Retail Investors Offered Hobson’s Choice, Not ETFs
By Dave Fry, Founder/Publisher, ETF Digest (www.etfdigest.com)
I’ve spoken to many individual investors who feel trapped in their current investment scheme. They are losing money and they’d like a change. They actually need to adjust their portfolios to suit the current market. But their brokers discourage the pursuit of alternatives like ETFs, and will sometimes simply refuse to buy ETFs when asked.
Why is this happening? Mainly because ETFs carry very low management fees, and the income of most financial advisors is tied to recurring fees. At some of the “full service” firms, individual investors have found that when they demand ETFs, the firms will add on high commissions or “wrapped management fees” that defeat the low fee ETF advantage.
This is a frustrating position to be in, and investors need to know that good portfolio alternatives are within their reach. It is easier than most people think to open an online account at a discount brokerage and utilize inexpensive ETFs in the way they were meant to be used.
Hiring advisors and portfolio management services might seem to be a good way to save time and avoid mistakes—but at what cost to you? If your advisors have incentives to offer you only the most expensive investment tools, regardless of their performance,
are you making the right choice?
Recently, a friend told me a story that shows how retail investors are being offered no choice at all when it comes to the allocation of their own investments. My friend is a well-educated, intelligent, professional person who has maintained a long-term relationship with a broker/friend at a well-known national firm. She has a variety of fairly small accounts which the broker has loaded up with mutual funds that pay the broker high recurring fees.
My friend has been increasingly dissatisfied with her low returns, so she asked the broker if she could consolidate her accounts and invest in ETFs or index funds instead. The broker told her, “You don’t know what you’re talking about. The program we’ve designed for you is the right program. Stick with the plan.” The broker even followed up with a “memorandum” telling my friend not to call on her anymore because she has bigger clients to deal with and can’t spend time trying to educate her as to correct investment choices.
I have never heard of this kind of arrogance, and I have been in the business over 30 years.
So, what did my friend do? She has decided to stay with this broker because she does not know what else to do. She wants to have a personal relationship with “an” advisor, and of course, she does not want to pay the surrender fees the brokerage firm would charge her if she left.
My friend does not realize that just as there aren’t any “full-service” gas stations anymore, the advisory business has changed. Most brokers know little about investing—and a lot about gathering assets and collecting fees. And, if you don’t like it, shut up!
Retail investors are being offered a modern version of Hobson’s choice. This term takes its name from an inn-keeper who kept at least 40 horses for hire, but who never let a man choose his own horse from the great variety on view in the stable. Mr. Hobson offered his customers the choice of the horse nearest the door or no horse at all.
Many individual investors have their financial savings locked up in retirement accounts that offer them only one “choice”: to keep adding money every year to “the plan” some sponsor, employer, advisor, or broker has set up for them. And unfortunately, over the past five years, most “plans” have not prospered.
If these plans do include ETFs, the plan managers will usually add extraneous management fees which reduce the inherent cost-effectiveness of these securities. But most plans do not include ETFs since they are set up to deliver returns directly to the investor, not to provide recurring fee income to advisors.
Mutual funds are a popular component in these plans because they pay high fees to fund managers with a percentage rebated to brokers and advisors as a recurring fee. Additionally, mutual fund managers earn bonuses for beating various benchmarks, even if their funds are dropping in value. Brokers and advisors like investment plans that require you to add more funds every year, because even if these plans make no money, the brokers/advisors can continue to collect their fees. The fee structure of hedge funds is better for investors: fund managers collect their lucrative fees if the fund actually makes money for all parties. This is a major reason for the explosive growth experienced by the hedge fund industry.
While most individuals are not able to invest in hedge funds due to the high minimum account sizes, ETFs are soon going to make individual hedge funds possible. There are new types of ETFs now entering the registration process, and these new securities will allow retail investors to take offsetting market positions more easily—if they have their accounts ready and have proper guidance in the use of these effective and low-cost investment options.
Many investors today are merely gritting their teeth and finding comfort only in the apparent wealth transfer occurring from stocks to rising home prices, which makes them feel they are maintaining their wealth status quo. However, despite the rise in home prices over the past five years, home equity has not increased due to the “asset extraction” stimulated by today’s cheap money. If you take this into account, the wealth created by rising real estate prices is an illusion, since the equity is being spent.
Instead of finding false comfort in the theoretical list prices of their homes, investors should be taking action to strengthen their portfolios, but it appears that they are not.
I see strong evidence of individual investment aversion in the mergers being discussed among online brokerage firms due to declining trade revenues. And CNBC has reported that its investor audience is down 50% from the boom days of the late 1990’s.
Retail investors are turned off by the financial markets, partly because of poor investment performance, but also because of scandals and conflicts of interest within the investment industry which have further exacerbated the losses in individual portfolios.
It seems that many have abandoned ship and moved to the greener pastures of real estate. How many cocktail parties have you gone to where someone has bragged about the value of homes versus stocks? The seductive attraction of the profits offered by active investment in the real estate boom is too powerful to ignore. And more importantly, investors trust real estate and not Wall Street.
It is not hard to see why so many are losing confidence in market investing. Brokers and plan managers are telling clients that they have very few investment choices, and retail investors are being led to believe that they do not have the ability to take action when it is needed. Over the years, individuals have been clinging to broker relationships that are sorely conflicted and that primarily benefit brokers and their firms, while placing retail investors in a deceptively limited, even debilitated, position.
But investors can take control and exercise much more choice. If they do a little research and consult unconflicted sources of portfolio advice, like unaffiliated newsletters, they will find that a broad range of low-cost investment alternatives are within their reach—such as ETFs, index funds, and, eventually, an ability to create their own individual hedge fund. Investing in the market does not have to be like a visit to Hobson’s stable. |
