Why Income and Patience Matter to Advisors

The financial services industry has changed a lot over the past few decades. From the products sold to the technology used to the clients served, advisors today are working in a much different environment.

One of the biggest changes, according to Fred Taylor, president and co-founder of Northstar Investment Advisors in Denver, is that advisors have become "managers of managers."

While many advisory firms are outsourcing their clients' investments to mutual fund managers or ETF providers, Northstar has forged a different path, focusing on finding individual dividend-paying stocks that meet clients' need for income, especially as they near or are in retirement.

"We analyze and pick individual companies that have strong operating businesses and pay meaningful dividends," said Taylor.

Those companies have to increase their dividends every year, too. Dividend yields have gone up roughly 3% to 5%, he said, but "the most important thing that we look for are companies that not only pay a meaningful dividend, but also increase their dividends every single year, roughly two to three times the rate of inflation."

He said there's a high correlation between a company increasing dividends and its stock price. "The longer you own a stock, and if it increases its dividend over time, the greater likelihood the price of the stock's going to go up because the dividend acts as something that holds up the stock price," he said.

Northstar is a fee-only RIA that was founded in 1995. Then, investment management meant picking individual stocks, but since the early '90s, most people are using the "Harvard-Yale model, which is to own a lot of different asset classes and many different managers," Taylor told Investment Advisor in October.

"Most people had their money managed by stockbrokers or local trust department officers 20 years ago. Now they're really having their money managed more by RIAs, but they've become asset allocators," he said.

His firm still analyzes companies and picks individual stocks to build clients' portfolios "because our investment strategy is truly about income."

Clients have to live off that portfolio, he said, so it had better generate income.

As clients' needs have changed, so have the products advisors use to meet them. For example, consider the growth in alternative investments, which Taylor says is "a nice way of saying 'hedge fund.'"

"In the old days, hedge funds were very limited," he said. "Only the very wealthy used them, and now a lot of individuals can get into hedge funds or alternative investments."

Taylor doesn't particularly like hedge funds. They're expensive, first of all, but "hedge funds by their nature really haven't done all that well since the financial crisis because they've had to be long and short the market, and you really wanted to be long-only since March 2009. I think a lot of individuals have gotten into alternatives at the wrong time," he said.

Many Good Salepeople, Not So Many Good Advisors

As the industry moved away from picking individual stocks, it also moved away from personalization toward automation — not just in the recent robo-advisor trend, but also in product design. "Everybody's using exchange-traded funds now, and before that they were using mutual funds," Taylor said.

He expressed concern over that trend, especially robo-advisors, as it puts a lot of pressure on investors to understand a subject they may not know much about.

On robo-advisors, he said, "we don't know how that's going to play out in a time of crisis when you're not talking to a real person. You may just be talking to a computer" providing automated advice.

Investors in exchange-traded funds got a taste of that in the Aug. 24 correction, he said, when "the bid-ask spread was incredibly wide. When the market fell 1,000 points that morning, most of the indexes were down 5%, but some of the bid-ask spreads on these large ETFs were 15% to 20%. By the end of the day, they got more in line with the index, but the poor client who sold at the open — it was not a good thing."

The sheer number of "advisors" vying for clients' business, though, has made it difficult for clients to even know whether they're getting good advice. "There are 400,000 people who call themselves financial advisors and that can be anywhere from a stockbroker, an insurance person, an accountant, an investment advisor — there are so many different options out there so it's really hard for people to decide what to do," Taylor said.

He said the best way for clients to find an advisor is a good old-fashioned referral from someone they trust, someone "who can tell the difference between an advisor who truly has your best interest at heart and somebody who's just trying to sell you something. There are a lot of good salespeople out there, but there aren't that many good advisors."

A More Mature, and Knowledgeable, Client

As the industry has evolved, so have advisors' clients. The boomers who make up the bulk of advisors' client base are getting more knowledgeable, about fees in particular, according to Taylor. "They're starting to realize their RIA might be charging them 1% to manage the money, but now that they're outsourcing the money management, they're getting charges from the mutual fund managers or the ETFs and they might be paying an extra 30% to 50%."

They're becoming inured to crises, too. During the correction in late August, Taylor said, he got "very few phone calls" from uneasy clients. Part of that was because Northstar was proactive about reaching out to clients, he said, but "in 20 years, we've seen a lot. We've seen the Asian crisis, we've seen 9/11, we've had the tech-Internet blowup, we had the financial crisis, we had the debt ceiling crisis in August 2011. Clients have matured and have gotten more used to the ups and downs of the market."

Taylor stressed the importance of income over performance: "We don't invest to beat the market, so we're not performance-driven. We're really income-driven."

Advisors who want to just match market returns for their clients can do so with low-fee index funds, Taylor said, but "if they want an investment strategy or philosophy like we have, which is really about living off your money and generating income, then that's a completely different way to look at your money."

Younger clients might be less interested in that income solution at first, but Taylor said, "I can tell you from age 50 on, you are going to care about generating more income so at some point you can retire on that."

He said clients should ask themselves, "'What are my investments supposed to do for me? Are they supposed to match markets or are they supposed to generate income for my retirement?'"

He suggested a two-pronged approach: "You want to match the market, you own index funds, but some of your money should be invested for income you can live off eventually."

One thing that hasn't changed in 20 years? "You have to be patient," Taylor said. "Time is truly your friend and you need time to work for you. If you jump in and out of the market all the time, it really doesn't do you any favors."