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Investing Specialists

3 Investing Trends to Keep on Your Radar

We round up some of the most notable developments, from passives to robo-advice, and discuss their implications for investors.

More and more cars are electric, and self-driving ones are on the horizon. We can order paper towels and dog food online in the afternoon and find them on our doorsteps the next morning. Most of us carry powerful computers in our purses and pockets that don't just allow us to conduct work and stay in touch with our loved ones, they also enable us to track our fitness levels, order our morning coffee, and watch our favorite TV shows.

No doubt about it: The pace of change in our world is breathtaking, thanks in no small part to technological advances.

What's gotten less attention, however, is that the earth as been shifting beneath investors' feet, too.

If an investor wanted investment help 25 years ago, for example, she might call a full-service broker, who in turn might steer her toward a mutual fund, probably with an active stock- or bond-picker at the helm. The investor would likely pay a 5.75% sales charge to get into such a fund, as well as an annual expense ratio of as much as 1.75% or even more. If she wanted to keep tabs on the fund's performance, she'd have to find its return in the newspaper, and wait until the end of each quarter to receive a report from her broker on how she’s doing overall.

In the space of a few decades, however, the entire process has been turned on its head. Although investors continue to seek financial help, very few are paying full freight to buy load funds these days. Instead, most financial advisors are employing inexpensive passively managed products for their client portfolios, and charging them a separate fee, independent from the products, for their planning services. Investors can check up on their holdings and their total performance in real-time using a site like Morningstar.com or via client portals supplied by their advisors. They can also review performance or make trades on their phones or even on their watches.

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: 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 also tend to have lower tax-related costs than actively managed funds, helping to further increase take-home returns for investors who hold the funds in taxable (i.e., nonretirement) accounts. 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 it's not as though most active funds did such a great job of limiting losses during the financial crisis. That said, it is highly likely that the performance of capitalization-weighted U.S. equity index funds won't always look as unassailable relative to active as it has in the recent past; there will no doubt be years when performance will look a little 'meh' relative to the active universe. That's not a reason to avoid index funds, certainly, but something to be aware of. It's also true that some asset classes simply don't lend themselves well to basic, cap-weighted passive approaches. On the short list: high-yield bonds and emerging-markets equities. Moreover, plenty of ETFs are neither cheap nor tax-efficient, even though the vast majority of investor dollars are in products that look good on both attributes. The popularity of ETFs has given rise to a wave to gimmicky products that don't serve investors well.

But there are more substantive risks for investors embracing index funds. One is that investors who use advisors to manage their portfolios may be paying lower fees on their portfolio holdings, but their advisors may be charging them higher fees for their services, thereby offsetting or even negating the savings on the product side. That argues for investors giving due attention to their all-in costs: how much their funds charge as well as how much they're paying their advisors. Additionally, 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. This article includes some of the key questions to ask your advisor--or yourself--if you plan to shift more of your portfolio into passively managed products.

Trend: New ways to hire--and pay for--financial advice.
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.

The Department of Labor's fiduciary rule seeks to reduce the conflicts of interest that can go along with the commission model. As a result, many advisory firms have scrapped commission-based sales or have moved to allow investors to operate in both a commission- and fee-based capacity.

Meanwhile, the fee-only model is alive and well, but the umbrella has gotten broader. In addition to the AUM model, fee-only advisors may charge for their services on an hourly basis or a per-engagement basis. Alternatively, some advisory firms have styled their services as a monthly or annual subscription, similar to how you'd pay for a gym membership; this is often called the "retainer" model. 

Finally, some new models have gained prominence. 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. For example, Vanguard Personal Advisor Service charges 0.30% and is available to investors with at least $50,000 in assets at the firm. (The service combines human financial advisors with robo-advisor technology.) Most of these services focus on low-cost index funds and ETFs.

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 or opt for a retainer-based program. 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. This article reviews some of the key considerations to bear in mind; at a minimum, ask if a prospective advisor is a fiduciary and a certified financial planner. It's also 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: 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. (Target-date funds also look great from the standpoint of investor returns.) 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.