The torrent of disturbing allegations from the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry has prompted many Australians to question whether their interests are being served by financial advisers. Faced with this new reality, we feel it’s a crucial time to take a step back and examine the value of good financial advice and the ways in which self-directed investors can seize on that value without relying on a financial adviser.

Morningstar works with thousands of financial advisers globally and we feel that using our tools and research and applying our philosophy of prioritising end-investors can help advisers better serve their clients. Morningstar was founded because we felt it was unfair that people did not have access to the same information as financial professionals. We want to empower individual investors to take charge of their own financial outcomes—either by directly investing themselves or by having access to independent research that can be used to validate advice from their advisers.

I have been a self-directed investor from the time I began investing in my early 20s. While this may not be the path that is right for everyone, I have always enjoyed the intellectual challenge of investing and find it hard to believe that I can find an adviser that is more interested in my financial goals than I am.

That being said, choosing a financial adviser has never been easier, and many investors welcome the chance to do so. However, just as we get the politicians we deserve, so it goes for financial advice. As a society, we are woefully uninformed, and more disturbingly we seem blissfully ignorant when it comes to financial matters, happy to hand responsibility for our financial future to perfect strangers, or act on BBQ hearsay.

We have created this guide with the self-directed investor in mind. And we hope it will be among the first steps you take on the path to achieving financial freedom—and deliver some intellectual nourishment and satisfaction along the way.

Before we get into more detailed and practical advice, we embark on a brief overview of the state of financial advice today, which we think will better equip you to use the advice that follows. Briefly, this guide will outline:

  • The state of financial advice today
  • Traditional methods versus goals-based investing
  • We finish the guide with a brief discussion of behavioural coaching and explain how its principles can help you block out the noise and focus on value.

We trust you find this guide useful. Happy investing.


Financial advice in Australia

“Where are the customers’ yachts?” – Fred Schwed

The full guide explores the financial advice landscape in Australia, and how we got to where we are. This context is crucial to understanding how financial advisers prioritise their time and their competing priorities. Find the full guide on Morningstar Investor.


What does good financial advice look like?

“Investing is simple, but not easy.” – Warren Buffett

If putting clients into unsuitable investment products constitutes poor financial advice, it stands to reason that the inverse must be true: steering clients into the best investment products is good financial advice. In absolute terms, this is certainly true. The ability to earn returns that far exceed the market indices is why Warren Buffett is closing in on US$90 billion, whereas you, all presumptions aside, are probably not. Obviously it’s a little unfair to compare your financial adviser to one of the world’s greatest investors. Even moderately exceeding market returns would be a great outcome. But in practice this is very difficult to do over the long term.

Traditionally the financial services industry prefers to ignore the impact of financial planning decisions and instead focus on two measures of how a portfolio performs, alpha and beta. Beta represents the risk that an individual takes based on their asset allocation. The higher the allocation to equities, the higher the beta of the portfolio will be. Historically this has led to higher long-term returns but also increased volatility as equity returns can fluctuate greatly over certain periods of time (the 2008 GFC, for instance). Alpha, on the other hand, represents the excess returns that result from actively managing a portfolio and selecting higher performing investments—in other words, the benefit of picking stocks that outperform the market indices.

If an adviser is paid solely to manage a portfolio of assets, and does nothing else, i.e., offers no additional advice on anything other than the investment of your assets, then the concepts of alpha and beta should be relatively good measures of the value of advice. However, advisers typically face numerous constraints that limit the amount of time they have to select investments. More regulations, more compliance, pressure to win new customers and serve existing ones, not to mention an approved product list that limits the universe of investment options. To that end, consider the following analysis by Capgemini, which reveals how US financial advisers allocate their time:

How US financial advisers allocate their time
Servicing existing clients: 40%
Administrative tasks: 24%
Prospecting for new clients: 17%
Investment research / portfolio management: 10%
Compliance: 5%
Training: 4%

Little wonder that then many advice practices resort to outsourcing the investment selection side of the business to a third party. This accounts for the growth of managed accounts—a mechanism that allows the outsourcing of the investment decision-making to a professional money manager.

The adviser works with the client to select an investment objective that corresponds with a pre-established strategy from a professional investment manager. The purchase of the individual securities is then done by another third party based on the strategy and the securities are held in the client’s name.

There are two crucial points for individual investors to note here. Find them through the full guide on Morningstar Investor.

What is the traditional approach to financial planning?

The delivery of good financial advice has undergone somewhat of a revolution. Traditional financial planning usually involves assessing a client’s risk tolerance based on a questionnaire that evaluates your behaviour according to various market scenarios.

This self-assessed willingness to take on risk would then translate into an asset allocation target, which is in turn applied to your whole portfolio. In other words, if you indicated a high willingness to take on risk, the adviser would recommend that you invest in riskier investments.

At Morningstar we see three main problems in using a self-assessed risk tolerance as the foundation for financial advice. We go through these three problems in our full Guide to Better Investing Outcomes on Morningstar Investor.

What is a goal-based total-wealth approach to financial planning?

At Morningstar we believe in putting the investor—rather than the investment—first. We think today’s investors are concerned with more than beating the market. Our approach looks beyond investments and retirement and instead prioritises all your major financial goals. 

Following are four examples of considerations you should make prior to investing: focus on goal attainment; total wealth approach; risk; portfolio construction.

We provide two scenarios for each:

  1. Working with an adviser The first scenario is for individual investors who want to use an adviser. Morningstar works with thousands of advisers around the world to help them provide better financial outcomes for their clients. There are many ways of providing goals-based and total wealth-focused advice, but the elements we have outlined should seem familiar if your adviser is following a similar philosophy.
  2. Independent investor The second scenario is for independent individual investors who do not want to use an adviser but still want the benefits from a systemic approach to financial planning. This would also apply to individual investors who want to do their own work to test and validate their adviser’s recommendations.

In the full guide we walk through these two scenarios for each of the four considerations. Find it on Morningstar Investor.


Behavioural coaching

“The investor’s chief problem—and even his worst enemy—is likely to be himself.” – Ben Graham

Another area in which advisers can add value is behavioural coaching. Simply put, it’s through behavioural coaching that an adviser can stop you from making bad decisions. Before we introduce techniques independent investors can use to prevent poor decisions, let’s examine why such decisions are made.

When the markets start dropping, do you begin to panic? Do you feel envious when you hear that other people’s investments are beating yours? Investing is clearly more than a mathematical analysis of risk and return. It’s a struggle with ourselves: to block out irrelevant information, to have the strength to stick to a plan and to resist the urge to follow the herd (except, of course, when it knows better than we do). Facing this internal struggle, investors are often told to avoid the emotional roller coaster and magically remove emotions and temptation from the picture. Easier said than done.

Consider these two options. Which one should you choose?

a. Buy low, sell high (i.e. make a profit);
b. Buy high, sell low (i.e. put your money in a big pile and burn it)

Got your answer to that one? Great, now let’s try another one. Imagine a story splashed all over the news about a hot company with a revolutionary new product, think, the next Apple or Tesla. Should investors:

a. Check out the company and potentially invest;
b. Ignore the news and invest as before.

We may assume “a” is the correct response. But we’re likely to be conflicted. At the same time, we sense it’s a trick, and that “b” is probably the right answer. But “a” feels natural because words such as “all over,” “hot,” and “revolutionary” ring positive, and they tell us that many other people like the company. We’re naturally drawn to things others like and find valuable. Behavioural scientists call that “social proof”.

Unfortunately, investing isn’t natural. If other people like an investment, the price goes up. If the price goes up, all things being equal, you’re buying high—which is like putting money in a big pile and burning it. Yes, there are many nuances here, like the fact that other people might drive the price up even more after you buy it (a phenomenon known as the “greater fool” theory). But putting aside the nuances and our innate temptation to try to outsmart everyone, that’s one small part of the crazy logic of investing.

So, investing is a bit crazy. Why should that matter? It matters because if we do what feels natural, if we don’t understand the crazy world of investing, we can lose our money. This doesn’t mean that we might “miss out” on a hypothetical future gain. It could be much more serious than that—it may mean failing to reach our goals.

Investing is fascinating, and it’s often exciting and fun. But we can’t ignore the dark underside. Investments are always risky, and there’s always the chance of losing out. But, a key factor that make investments risky is our own behaviour as investors. Studies show that investors who actively traded stocks in the market made mistakes again and again—and had returns that were one third lower than that of average return.1 Even investors who have invested in mutual funds have similar challenges—losing up to 3.11% of returns on average (some are better, some are worse).

As Ben Graham said in The Intelligent Investor: “The investor’s chief problem—and even his worst enemy—is likely to be himself.” So, what actually happens?

What we do wrong

While there are many ways in which investors can run into trouble, three problems are very common:

  • Problem #1: Chasing returns. If you’ve ever talked with mates about the stock market, you’ve probably felt the urge to invest in a new hot stock or sector. The problem is this: so has everyone else.
  • Problem #2: Exiting the market during downturns. When the markets get jumpy, people ask themselves, “Is the market going to fall more, and should I get out?” Unfortunately, it’s impossible to tell whether a drop in the markets will continue, or whether it will rapidly turn around. In the extreme, Morningstar research shows that if investors pulled out of the market and missed the 10 best upswing days from 1992–2012, they’d have lost 45% of their returns.
  • Problem #3: Picking inappropriate investments. Investors are inundated with information about investments. It can be overwhelming, so we often go with what feels right. Unfortunately, for complex issues like asset allocation, diversification, and portfolio selection, the details matter, because they help drive long-term growth and determine whether we reach our goals.

The importance of staying invested; ending wealth values after a market decline

Chart illustrating the importance of staying invested

Source: Simple but Not Easy: Morningstar’s Guide to Helping Investors Overcome Behavioral Obstacles

What we can do about it

Many of us are hardwired to make mistakes in the market. Common errors (or “biases”) include being overconfident in our ability to pick stocks, focusing unduly on recent returns, and underestimating the power of compound interest. The research on these biases is extensive and spans decades of work. Here’s a quick summary of the key lessons from this research, which you can use as a starting point to think about the way you invest.

If there’s one overriding lesson in the research, it’s this: we’re hardwired for these biases, and the most common advice in the investment community—telling investors to just be smart and resist them—is woefully insufficient. Instead, we should look for clever ways to avoid or short-circuit such biases.

In the full guide, we explore the common biases that investors have and how to overcome them. This helps investors achieve better investing outcomes.