In the summer of 1973, my cousin's parents left the country on vacation. My cousin was 13 years old, I was 12, and my younger brother was 10. My brother and I moved into my cousin's house for the next two weeks, and the three of us ran the show. Nobody thought anything of it — not my aunt or uncle, not my parents, and not my cousin's neighbors. In South Sacramento, where junior high school kids routinely held part-time jobs, 13 years was plenty old enough.
Now, of course, my aunt and uncle would be jailed, with the Internet abuzz. Any idiot would know that children of that age should not be left alone. Well, 40 years ago in South Sacramento, where many junior high schoolers were already employed, and thought they might get married the summer after their high school graduation, any idiot did
not know such a thing. At that time, in that place, a 13-year-old was not a child.
My point? It's hard to see revolutions while living through them. Changes occur gradually, almost imperceptibly, until one day you step back and realize that it has all become so very different. Such has been the case with parenting standards, and also with financial advice. And happily, while I am far from convinced that today's parents are an improvement over their predecessors, today's financial advice surely is superior.
PRICE IS THE START
The most obvious change to financial advice has been the unbundling of services to permit lower-cost shopping. Once wrapped irretrievably into brokerage commissions, stock and fund advice can now be purchased in multiple ways. It may be bought through asset-based fees, or through flat fees, or at a discount price via robo-advisers that communicate with their customers through the telephone and Internet. Or it may be dispensed with altogether, for investors who seek only their own counsel. This new flexibility is a clear investor benefit. There is more choice, an option to pay significantly less, and greater transparency.
(That said, the switch from commissions to asset-based fees does have its drawbacks. For true buy-and-hold investors, who purchase a security and then hold it for a decade or more, asset-based fees are more expensive than commissions. Also, asset-based fees encourage financial advisers to trade, so as to justify their ongoing charges. That is not a good thing; few investors benefit from higher portfolio turnover.)
BEHAVIOR IS THE FINISH
But while unbundling has attracted the attention, there has been another, quieter evolution that has been less discussed: the move from treating financial advice as "selecting the best security" to "motivating the best behavior."
Not, I hasten to add, that there's anything wrong with owning excellent securities. After all, I am employed by Morningstar Inc. But Morningstar's traditional business of security-versus-security comparisons covers only one aspect of achieving financial success and is far from a sufficient cause. Investors who have bad investment habits, ranging from spending to saving to responding to market crises, will generally fare poorly even if their securities are good.
The trend to motivating better behavior extends across all advice channels.
With full-service advice, financial professionals are becoming more holistic. Rather than define their value as primarily coming from recommending funds or stocks that the investor could not find without assistance, they are instead positioning themselves as the financial equivalent of personal trainers. Successful personal trainers, by and large, do not possess fitness secrets. Their business consists of telling their clients what is publicly known and then ensuring that the actions are taken. Their value lies not in the ideas, but rather in the execution.
(Of course, financial advice is more complicated than personal training. It's only an analogy, my financial-adviser friends.)
ALPHA, BETA, GAMMA
Morningstar's David Blanchett and Paul Kaplan use the term "gamma" to describe what advisers can do for their retired clients beyond the alpha of security selection and the beta of asset allocation. In a typical retirement situation, they argue, an investor can pick up another 1.6 percentage points per year in return through 1) correct asset location (for tax purposes); 2) asset allocation that considers the investor's total wealth in addition to risk capacity; 3) the appropriate use of annuities; 4) dynamic withdrawal strategies that adjust to market changes; and 5) taking liabilities into consideration when doing asset allocation.
Politely — as it is their term and not mine — I would suggest extending the concept of gamma beyond investment techniques. For me, gamma consists of
anything that improves an investor's outcome besides what people normally think of as a job for financial advice: that is, asset allocation and security selection. The beauty of gamma is that it is achievable. It's hard for financial advisers to deliver new betas to their clients, or to find alpha. But cutting tax bills, incorporating better withdrawal strategies, improving savings behavior, developing a strategic rather than tactical mindset ... these are things an adviser can do, and well.
So, too, can other advice mechanisms.
Within 401(k)s, computerized advice began with the old school of alphas and betas. The online-advice providers of the New Era, of which Morningstar was one, competed for business almost solely along those lines, by pitching corporate treasury departments about the sophistication of the investment models. Each provider claimed to have the best forecasts and, thus, the best recommendations. Such discussions were largely beside the point. High 401(k) balances occur from high contribution rates, made for many years, and invested in diversified, low-cost portfolios. Further details are mostly rounding errors.
Happily, today's employers know now what they did not know then. As a group, they no longer worry so much about investment wizardry, focusing instead on the basics. Employers have pushed hard on 401(k) costs, driving down fund fees and record-keeping expenses. They have adopted automatic enrollment and, increasingly, auto-savings programs that push employees into making greater contributions. And for the most part, they are fine with defaulting into target date funds. Why fuss over the nickels of the investment details when there are dollars to be made by improving investor behavior?
STEP FORWARD
Robo-advisers also represent a step forward. True, they exaggerate the specialness of their investment recommendations, which are sensible rather than remarkable, but they are less guilty of that sin than were their 401(k) online advice predecessors. They also don't whiz and bang in the fashion of the 1990s offerings from the big Wall Street brokers. The central promise of robo-advisers is modest: a diversified, low-cost portfolio that gives some useful tax advice. Those items are much easier to achieve than generating alpha, but they are not necessarily less useful.
None of this should be read as implying that all financial advice is trustworthy, reliable, and worth the price it demands. That has never been true. As a lucrative industry with low entrance standards, financial advice has been and will be a refuge for ambitious frauds. But the direction is encouraging. The movement away from promising investment magic, and toward discussing better investment habits, can only lead to better investment outcomes.
John Rekenthaler is a columnist for Morningstar.com and a member of Morningstar's investment research department. His views are his own. This column originally appeared on Morningstar.com.
