A word on (financial) advice

Most Australians aren’t getting any advice when it comes to their finances. More than 85% are unadvised (according to ASIC, only 12% received advice in the year to August 2019, and there is no indication that this will have gone up – if anything, the opposite).

Meanwhile many people are starting to trade for the first time. With interest rates at rock bottom, keeping cash in a savings account just doesn’t cut it. Instead, Australians are looking for better ways to grow their money; COVID increased awareness of investing and trading (as we’ve witnessed first-hand at OMG) with more than $9 billion in retail funds coming into the market in the year to June 2020. As well as jumping into the share market, some are even dipping their toes into less understood products such as crypto-currencies (scary).

In other words, people are not getting advice, just when they need it most. And soon, they’re going to need it even more…

Blessed are the millennials?

We’re also on the cusp of the greatest intergenerational transfer of wealth in Australia’s history. As Aleks Vickovich pointed out in the AFR, $3.5 trillion will move from Baby Boomers to Gen X and Gen Y in the next 20 years. But without proper financial planning, there’s a good chance they’ll squander it. The Williams Group estimates that 70% of families will lose their wealth by the second generation and 90% by the third.

As an experienced trader, I am very aware of the risks around investing. What we need globally is better financial education, and advice. And I’m passionate about providing these as part of our solutions at OMG.

“We’re...on the cusp of the greatest intergenerational transfer of wealth in Australia’s history”

Financial advice is less available and less affordable

All this comes at a time when the Big Four banks have been moving away from advice and the number of IFAs (independent financial advisers) is dwindling, partly due to the higher standards and costs imposed by FASEA (Financial Adviser Standards and Ethics Authority). There’s been a 26% drop in adviser numbers over the last two years according to the AFA Landscape 2020 report. And they now expect it will drop to less than 13,000 advisers by the end of 2023 – that's a staggering 53% drop from its peak just before the Hayne Royal Commission

The FOFA (Future of Financial Advice) reforms were introduced to make advice more impartial and transparent by removing financial incentives for advisers to plug products. But now that advisers have to jump through more regulatory hoops, the cost of advice has gone up (by 28% in the last two years). So, there’s less advice available and what’s left is more expensive (and only getting more expensive). The problem is that the majority of Australians (approximately 60%) can’t pay for it – or won’t. So, why not?

Advice or avo-on-toast?

I chatted with James Claridge, our financial advice expert who founded and built Investfit, a company we’ve recently acquired and will soon be relaunching as Openmarkets Advice. We talked about the case of a young person of 25, earning around $70k/year, with less than $100k in their super. Spending $3k/year on financial advice just isn’t appealing. As James puts it: “Young people go: ‘I’ve only got $40k in my super, I’m not spending three grand on advice, that’s nuts!” It’s too large a chunk of their cash. Despite being at the stage of life where financial advice is most critical, they’re likely stuck in a default, balanced super portfolio.

So, it’s no wonder Australians are shunning financial advisers. From 2019 to 2020 the numbers fell even further – with 150,000 fewer people receiving advice according to AdviserRatings. James points out that the barriers aren’t just cost: “There is a level of mistrust in the financial advice industry, particularly flowing from the Royal Commission.  In addition, the perception among many people is that advice is just not applicable to them.”

“Young people go: ‘I’ve only got $40k in my super, I’m not spending three grand on advice, that’s nuts!’” - James Claridge, Openmarkets Advice

I, robo-adviser

Isn’t this crying out for an automated, data-driven solution? Absolutely. In recent years, robo-advice has sprung up as a way to offer cheaper, automated investment advice.

“Current robo-advice platforms typically ask questions to ascertain your attitude to risk, and guide you to a relevant portfolio, and then automate the investment and reporting process. However, what’s exciting is there is an opportunity to do so much more, by inputting a lot more customer data, and using stochastic modelling, “says Claridge.

Scaled advice: simple, or stupid?

Scaled advice (also known as ‘limited advice’) is another approach to making financial advice more accessible. One of the FOFA reform objectives was to ensure that financial advice will be within the reach of a wider range of Australians, by facilitating the expansion of a new form of advice called ‘scaled advice’”. Essentially, scaled advice just focuses on a limited issue, such as retirement planning, rather than taking a holistic look at someone’s entire personal circumstances.

Scaled advice can be appropriate for people who don’t have complex finances, such as the 25-year-old with $40k in super. All they need to know is the best investment strategy for their super, how much insurance they need, and whether they should save more (if they can – most young people are already stretched). This can be delivered for a few hundred dollars – a fraction of the cost of traditional advice.

But even for a simple situation, scaled advice can fall dangerously short. It’s one thing to plug in some data, run calculations, and spit out future projections. The issue is the confidence level of those projections.

Deterministic vs stochastic modelling… WTF??

Surely there are some better stats out there by now, right? And yes, there are: warning, this is about to get a little nerdy.

Most advice engines use Deterministic Modelling. This takes an average of stock market gains each year, plugs that in, and projects how much someone will have in their super by the time they retire. But these results are only 50-50. There’s as much chance the strategy will fail as succeed. Why? Because stock markets fluctuate. They don’t go up the same amount each year. They have frequent booms and busts. All this affects the accuracy of a calculation using fixed, pre-determined parameters.

“It’s a total coin toss," - James Claridge.

Who wants to risk their future on a game of heads or tails? Fortunately, there’s a much better way.

What we’ve built into Openmarkets Advice is an advice engine that uses stochastic modelling. Basically, instead of inputting fixed parameters, stochastic modelling allows for randomness. It takes into account that the market is more of a yo-yo than a steady climb. From the 1987 crash, the tech wreck, the GFC and now COVID, modelling all the ups and downs is critical.

No one can time the markets – remember that. No one (except maybe an insider trader!) has a crystal ball. But if we plug in that variability, that randomness, we can produce projections with much higher confidence – up to 90%. This gives you a much better idea of probabilities: such as an 80% chance that your super will last you until you’re 90. So, if someone is anxious about running out of money, they can choose to draw down less, based on what the modelling indicates.

Tackling a risky business

Stochastic modelling is much better at factoring in risk. If you model margin lending (where you buy shares with borrowed money) using deterministic modelling, it always looks like a no-brainer. More money = more shares = more profit. But start using stochastic modelling and you’ll  see the shades of grey and understand leverage properly, which will help our clients achieve better risk-adjusted returns.

The second thing we do – and this makes Openmarkets Advice unique – is optimisation at massive scale. A normal financial adviser will do a risk tolerance profile and model one or two portfolios. We can model hundreds of portfolios in seconds and show the best one for the client. And help advisers save time, demonstrate the value of their advice and meet Best Interest Duty – all at the same time.

So, thanks to advances in data and technology, there IS a huge opportunity to deliver affordable advice – with a higher level of confidence, and less risk. What next?

Disintegrating financial advice

FOFA, the Royal Commission, MiFID and others are all aimed at creating more transparency and protection for consumers. But they’ve also resulted in everything becoming siloed again in the industry. Banks have pulled out of giving advice to avoid conflicts of interest. Research providers have globally been mandated to separate from brokers, which makes their position less viable, reducing the amount of research available (a key advice ingredient). By debundling, the industry appears to have shot itself in the foot.

“If aggregate research spending is cut, for example, possible unintended consequences include a reduction in analyst numbers and a corresponding reduction in research coverage” – MiFID II - A New Paradigm for Investment Research, CFA Institute

Reconstructing advice in a marketplace model

While the ending of vertical integration may have in part dismantled the industry, there’s a big opportunity to reassemble the parts differently. The siloes we’ve created are a benefit, as they create more real choice and remove conflicts of interest. But how do we make them commercially viable?

Fintech solutions have been coming in hard over the last 10 years, with robo-advice and now improved technology and data modelling. This has effectively democratised access to advice, but how can these smaller companies acquire customers affordably?

The major shift in thinking is that financial services have traditionally wanted to own everything. However, a more powerful model is where the siloed expertise is connected together with a common access to the market. Rather than department store, think boutiques in a shopping mall.

The new marketplace model is already gaining traction across financial services, notably in banking, as Brian P. Brooks, pointed out in , “How unbundling and decentralisation are reshaping banking and financial services’

“The evolution shows promise for improving the reach and quality of financial services by creating more choice for consumers to assemble a portfolio of products and services … which they can adjust as their lives change." - Brian P. Brooks, Acting Comptroller of the Currency

Open architecture opening the market

At OMG, ultimately what we’re building is an ecosystem that acts as a matchmaker between consumers who need services and the people providing them.

We’re reconnecting all the parts of the industry – advice in this case – in one space so people can access all the revolutionary tech out there. Financial advisers can access new clients and manage them much more efficiently, without heavy client acquisition and onboarding costs. Consumers can get innovative, low-cost solutions and access to different tools. Research providers who suddenly lost their entire distribution will be able to use Openmarkets as the open broker to distribute their assets to over 200,000 people.

In other words, real open architecture providing access to affordable, sustainable quality financial advice, now that the country really needs it. A win-win. Watch this space.

Originally published on medium.com

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