If your client’s circumstances have dramatically changed in recent months, they may be in dire need of your advice. And that includes advice on products with lower fees.
Because of Covid-19, some clients may have to save more and longer to reach their goals. Economic shutdowns have largely hurt lower-wage earners and the self-employed. Such working- and middle-class investors represent a large proportion of clients served by advisors, according to data from the Mutual Fund Dealers Association of Canada, and these investors typically want to grow a retirement account without taking on too much risk. Historically low interest rates are making that goal harder.
While pandemic impacts are out of your client’s control, investment costs aren’t. For a buy-and-hold investor with an RRSP, the impact on returns from high fees, including compounding loss, is stunning.
A client with a $250,000 portfolio and a 15-year horizon, earning a 5% annual return and paying 1.94% in fees, keeps 53% of total investment returns, according to an online calculator on the website of author and investor advocate Larry Bates. The figure includes compounding losses attributable to fees paid. (The 1.94% fee is the median expense ratio for asset allocation funds in Canada, according to a 2019 Morningstar report.)
The calculation packs a wallop but comes with caveats. The assumed return is admittedly conservative, for instance, and product and advice costs are lumped together. Also, it doesn’t make sense to capture all compounding losses. A client needs to pay something — especially for advice, which isn’t commoditized in the way portfolio management is for a long-term buy-and-hold RRSP investor.
Regardless, armed with data from online calculators, clients will increasingly ask whether costs are justified. And it’s a good question.
Research dating back to 1991 shows that active management costs generally aren’t worth the returns, and the annual SPIVA reports show that actively managed funds underperform their benchmarks over long periods. Yet, many Canadian advisors continue to favour expensive actively managed funds despite net returns below passive benchmarks.
Sales constraints are also in play. A 2020 Dalbar Canada study found that, at the Big Five banks, advisors discussed mutual funds at 68% of meetings with clients who were less than 10 years from retirement; ETFs, which typically cost less, were discussed 6% of the time. Having access to ETFs through fee-based accounts only is also an issue when serving investors with smaller portfolios. Further, only a handful of MFDA firms have the operational capacity to offer ETFs, and firms can find the regulatory hurdles daunting. ETFs in a mutual fund wrapper may be a simpler alternative.
While none of this is new, there’s added urgency to control costs if hard-hit clients are to meet their retirement goals over a period of lower expected returns. The client-focused reforms will also contribute to a focus on costs, with new requirements to provide cost information — including compounding effects.
There are other signs that investors are becoming more cost-conscious. Canadians opened more than 2.3 million do-it-yourself (DIY) accounts in 2020 — a roughly 172% year-over-year increase, according to Investor Economics. Fees likely played a role in DIY growth, and those who start investing this way will continue to expect low costs. Controlling costs may help you build, or at least maintain, your book.
Of course, forgoing advice may have negative consequences: DIY investors’ inquiries and complaints to the Investment Industry Regulatory Organization of Canada were up 270% last year from 2019.
At a practical level, firms aim to serve more clients, including less profitable ones, by leveraging tech to automate and scale certain tasks. That’s necessary, but won’t matter to clients if advisors don’t build evidence-based practices. Does your viewpoint on costs align with the evidence or support a conflict of interest? Why isn’t research on performance and fees part of advisor education, such as pre-licensing courses?
Asking those questions is tough — particularly if they lead to more uncomfortable discussions about your firm, practice or industry. Shifts to things like unbundling fees and innovative business models offer clients great choices, but there are no easy answers.
Still, the questions are important, and clients will be asking them if you aren’t. With people increasingly affected by — and sensitive to — economic disparity, and critical of Wall Street (see the GameStop saga), jettisoning high-cost products is on many clients’ to-do list. They won’t stand for them, and neither will the best advisors.