Today information is more freely available, and our industry is so much more transparent; the client can not miss the charges nor the performance - even if they do, it is sent to them to make sure, and they are getting a much better deal.
It just does not feel like that when you look at lower or negative returns, or worse, a small positive return that becomes negative because of the cost of advice.
This problem is known as the ‘Money Illusion’, a phrase first coined by Irving Fisher in his 1928 book and used by both Keynes and Freidman.
Setting aside both suppliers and governments who contribute to the illusion through a reluctance to change prices and report uncomfortable numbers there are three human factors that we can seek to manage: -
Myopic loss aversion
If we keep checking headline performance, or having it pushed onto us we can lose sight of the big picture. The perceived immediate loss in the numbers feels more real than the impact of inflation that feels more long term and indirect. For example:
- If inflation is 14 per cent and returns are 12 per cent, this is a real loss of 2 per cent
- If inflation is 0 per cent and returns are -2 per cent, this is a real loss of 2 per cent
Despite giving the same outcome, behavioural psychological research suggests that people feel 1) is better than 2)
Heuristics or rough rules of thumb
People do not - or don’t like to - make precise calculations. Big round numbers seem good, small precise numbers can get rounded to feel worse. People remember a round number they invested, say £100,000 but do not think about the small gradual fall in its purchasing power.
People can easily see their money in the bank or salary, but real value or real wage requires knowledge of price changes and calculations.
So how do we overcome this?
- Clearly attach the advice fee to the adviser and the advice. If a client knows and chooses; how a fee will be paid, how much the fee is and what is provided for the fee then why would the returns change anything? Perhaps there is a need to refocus on all the other benefits of advice to support this and that is why our review reports list the things that an adviser has done up front such as: ‘Making sure that you are not paying any unnecessary tax’, ‘ensuring that you are taking the level of risk that you are comfortable with’, ‘making sure you are in the right product’, ‘making sure that their investments are regulated ‘ and leading onto the next point ‘ that you plan is on track’.
- Make a long term, cashflow plan. If clients can see that by following the plan they can afford the things that they must, like to or dream of buying with their money in the future nominal returns shouldn’t matter. Of course, this only works if the inflation and growth assumptions are reasonable for their risk profile and based on objective data. Over-promise and it only compounds the problem. As well as mitigating some of the money illusion, being able to engage in the planning process, being heard and a quality understandable plan has its own distinct value.
- Illustrate the effects of inflation and use real returns in the plan. Rather than being the missing information the effects of inflation can become taken as read if it is built into a consistent process from risk profiling, through cashflow planning and review.
Beyond the Money Illusion there will be some scepticism about the value of financial advice if it does not improve the client's wealth by more than its cost and that is understandable given the trends and habits over the last 10 years.
In the way that a bull market made it easier to attach the value of advice to investment returns a period of negative returns will compel us through necessity to revisit the principles, thoughts and techniques around the implementation of RDR.
I have been an adviser that charged non-contingent non-provider facilitated fixed and hourly fees, I have managed teams that operated this way and I know many advisers that still do this today.
It does work and consumers like it. Who do customers respect more when selling a house? The estate agent that charges a contingent percentage or the solicitor who charges a non-contingent fee? In the time since RDR we have seen an increase in ordinary people paying for personal services that they could theoretically do themselves.