Greetings, dear readers! Welcome back to our Third and Final Installment of our blog series where we delve into the errors that have infiltrated the investment management world and the crucial realms of investment wisdom and strategic counsel. In the previous segments, we have explored the evolving landscape of investment practices and uncovered the pitfalls that can hinder our journey toward success.
Today, we embark on the culmination of our journey, addressing the pivotal topic of "Dropping Rigorous Counseling." This installment uncovers the vital importance of providing steadfast, professional guidance to investors and highlights the potential it holds for reshaping our approach to the ever-changing investment sphere. Join us as we explore the challenges, opportunities, and promises that lie ahead when we prioritize rigorous counseling in the investment world. Let's dive in!
Our third error — an error of omission — is particularly troubling for all of us who desire our work to be recognized as a valuable professional service.
In addition to the two errors of commission: accepting the increasingly improbable prospect of beating the market as the primary measure of our profession and focusing more on business achievements rather than professional success, we have somehow lost sight of our most significant professional opportunity to serve our clients well and shifted our focus away from effective investment counseling.
While the largest institutional funds with expert staff are undoubtedly capable of handling all their responsibilities without assistance from professionals with training and experience in the complexities of designing optimal long-term investment programs, most investors — particularly individuals, but also most investment committees at small and midsize public pension funds, corporate retirement funds, as well as the endowments of colleges, universities, museums, and hospitals — understandably lack expertise in contemporary investing and may not possess broad experience. Many require help. All would appreciate access to the best professional thinking and judgment.
We Can
Investment professionals are well-positioned to offer crucial assistance. Some of the help clients need revolves around understanding that selecting managers who will consistently outperform the market over the long term is no longer a realistic assumption or a "given." (Yes, some managers will succeed, but predicting which ones in advance has become exceedingly difficult.)
Investors also need assistance in comprehending that losses from excessive efforts exceed gains. More importantly, they need help in gaining a realistic understanding of the long-term and intermediate prospects for various investments — prioritizing risk and volatility first, rate of return second — so they can anticipate outcomes and determine strategic portfolios and investment policies.
Even more crucially, as noted previously, most investors require assistance in developing a balanced, objective understanding of themselves and their situation: their investment knowledge and skills; their tolerance for risk in assets, incomes, and liquidity; their financial and psychological needs; their financial resources; their financial aspirations and obligations in the short and long run; and so on. Investors need to realize that their primary concern is not merely outperforming the market. It is the combination of these other factors that shapes their individual reality as investors.
Although all investors share certain similarities, they also differ greatly in various ways. All investors are the same in that they have choices, their choices matter, and they all seek success while avoiding harm. However, investors differ significantly in aspects such as assets, income, spending obligations and expectations, investment time horizon, investment skills, risk tolerance, market experience, and financial responsibilities.
With all these differences, investors — both individuals and institutions — require assistance in designing investment programs that are genuinely well-suited to their individual strengths and weaknesses. What suits most investors significantly differs from the fruitless struggle to beat the market.
Drawing an analogy with skiing is illuminating. At renowned ski resorts like Vail and Aspen in Colorado, countless skiers relish their time on the slopes. This is because each skier selects trails that align with their skills, strengths, and interests.
Some prefer gentle "bunny slopes," while others opt for moderately challenging intermediate trails.
Advanced skiers choose more difficult slopes, and there are those who tackle extremely challenging trails meant for fearless experts.
When each skier chooses the trail that matches their capabilities and pace, everyone enjoys a satisfying experience.
We Should
Similarly, if investment professionals were to guide investors toward programs that match their investing skills and experience, their financial circumstances, and their individual tolerance for risk and uncertainty, most of the diverse investors could align their investment strategies with their own investment skills and resources, consistently achieving their realistic, long-term objectives.
This constitutes the essential — and not overly complex — work of basic investment counseling.
The most valuable professional service we can offer to nearly all investors is effective investment counseling. Unfortunately, a large number of investment managers currently overlook this vital aspect. Neglecting the crucial service most needed by investors, one that would hold the highest value for investors and that, if conducted meticulously, would have high probabilities of success, is more than ironic. It constitutes the most significant challenge and the greatest opportunity for our profession's advancement.
An Example of the crucial need for investment counseling for individuals has been magnified by the significant shift from defined-benefit (DB) to defined-contribution (DC) retirement plans.
Potentially the most valuable financial service ever extended to individuals, DB pension plans ensure retirees receive regular payments from well-managed, low-cost, long-term investments. These plans demand no investment expertise or skill from retirees, eliminating the need for caution during market peaks, the requirement for bravery amidst market collapses, and the fear of outliving their funds.
In contrast, today's DC plans place the onus on 55 million participants to structure their own portfolios.
Nearly 20 percent "invest" entirely in money market funds because they started with such allocations when their balances were modest and have yet to revise their initial choices.
In plans allowing investments in the company's own shares, 17 percent of participants allocate over 40 percent of their holdings to that single company. (As exemplified by Enron Corporation, Polaroid Corporation, and others, this can lead to painful lack of diversification.)
For a significant number of workers, the more pressing question is: How many beneficiaries fail to realize the substantial capital needed to generate a comfortable monthly sum, and how many of them will exhaust their funds in old age?
A common guideline is to limit annual withdrawals to 4 percent of assets. For participants in their mid-50s, with only a decade to increase savings, the average balance now stands at $150,000. At 4 percent, this yields a mere $6,000 annually (before taxes and inflation), and even at 6 percent, the figure rises to just $9,000. This is a challenging situation.
Helpful Change
Target date or life-cycle funds convert the "do-it-yourself" investment products into a service, marking a step in the right direction. The low-cost computer models offered by leading 401(k) managers similarly contribute positively. Investment organizations that are shifting from product-centric to service-centric strategies report highly favorable results in both the professional and business domains.
This transition makes basic investment counseling scalable and nurtures the hope for further progress. For instance, instead of having just one target date portfolio, why not offer three, categorized by higher, lower, and average appetites for market risk?
Congress has played a role by enabling, rather than impeding, plan sponsors' provision of advice to participants on basic investment decisions. Certain major investment managers are taking tentative steps toward advising on attractive or unattractive market sectors, although they often omit the critical task of understanding the investor's situation, capabilities, and objectives. A handful — though only a few — of managers offer an array of investment capabilities and guidance on the optimal mix for specific clients. However, much remains to be done to bridge the gap between what is necessary and what is made accessible to investors.
Our Promise for the Future
Enhancing the alignment of investment service with each investor's long-term objectives — transitioning from "buyer beware" product sales to enduring, mutual comprehension-based service relationships — would extend the duration of client-manager partnerships and consequently enhance their economic value.
Prolonging these relationships would be advantageous to both clients and investment managers alike. If the most effective way to deliver the essential service involves integrating investment counseling into existing client-manager relationships to safeguard and extend them, then the considerable profit margins in the current business should
absorb the modest expense. We owe it to ourselves and our profession to redefine our mission to include sound investment counseling, allowing both us and our clients to foster shared understanding and achieve success together.
As a profession, let's rectify our two errors of commission — defining our mission as "beating the benchmark" and allowing short-term economics to overshadow the long-term values of our profession. By addressing our error of omission and reinstating investment counseling in our client relationships, as we certainly can, both we and our clients will reap benefits in a classic win-win scenario.
Our profession's clients and practitioners would all benefit if we expended less effort on trying to "win" the unwinnable game of beating the market and instead applied more skill, knowledge, and time to helping clients recognize market realities, understand themselves as investors, and clarify their realistic objectives, subsequently adhering to the best path for each individual.
With appropriate action, we can look forward to success in the future as a trusted profession and as individual professionals. By doing right by our clients, we will also be doing right for ourselves when we guide our clients toward success in the game of investment winners.
As we conclude our journey through this three-part blog series, we hope that you've found insights that resonate and illuminate the path ahead. Recognizing and rectifying errors is a testament to our commitment to growth and excellence in the realm of investment management. By addressing these challenges head-on and refocusing on rigorous counseling and prudent strategies, we pave the way for a more prosperous future.
Remember, the world of investments is ever-evolving, and staying informed and adaptable is key. Let's continue to learn, improve, and work together to shape a landscape where both investors and professionals thrive.
Thank you for joining us on this exploration, and here's to a future marked by wisdom, success, and collaborative achievement.
Don Bird
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