How to be a better investor: episode 3 |
Tweet | ![]() |
<p><strong>Ruslan: </strong>What’s the difference between a financial service and a financial product?<br /><br /><strong>Saf: </strong>A financial <em>product</em> is something you buy and own, like stocks.<br /><br /><strong>James: </strong>A financial <em>service</em> is when someone performs an action for you that you would otherwise have to do yourself or leave undone, like your taxes<br /><br /><strong>Ruslan: </strong>Ok. I want to buy life insurance to protect my family after I pass, but I don’t understand the terms and conditions, so I use a financial advisor. That’s a…… <em>(Pauses uncertainly)<br /><br /></em><strong>Saf: </strong>The advice is the service.<br /><br /><strong>James: </strong>The insurance is the product.<br /><strong><br />Ruslan: </strong>This is confusing. Which do I need?<br /><br /><strong>Saf + James: </strong>Both<br /><strong><br />Ruslan: </strong>Argh! How do I know if it’s worth it!<br /><br /><strong>Saf: </strong>Well, there’s ways to make sure you get value from both. When vetting financial products there’s two rules.<br /><br />Rule 1: DON'T buy anything you can’t explain in your own words<br />Rule 2: Know <em>why</em> you’re buying it – and compare, compare, compare!<br /><br /><strong>Ruslan: </strong>What about service<br /><br /><strong>James: </strong>Ask questions. Lots of questions.<br /><br /><strong>Ruslan: </strong>Like what?<br /><br /><strong>James:</strong> How is your advisor getting paid? An hourly fee? Commissions? Something else? If they’re being paid based on what you buy, then are they selling you what’s best for you? Or what makes them the most money?<br /><br /><strong>Ruslan: </strong>Ohhhhh.<br /><br /><strong>James: </strong>Yep.<br /><br /><strong>Ruslan: </strong>Wait. What about the advisor from my bank?<br /><br /><strong>James: </strong>Ah. See, he’s an advisor that also sells products. Make sure you’re being shown more options. Not just the products from their bank. You have to look out for you!</p>
<p> </p>
<p> </p>
<p><strong><em><br /><br />Additional Reading:<br /><br /></em></strong><strong>Don’t Get Hosed When Buying Financial Products and Services<br /><br /></strong>Way back in another life, I worked in the mortgage department of a local bank running credit reports for mortgage preapprovals. I heard a lot of unfamiliar terms while working there, but the one that was the strangest and most puzzling to me was "financial product." The idea that a loan could be considered a product was completely foreign. The house was a product, clearly, but the mortgage? It made my head spin.<br /><br />In the years since, I've come to understand how mortgages really are products. Each type of mortgage has different attributes and ways that it "works." In this way, a mortgage is just like any other product on a shelf. Each is devised to meet a certain need and has specific traits that you as a customer can use to distinguish between them and choose which best suits your purposes. But here's the thing: Many people I talk to don't know the difference between a financial product and a financial service, and that's a problem.<br /><br />Products and services are regulated differently, and that can have a big impact on you as a customer. In countries like Singapore, for example, all financial products go through a deep vetting process where the regulating body determines if the terms and conditions are fair and meet a baseline standard of safety for the average investor. The process is slow, and it results in fewer options for customers, but it does provide a bit of protection for the uninitiated since there are few, if any, predatory products available. However, it requires a lot of resources to oversee this process, and one could argue it is too much regulation for a free market system. <br /><br />In North America, our markets are based on the principle of "caveat emptor," or "buyer beware." In other words, the responsibility of determining if a product is beneficial or predatory is placed mainly on you, the buyer.<br /><br />For this reason, in the United States, products are regulated mostly on the basis of disclosure. Companies that sell financial products are required to disclose the terms and conditions of those products to the customer. You know those impenetrable documents of legalese that you have to "read" before signing your mortgage or buying stock? Yup, that's what passes for open and transparent disclosure of a product. If, after being offered the disclosure, you still sign the agreement and get hosed, then it's caveat emptor, my friend. Caveat emptor.<br /><br />So, let's say you want to buy life insurance to protect your family's lifestyle in the event of your untimely demise. You begin to read the disclosures for a few products, and it becomes clear that you could use some help understanding the terms and differences. So, you hire a financial advisor to help you. Now, advice is a service, and services are regulated differently than products.<br /><br />Services are regulated on the basis of qualifications and <a href="https://www.morningstar.com/articles/917875">conflicts of interest</a>, but that doesn't mean that just because an advisor has a certification of some sort that he is going to put your best interest first. There are plenty of firms that blur ethical lines, push limits, and then there are flat-out fraudsters who have not yet been caught. When you hire an advisor, you can't depend on <a href="https://www.morningstar.com/articles/933338">the government</a> to have completely vetted his trustworthiness. You still need to adhere to the idea of "buyer beware<em>."</em> One of the ways you can beware when vetting financial advice is to have a clear understanding of how the person you are hiring gets paid. Knowing that can help you understand his financial incentive. <br /><br />Imagine walking into a clothing store where the salespeople earn a commission on everything you buy and saying, "I know nothing about clothes or style. Please just tell me what I should buy, and I'll take it." You would never do that! Not because the salespeople aren't good at what they do or don't deserve the commission--that's not the point. The point is that they are incentivized by the company that they work for to sell you the most expensive wardrobe you will accept. We all know this model. There's nothing wrong with it, but as a shopper you generally want to avoid leaving the bulk of your decision in the hands of someone who has that kind of incentive. If your goal is to get a good wardrobe at a decent price, you shouldn't leave 100% of the decision in the hands of the salesperson. It's just not smart. The same thing goes for financial products and services.<br /><br />Sometimes, it can be hard to tell whether someone is a salesperson or a serviceperson, and sometimes one person will play both roles. For example, when you visit the doctor and he diagnoses your illness, that's a service. If he then suggests that you buy a particular brand of medicine, that's a product. If you knew that the doctor received a commission if you buy the drug, would you weigh the advice differently?<br /><br />Similarly, you may hire a financial advisor to help you create a plan to get from here to retirement. You discuss strategies for saving, investing, and what your life goals are. The advisor helps you understand the steps necessary to achieve them. This is a service.<br /><br />If that same advisor sells you a life insurance policy and several mutual funds, these are products. The advisor has now switched roles from serviceperson to salesperson. There is nothing wrong with this, just as with a doctor or a hair stylist recommending a particular brand. You, the customer, simply need to know what you're buying, and how the incentives are structured so that you can weigh the product recommendations accordingly.<br /><br />So, then, what's the smart shortcut for identifying and vetting financial advice and products? First, let's talk about simple definitions for each. Since these are rules of thumb, they aren't exact or perfect, but we're all about being "<a href="https://www.morningstar.com/articles/944009">good enough</a>" here.<br /><br />A <em>financial product</em> is something you buy (including contractual agreements like loans) and take ownership over, along with the responsibility for complying with the terms of ownership. Examples are checking and savings accounts, stocks, funds, mortgages, and insurance policies.<br /><br />A <em>financial service</em> is when someone performs an action for you that you would otherwise have to do yourself or leave undone. Most often in the financial profession, services involve the application of expertise. Examples are financial planning, investment advice, tax preparation, and legal consultation.<br /><br />Rules of thumb for vetting quality are a bit tougher, but here's my best shot:<br /><br />When vetting financial products:<br />1) Don't buy anything you can't explain clearly in your own words.<br />2) Decide on a few attributes that matter most to you and compare at least a few options. For example, when comparing shares of stock, you may care most about past performance and strength of the brand. With loans, you may care most about the interest rate and whether or not there is a prepayment penalty. If you can't name at least a couple of product attributes that matter to you, then you don't understand it well enough (see number 1).<br /><br />When vetting financial services:<br />1) Understand how the person gets paid. Does the advisor charge an hourly fee? Earn commissions on sales? Take a percentage of earnings? Some combination of those? Then make some decisions about how the financial incentives might affect the services rendered and adjust your cost-benefit analysis accordingly.<br />2) If you are working with an advisor who also sells products, make sure that you are being shown more options than just the ones they sell. If you are paying for expertise to help you make the right choice of investments for your needs, then you should know that you are being shown the full menu, so to speak, and not only the few options that they are selling.<br /><br />Bottom line: Financial products and services can be confusing and often purposefully opaque, but the responsibility of protecting your own interests while navigating this landscape falls on you, the buyer. Knowing the difference between financial products and services is a first step in vetting the advice you receive and the products you are shown. It's your responsibility, so remember that, and caveat emptor!<br /><br /><em>The additional reading is by Sarah Newcomb, a member of Morningstar's Behavioural team.</em></p>

15/01/2021 Morningstar's head of policy research Aron Szapiro explains what sort of changes a Biden government will make and how they will affect company valuations.

14/01/2021 Freight-rail, building temperature efficiency, and carmaking are among the sectors Aviva Investors' Jaime Ramos Martin has his eye on.

13/01/2021 Dividend investors had a hard time in 2020, but Morningstar analyst Dan Lefkovitz think the outlook is brighter for the year ahead.

11/01/2021 Morningstar Investment Management's Dan Kemp reveals the three investment themes on his mind for the year ahead.

06/01/2021 Morningstar equity analyst Allen Good looks at the prospects for oil and gas giants in the year ahead.

05/01/2021 China had a strong year after a rocky start, but can it continue—and what does a US President Biden mean for the region? Morningstar analyst Lorraine Tan explains.

04/01/2021 Morningstar equity director Alex Morozov considers the outlook for tech, travel and beyond for the year ahead.

01/01/2021 How to plan for things you can't plan.

25/12/2020 2020: we look back at the highs and lows of an unprecedented year in financial markets and explore the themes shaping 2021.

22/12/2020 Music streaming companies have seen stellar growth in user numbers. We ask Morningstar equity analyst Neil Macker if the trend can continue.

21/12/2020 While it stands as the largest addition in the index's history, this likely won't impact everyday investors all that much.

18/12/2020 Will there be opportunities to deploy cash in the new year? Will there be a reprieve from covid? And what will the incoming Biden administration mean for markets?

18/12/2020 Companies that specialise in solar, building efficiency and renewables underpin Aviva Investors' Climate Transition Global Equity Fund, says Jaime Ramos Martin.

16/12/2020 Why does liquidity matter to investors, and how can it affect your returns? Morningstar equities director Tom Whitelaw explains.

14/12/2020 Learn what we look for when rating a company.

14/12/2020 Morningstar's new approach unpacks the environmental, social and governance risks that companies face.

10/12/2020 Industrial companies typically generate better cash flows and can offer a steady income stream, says the IML founder.

09/12/2020 The lofty valuations of Tesla and Afterpay typify the effervescence and speculation in the market, says the IML founder.

08/12/2020 Car makers may not be an obvious investment choice for ESG-conscious investors, but Morningstar analyst Tancrede Fulop says some of the largest companies score highly in some measures such as safety and human capital.

07/12/2020 Janus Henderson's Matt Peron considers how the relationship between the US and China will evolve under a President Biden.

04/12/2020 What is active investing, and what is passive investing? We're at the whiteboard to explain the pros and cons of each

04/12/2020 Treasury Wine Estates remains an undervalued stock in spite of China's demand-destroying tariff on Australian wine. Morningstar director of equity research Adam Fleck explains why.

03/12/2020 And do any other assets currently compare?

02/12/2020 We're at an inflection point in ESG investing, says Sustainalytics founder Michael Jantzi. Here's why.

01/12/2020 Beaten-down travel stocks and BNPL providers featured heavily, says nabtrade’s Gemma Dale.

30/11/2020 Many people were waiting for the opportunity to buy shares at historic discounts, says nabtrade’s Gemma Dale.

27/11/2020 The 171-year-old wealth manager has had its scandals but there's merit to its turnaround strategy and the quality of its other assets, says Morningstar's Shaun Ler.

27/11/2020 BNPL products such as Zip Co help boost consumer spending but they come with risks and are overvalued, says Morningstar analyst Shaun Ler.

26/11/2020 The Magellan co-founder argues the ecommerce acceleration is here to stay and ponders the effect it will have on other sectors such as travel and commercial real estate.

25/11/2020 Greg Dean of Cambridge Global Asset Management explains why the consumer services sector has yielded healthy returns.

25/11/2020 Magellan's co-founder explains which tech behemoth the Magellan Global Fund no longer owns, why one was too tricky to value, and why regulation is no threat.

24/11/2020 Magellan's co-founder on why 2020 resembles 2000 and why covid-19 is a dry run for something that could be much worse without proper planning.

23/11/2020 Their shares have gotten hammered this year. Are they opportunities or value traps?

20/11/2020 Our new rating highlights the degree to which a fund or asset manager considers environmental, social, and governance issues.

19/11/2020 Morningstar's Grant Kennaway explains why sustainable funds are increasingly popular and why they're performing well.

17/11/2020 Morningstar director of equity research Johannes Faul looks at home improvement retailer Bunnings.

16/11/2020 From climate change to workers' rights, ESG is a big part of the investing world. We're at the Morningstar whiteboard board to explain what it means and why it matters.

12/11/2020 We're not out of the woods yet, says our head of equity research, as he looks for safety in businesses we can't live without and shies away from the banks.

11/11/2020 Perhaps it is time to have exposure to this economic powerhouse and its 1.4 billion population, says Morningstar's Peter Warnes.

10/11/2020 What happens when you buy something when your bank card? Morningstar analyst Niklas Kammer explains which companies are benefiting from your transaction.

09/11/2020 With travel bans and economic lockdowns, the luxury sector has been hit hard in 2020. But there are still opportunities, says Morningstar analyst Jelena Sokolova.

05/11/2020 A discussion of taxes, stimulus, regulation, and the likely market reaction as results from the 2020 poll come in.

03/11/2020 Why you should resist the urge to make predictions when there's a disconnect between the economy and security prices.

02/11/2020 Etoro analyst Josh Gilbert shares his thoughts on Beyond Meat and two other companies making inroads into the plant-based meat sector.

30/10/2020 The Magellan rainmaker explains why he doubts the Republican leader will prevail and why investors should brace for volatility—and ignore it.

29/10/2020 The market for plant-based meat is worth $14bn today and is expected to grow massively, says eToro's Josh Gilbert.

28/10/2020 Morningstar equity analyst Johannes Faul explores the flipside to the surge in growth in online sales.

22/10/2020 China and Hong Kong have been a happy hunting ground, says Longlead Capital Partners' co-founder Andrew West, who singles out tech, pharmaceuticals and power tools.

22/10/2020 These names stand to benefit from a resumption of leisure travel - and are all trading below our fair value estimates.

20/10/2020 Morningstar's Mark Preskett looks at three reasons why bonds are an important tool in your investment portfolio.

19/10/2020 A bigger stake in the online conveyancer PEXA could be the key to increasing Link Administration's revenue, says Morningstar's Gareth James.

16/10/2020 Longlead Capital Partners co-founder Andrew West reveals how his Asia-focused fund managed to make gains during the historic covid-19 sell-off.

16/10/2020 The investment board is back with an explainer on why you might invest in bonds.

13/10/2020 How to handle this decision—even when it is made for you.

12/10/2020 Nick Griffin of Munro Partners reveals why and where he sees opportunities in renewable energy, diagnostics and software.

09/10/2020 Take stock of your spending to determine if inflation is an issue for you.

09/10/2020 Morningstar analyst Chelsey Tam explains why investors are excited about the flotation of Ant Group and why it's different from Alibaba.

06/10/2020 Companies that address the growing demand for decarbonisation will have a 20-year growth opportunity, says Nick Griffin of Munro Partners.

30/09/2020 EXCLUSIVE EXTRACT: Morningstar's Mat Hodge and Lex Hall talk to the CEO of the independent producer and exporter about the company's fortunes and its future.

30/09/2020 Slow and steady wins the financial race.

29/09/2020 American Century Investments' low-turnover strategy invests in companies developing vaccines, treatments for neuro-cognitive diseases and innovations in telemedicine.

25/09/2020 By 2050, almost 20 per cent of the global population will be over 65 and demand for healthcare will climb, says Michael Li of American Century Investments.

22/09/2020 The destruction of an indigenous cave shelter was unforgiveable but there are other reasons why the iron ore heavyweight is overvalued.

21/09/2020 Morningstar equity analyst Kristoffer Inton on the outlook for the seven producers under coverage.

18/09/2020 Morningstar's Seth Goldstein singles out three undervalued stocks that span the entire electric vehicle supply chain.

18/09/2020 The bumps and bruises of election time may tempt you to shift your portfolio strategy.

17/09/2020 UK-based Premier Miton's Simon Evan-Cook says the tech rally of 2020 is reminiscent of the dotcom boom, but inflation could be a bigger threat.

16/09/2020 By 2025, the cost of batteries and manufacturing will fall and EV functionality will improve, says Morningstar's Seth Goldstein.

11/09/2020 Estimating the length of your retirement with personalized information will help you save the correct amount.

09/09/2020 Morningstar's Chelsey Tam reveals which stocks and sectors have shone—and which have underwhelmed.

28/08/2020 Products, services, what is what in the world of finance—and how to look out for yourself

24/08/2020 A raft of companies have cut their dividends this year, leaving income investors concerned. But Morningstar's Dan Lefkovitz says there are still plenty of options out there.

18/08/2020 DNR Capital's chief investment officer Jamie Nicol profiles some of the top ten holdings in his Australian Equities High Conviction fund.

17/08/2020 Morningstar's Brian Han explains why he has trimmed his fair value estimate for Australia's dominant telco and the future of its dividend payout.

14/08/2020 DNR Capital's Jamie Nicol reveals how his Australian Equities High Conviction fund finds quality businesses that will endure difficult conditions.

13/08/2020 Put your money to work if you're looking for financial freedom.

10/08/2020 Learn how to picture your goals so you can better reach them.

05/08/2020 Morningstar's Gareth James identifies three sector names trading at attractive discounts in an increasingly 'essential' sector.

05/08/2020 Reports of the strategy's demise are greatly exaggerated, says Morningstar's Christine Benz.

04/08/2020 Investors may assume a fund's yield to determine how much income it will pay, but it's not always so simple, warns Morningstar analyst Rajesh Yadav.

03/08/2020 It depends on your expectations and timeframe. Look at bonds as being portfolio stabilisers—sources of cash flow you can draw on when your equities are down, says Christine Benz.

28/07/2020 When utility stocks plunged during the onset of the pandemic Lazard Asset Management's Warryn Robertson knew it was time to jump in.

24/07/2020 Lazard Asset Management's Warryn Robertson looks at how the pandemic has affected toll roads and airports and what the future of travel holds.

23/07/2020 Morningstar analyst Tancrede Fulop singles out a few companies that have performed well and also led the way in looking after staff.

21/07/2020 New stock-pickers are prone to lose money. Are the lessons worth the price? We ask Morningstar's Christine Benz.

20/07/2020 Elevated iron ore prices have lifted mining company earnings to eye-watering levels but this doesn't make them income stocks, says Morningstar's Mat Hodge.

17/07/2020 Local miners should deliver stellar fiscal 2020 results but such outperformance is unlikely to last, says Morningstar’s Mat Hodge.

17/07/2020 --

16/07/2020 How to make some upgrades during this down time.

16/07/2020 Covid-19 has made the intended public offering impossible, says Morningstar's Andrew Willis.

15/07/2020 JPMorgan's Nicholas Weindling talks opportunities in Japan and reveals the stock that has been his largest holding for almost a decade

15/07/2020 The asset class has a habit of outperforming but Morningstar's Ross MacMillan sees signs of a bubble.

13/07/2020 Rachel Winter of UK fund manager Killik & Co talks payments, social media and investing in her monthly stock pick round-up

09/07/2020 And what we expect to see moving forward.

07/07/2020 Large growth maintains its supremacy in the Morningstar Style Box during a volatile first half for mutual funds.

06/07/2020 Nikko Asset Management's Peter Monson looks for strong sustainable returns and he sees that in Asian stocks that span financial exchanges, computer game makers and condiments suppliers.

02/07/2020 China’s ongoing recovery from COVID-19 presents solid investment opportunities, says Nikko Asset Management.

01/07/2020 Aviva Investors' Mark Robertson on the 'second wave', the widening gap between the West and China, portfolio protection and how covid has accelerated the tech revolution.

29/06/2020 Does the rise in smartwatches show that data, not diamonds, are a girl's best friend?

26/06/2020 They may be 'boring' says Fidelity's Bertrand Lecourt but these names offer solid and long-term returns by delivering essential services.