Chapter 11 – Principles of advising clients to buy direct shares

As with all things, Dover takes a prudent line when it comes to share investing. We like to minimise risk whenever possible, and we always work from the assumption that someone who does not like the adviser (for example, a judge) will one day evaluate the adviser’s work. We have found that this is the best mindset to have when it comes to compliance. 

Historically, the average performance of the average share market investment is a good one – 9.4% per year for the 20 years to December 2014. As of the present time, no one really knows what the share market’s future rate of return will be. Whatever the actual return, Dover’s approach to share market investing is that advisers should use the market average return as a benchmark. The aim should be to assist clients to achieve or beat this benchmark in the most efficient manner possible.

Dover’s basic proposition is this: the share market is a place to preserve and grow wealth; it is not a place for making a fortune.  

Please keep in mind the old question: where are the customer’s yachts? If advisers are truly confident in their ability to create fortunes in the share market, this is well and good. But the adviser should use his or her own money to test this ability. When it comes to client money, we think advisers should be much more conservative. Preserve first, grow second. Take the average as your benchmark. If you achieve that – well done!

There are many reasons for this. Firstly, the average is much more likely to be achieved. It is, in fact, what most people get. If your clients achieve what the market on average achieved – and used your advice to simply minimise the costs of doing so – this is a good result. If you can add a few percentage points to the market’s average, you have truly out-performed. 

Secondly, and this is where it pays to remember that your work will potentially be perused by someone who does not like financial planners, such as FOS, you are unlikely to be sued for helping your client achieve the market average. Remember, to successfully take action against you, the client would need to show that you failed to do something that a reasonable financial planner would have done. Most financial planners recommend managed funds. This means that most clients of most financial planners achieve the gross average return. They then pay high fees to the fund manager, meaning that their actual return is well below the market average. If your clients achieve the market average and then pay lower fees, they will outperform most investors. It will be hard to say their adviser was negligent. 

Basically, aiming for the benchmark, perhaps plus a few percentage points (which raises the prospect of underperforming by those same few points) will never get you sued – provided that the share market was the right place to invest in the first place.   

The market average is historically a good one and advisers who have helped their clients achieve this average have added real value. Advisers should be paid well for doing so. Advisers charging a fair price to educate clients on how to achieve the market return for the lowest fee possible is our aim.

With that in mind, Dover advisers are required to keep the following principles in mind when it comes to advising.

  1. The client makes the transaction

    At Dover, we think it is imperative that the client performs the transaction to buy or sell all shares. In most cases, this means that the client ‘logs in’ to their own online trading account and inputs the instruction to buy or sell themselves. Advisers should not gather or keep log in details for their clients and should never make the transaction on the client’s behalf.

    There are good prudential reasons for this. These reasons include:

    1. If the client makes the transaction, then it is clear that the client accepted the advice.

      Where an adviser actions the trade, then there is always a risk that a client will later claim that the trade was unauthorised. Sure, it is possible for an adviser to always ensure that they get written instructions from their clients, etc… but if the client is that involved, why not just let them make the trade themselves? Doing so makes the client’s consent absolutely clear. 

    2. If the client makes the transaction, then it is clear that they understood the advice.

      If the advice is to buy shares in BHP, and the client buys shares in BHP, then this is one more piece of evidence that the client understood what was being recommended to them. Yes, they will have signed an acceptance of the advice when you prepared it, but there is no such thing as too much proof.

    3. If you do not have the information (log in details, etc) then you can never misuse them.

      As anyone on a diet knows, the simplest way to not eat chocolate biscuits is to not buy them in the first place. If you never know your client’s log in details, then there is no chance that you could ever misuse them. Explaining to your client that it is a general policy that you simply do not gather these details will reassure any clients who are concerned about their privacy or security.

      It will also give you enhanced credibility at those (unfortunately frequent) times when the fraudulent behaviour of a financial adviser makes it into the news cycle. At such times, it is common for clients to seek reassurance that they are not at similar risk. This reassurance is much easier to give if you can point out that you have always studiously avoided having access to the client’s money.

      Of course, it is not just the financial adviser who can misuse client information. Often, it is more junior members of staff who create the problems.  Where junior staff have access to log in details, etc, it can create particular problems if (when) those staff leave – especially if they leave in unhappy circumstances. The log in details of every client will need to be changed, and you as the adviser will need to explain to every client why the change is taking place.

    4. If the client cannot make the transaction, they probably shouldn’t be investing in shares in the first place.

      Occasionally, we will have an adviser (actually, more often a potential adviser) tell us that they need to make transactions on their clients’ behalf because their client does not understand the software involved in doing this themselves. This is, of course, a huge red flag: if the client cannot operate simple software, then they are not suited to direct investment.

      In the case of older clients with lesser computer skills, the risk is still there: if the client’s mental state is such that they cannot learn a simple software package, then they should have a younger member of their family involved in their financial affairs anyway. The duty of care to elder clients is discussed here and in this here on the Dover website. Similarly, we once spoke with a financial adviser who told us he needed to make transactions on his client’s behalf because they were too ill to do it themselves. Once again, if the client is too ill to conduct his or her own trading, they are probably too ill to give consent to someone else to do it for them. 

      Remember, most online brokers also allow for telephone orders to be made. It is less time efficient, but can suit clients who are truly digital averse.

  2. Blue Chip all the way

    While there is no technical definition of a ‘blue chip’ share, and the term has an unfortunate link to gambling, most people understand a ‘blue chip company’ to be one that has a long history of solid economic performance in both good and difficult economic conditions. For Dover’s purposes, blue chip essentially means a company listed in the ASX50.

    Frequently, commentators will argue that it is the smaller, less well-known, stocks where fortunes are made. And this may be the case. But people should not be investing in the share market to make their fortune. Instead, people investing in the share market should be aiming to preserve their existing wealth and then enhance that wealth with whatever economic growth the share market comes to provide. Remember, the long-term performance of the share market is a good one: in the 20 years to December 2014, the market returned an average of 9.4%. This suggests that money invested in representative stocks will double its value every eight years or so – not making anyone a fortune, but certainly enhancing their wealth. Blue chips are the most representative of all stocks. 

  3. Ten years is the anticipated time frame

    This is an important aspect in all investing. Growth assets should aim to be held for at least ten years. If the ‘investment’ timeline is less than this, then the ‘investor’ is actually trying to make a fast buck. This is the fastest way to lose money. And an ever faster way for an adviser to embarrass themselves professionally. 

    This is not to say that investment assets must be held for ten years. There will be times when shares should be sold before this: either because the price has risen ridiculously high or because the company has really started to underperform and has little prospect of turning that around. When we say ‘buy with a ten year hold in mind,’ we mean that people should only buy shares that they expect, on the day they buy them, to hold for at least ten years. If they are not prepared to hold shares for this long, they should not be buying shares in the first place.

    There is an element of adviser-protection in all of this. In a Dover statement of advice setting out the recommended share portfolio, the adviser gets the client to agree that they will not take action against the adviser for at least ten years in the event that a share underperforms. This prevents a client ringing the adviser a month after they bought shares to demand their money back because the share price has fallen.

    This approach is also a crucial part of the client-education process: clients need to be educated such that they simply do not expect to receive huge short term gains. By setting out from commencement that the client should be looking at least ten years into the future, the adviser ensures that the client’s expectations are as well-informed as possible.

    These days, people who quote Warren Buffett can sound a little tiresome. But he is a rather good investor, and one of his statements is well worth remembering:

    “We expect to hold these securities for a long time.  In fact, when we own portions of outstanding businesses with outstanding managements, our favorite holding period is forever.”

    Note that Buffett is not saying he holds everything forever. If he needs to sell companies, he does. He is talking about the approach that he takes to businesses that he thinks are outstanding. When the investment is a good one, he holds on to it. This is why we suggest that the expectation when buying a share is that it will be held for a long time. This is logical,as you would only buy shares if you think they are going to be good investments. So, at the outset, we expect the investment to be a good one. Therefore, we expect to hold the investment for a long time.

    If time proves this to have been the wrong expectation (that is, if the investment proves not to have been a good one), then the investment can be disposed of. We are not saying shares must be held for ten years; we are saying that, on the day they are bought, they should be expected to be held for ten years.

  4. Australian shares are usually better

    This is not Dover being parochial: the dividend imputation system means that it makes sense for Australian taxpayers to prefer Australian shares over international ones. This is a deliberate design feature of the dividend imputation system.

    Under this system, the Australian taxpayer receives a franking credit for any tax paid to the Australian Taxation Office by the Australian company. This prevents a ‘double taxation’ occurring, whereby the company earns a profit and pays tax at its marginal rate (for larger Australian companies this is 30%), thus leaving 70% of the profit to be distributed to the shareholder. If the shareholder also has a marginal tax rate of 30%, this will means that the 70% after-company-tax dividend becomes a 49% after-company-tax-and-after-personal-tax dividend in the hands of the shareholder.

    Instead, then the shareholder receives the 70% after-company-tax dividend, they also receive a credit for the 30% tax paid, meaning that they do not have to pay any additional tax. For this reason, an Australian investor would usually prefer an Australian investment. An international investment would need to provide a much higher rate of return to justify making it. 

The Dover Group