The pace of change in our world is breathtaking, thanks in no small part to technological advances. Investors can check up on their holdings and their total performance in real-time using a site like Morningstar.com. They can also review performance or make trades on their phones or even on their watches. Although investors continue to seek financial help, very few are paying full freight to buy load funds these days.
To be sure, there's a lot to like about these developments. But investors need to be aware of both the positive and potential negative consequences of these trends to be able to make good decisions about them. Here's a roundup of some of the key ones that should be on their radar today.
Trend 1: Passive products continue to gain assets
This is the trend shaping the investment management industry today. Asset flows to passive products, both traditional index mutual funds and exchange-traded funds, began in earnest following disappointing active-fund performance during the financial crisis. And they show no sign of slowing down: In 2016, investors sent more than $500 billion to index fund products, including ETFs, while yanking more than $340 billion from various actively managed funds. Passive products have continued to attract monster inflows so far in 2017, too.
What's to like: Index funds and ETFs typically feature lower costs than their actively managed counterparts, and Morningstar's research has found that low expenses are the single most important predictor of whether mutual funds beat their peers. Many broad-market equity ETFs and index funds have lower costs than actively managed funds, helping to further increase take-home returns for investors. And because index funds and ETFs are usually "pure plays," giving investors unadulterated exposure to a given market segment, managing the asset-class and other exposures of an all-index fund portfolio is simpler than managing a portfolio composed of active funds.
What to watch out for: Active-fund partisans have argued that index funds and ETFs lack a toolkit for protecting against losses in bear markets; passively managed products don't have the latitude to retreat to cash or load up on defensive holdings when things look worrisome. That's true, but that's not a reason to avoid index funds, certainly, but something to be aware of. On the other hand, there are more substantive risks for investors embracing index funds, because ETFs and index funds are so easy to trade and make it simple to manipulate a portfolio's exposures, some investors and their advisors may be engaging in tactical strategies that don't necessarily contribute to better returns.
Trend 2: New financial advice models
Just a decade ago, investors could pay for financial advice in a few main ways: They could work with a commission-based advisor who was compensated via sales charges on product sales. Alternatively, they could hire a fee-only advisor who charged them a percentage of their assets each year (the assets under management--or AUM--model). "Fee-based" advisors charge clients a percentage of their assets annually and may also use commission products. Robo-advisors provide automated advice for a low annual fee as low as 0.25% or even less. Meanwhile, mutual fund companies and brokerage firms may provide advice for customers who have amassed sufficient assets at the firm.
What's to like: With more variations in advice models, consumers have the opportunity to "right-size" their advice buys. Investors who need ongoing comprehensive financial guidance may want to stick with the AUM model. Meanwhile, investors seeking infrequent and/or surgical guidance will likely find that paying for advisory services on a per-project or hourly basis is more cost-effective.
What to watch out for: The profusion of different business models means that the business of selecting an advisor is more complicated than ever. It's worth asking exactly what types of services are included in the fee you're paying: Robo-advisor fees might look like a screaming buy relative to the fees that a full-service human advisor charges, but the robo won't be able to give you advice on nonportfolio matters like whether to pay off your mortgage or purchase long-term care insurance.
Trend 3: An increased emphasis on behavioral factors that can affect investor outcomes
Researchers have long known that bad timing decisions have the potential to drag on returns. For example, many investors hunkered down in bonds during and after the financial crisis; by the time they got themselves out of their defensive crouches, they had missed out on a meaningful chunk of stocks' returns after the recovery. Morningstar has attempted to shine a light on and quantify investor behavior--the good, the bad, and the ugly--via its investor return data and director of fund research Russ Kinnel's annual "Mind the Gap" study. Beyond portfolios, financial professionals and researchers have also become increasingly attuned to other behavioral factors that can shape outcomes for individuals--for example, the tendency for retirees to prefer spending income from their portfolios rather than touching their principal via liquidating highly appreciated positions.
What's to like: In recognition of the fact that even the best-laid financial and investment plans won't be successful if they run counter to the investors' behavioral biases, financial advisors and institutions are increasingly incorporating behavioral-finance findings into their product offerings and services. Many robo-advisors have also embedded behaviorial research into their services. In short, investments are optimized not just for returns, but with an eye toward earning competitive returns while also ensuring that the investor sticks with the program.
What to watch out for: Behavioral finance is trendy right now, and with any trend comes the opportunity for gimmickry. Beware of advisors who are using behavioral finance as their main hook to snag clients; high-quality advisors have been employing behavioral finance into their practices for years. Likewise, some of the best products from an outcome standpoint aren't newfangled products at all, but rather tried and true options like balanced and allocation funds. Because their performance is typically even-keeled and their strategies embed regular rebalancing, such products can be fine options for minimalists who want to keep a lid on their all-in costs while also managing behavioral risk factors.
