risk & tax gamma, which may be quite conservative in SA.

The widespread use of ILLA’s (investment-linked living annuities) in SA makes this a very applicable value-add for investors in choosing a financial advisor. Establishing the differences between vital goals and aspirational goals for clients particular financial situations and prioritisation between the two are better done with the objective view and professionalism of a financial advisor.

Behavioural coaching

Behavioural coaching is a valuable tool that helps clients stay invested during times of market stress. Investor behavioural biases which are detrimental to long-term investment returns can be mitigated, and in some circumstances, totally eliminated. A common theme that arises in times of market scepticism is the nature of market volatility and the fluctuation of asset classes such as equities. For prolonged periods, prior to market recovery, this may cause investors to lose confidence and sell (low) out of asset classes – making a loss where they could have taken advantage of cheaper asset class valuations invested at a discount instead.

The returns that investors experience due to inherent biases, are actually very different from the actual net fund performance. Behavioural coaching, therefore, can add up to 1.5% annual gamma, especially in protecting individuals from themselves during times of significant drawdowns.

Popular investor biases that feature include herding, loss aversion, availability bias and limited cognition.

Loss aversion bias

Loss aversion is the process whereby investors start selling from their investments during times of market drawdown. This is a crucial error, and the impact can weigh heavy on investor portfolios. Assuming an amount was invested in the local equity market (FTSE/JSE ALSI) 20 years ago, if the investor missed only the top five trading days (0.1% of total trading days), which is impossible to anticipate, they would have 28% less capital versus the individual who had stayed invested throughout the term.

Herding & availability biases

Herding and availability biases centre around investor and market trends and usually tempts the investor to follow blindly into the popularity without first consulting their financial advisor. The recent emphasis on index funds relate to this particularly. Whilst these funds have merit in some portfolio contexts, blind faith in pure indexing as an investment strategy can be misleading as the Index Funds asset allocations may be very different to the investor’s recommended asset allocation based on their original investment strategy.

Indices have produced competitive returns historically, but its use and application should be considered carefully, especially in our current environment. Trends tend to fade with time and the role of the advisor is imperative in educating the investor/client in order to manage the client’s funds in diversified investment strategies.

Technology has now made information more engaging and catered to our preferences, biases are emphasized to give us a false sense of confidence in our selective knowledge. The availability bias makes individuals choose readily available outcomes and see this as a true reflection of reality without seeking advice or cross-referencing research. This is achieved through presenting articles and pieces as fact, rather than interpretation or opinion.

Limited cognition bias

In a universe where an abundance of information is available, the behavioural bias accepts a sub-optimal solution to a complex problem, due to investors avoiding the difficult task of evaluating all available options. Individuals are not always uninformed but take cognisance of their potentially wrong decisions and take steps to avoid them. In economic theory this is known as mental accounting. This thinking leads to outcomes that involves one-sided approaches, where individuals will formulate their investments disconnectedly rather than the correct, total portfolio approach. One could look at it as having a savings account and credit card debt, for example.

Conclusion

The above are all areas where the guidance of a financial advisor can add significant value to clients – equating to around 4.15% p.a. Financial planning professionals keep well-informed and up-to-date of relevant information (facts and data) that impact investments and personal finance, removing all the noise and misinformation.

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