cap-i-tal (noun): wealth in the form of money or other assets owned by a person or organization for the purpose of investing
per-se-vere (verb): continue in a course of action even in the face of difficulty
Over the last several days, investors have seen drastic swings in major world markets. Equity markets around the world fell in the wake of the Brexit vote, major currencies moved to extreme levels, and lately, markets are on the upswing again. In times of great market distress, the investment industry consistently offers the following words of “comfort” for your capital:
- Don’t sell or panic;
- Invest for the long term; and
- This is a buying opportunity.
The above statements result in cognitive dissonance for many investors faced with these market oscillations. And rightly so. When markets are up, investors invariably concern themselves with returns, risk is a secondary thought. In periods of drawdowns, investors begin to concern themselves with “preservation of capital” – risk aversion comes to the forefront.
As the chart below illustrates, “preservation of capital” is a critical component to long term investing success. The more you lose, the more you need to recoup to get back to even.
I would argue that in order to preserve capital, your capital must persevere – through good times and bad. While asset allocation and diversification are foundational to minimizing losses and enhancing long term returns (more on these at another time), the first steps investors need to take, are to ensure their portfolio is set up for success from the very beginning.
Ensuring the advisor is a Fiduciary
When advisors hold themselves to a fiduciary standard, they are legally committed to place their clients’ best interests ahead of their own. Advisors who hold the Chartered Financial Analyst (CFA) designation, are bound by the CFA Code of Ethics to act in their client’s best interests.
Surprisingly, most advisors and planners in Canada are only held to the “suitability” standard. The suitability standard permits them to sell higher priced, higher commission products to their clients – even when there are similar products available that have a lower cost (and thus higher return). Asset allocation decisions may also be impacted as equity funds typically have higher commissions than cash or fixed income allocations. Essentially, the suitability standard does not require the advisor to put the clients’ interests first.
The best interests of the client must be aligned with the advisor in order to ensure transparency and avoid the drag of fees and often hidden commissions. This subject has come to the forefront in the United States as of late, and a recent White House study reported over $17 billion in losses to investors related to conflicted advice.
Ensuring the advisor is Fee-Only
Fee-Only advisors are not compensated for transactions, and do not receive commissions or rebates from third parties. The lens is focusing increasingly on what investors are paying for investment management and the advice they are getting. The rise of low-cost ETF solutions is also shedding light on this subject.
Fee-Only should not be confused with Fee-Based, the latter may also receive commissions from third parties that may not be transparent. Fee-Only advisors typically charge a percentage fee based on the client assets, with all fees being fully transparent and disclosed on client statements.
With Fiduciary and Fee-Only advisors, the financial interests of the advisor and client are aligned. Once these cornerstones are in place, all other aspects of the portfolio, including portfolio construction, asset allocation, diversification and risk management – have their best chance of succeeding.