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Should I use an Investment Advisor?


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"A man who is his own lawyer investment advisor has a fool for a client."

           —— apologies to Leigh Hunt (1784 - 1859).

Prospective clients often ask us whether they should hire an investment advisor to manage their investments.

This is a complex question which should be carefully considered before deciding.

bulletWhat Good is an Investment Advisor?
bulletIs An Investment Advisor Worth the Fees?
bulletGoing it Alone
bulletGoing it Alone — Are You Qualified?
bulletBottom Line

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What Good is an Investment Advisor?

A good investment advisor will essentially act as your personal CFO (Chief Financial Officer).  Here's (some of) what you can expect them to do for you:

bulletCustomize an Investment Plan.  A good advisor will help you design a custom investment plan to suit your individual situation.  It should take into account your financial goals, as well as your need, willingness, and ability to tolerate risk.  Your investment plan should generally be designed to minimize your tax-burden (if possible and prudent given your circumstances).
bulletEnsure Consistent Implementation of your Investment Plan.  We've found that many people make dramatic changes to their investment strategies on a fairly regular basis.  Failure to consistently implement an investment plan is one of the principal reasons for underperformance.

Often-neglected parts of a good investment plan include (but are not limited to): periodic rebalancing and tax-loss harvesting.  A good investment advisor will constantly be alert for opportunities to prudently harvest losses and for situations which suggest partial (or complete) rebalancing might be prudent.
bulletAct as a Human "Circuit Breaker."  A good advisor will try to "talk you out of" doing things which might be hazardous to your wealth.  People often get urges to act on emotion.  These contemplated actions often have predictably negative financial consequences.  A good financial advisor will help you to understand when acting on some of your impulses may be imprudent.

More specifically, investors have a strong tendency to chase hot returns and attempt market timing.  It is quite useful to have a "voice of reason" available to remind you of the imprudence of such actions.  Thus, what an investment advisor does NOT do (e.g., chase performance and attempt market timing) may be MUCH more important than what they actually do!
bulletKeep up on the Latest Greatest Research.  A good financial advisor is constantly updating their theoretical and empirical knowledge of the science of investing.  As the research reveals new truths about prudent investing, a good financial advisor will adapt your investment plan accordingly.  Most lay people don't have the time or inclination to read academic journals to keep up on the latest research.  For examples of the sort of research we are talking about, see the red entries here.
bulletKeep up on the Latest Changes in Federal Tax Laws.  A good advisor constantly assesses how emerging changes in tax laws might suggest improvements in your investment plan.
bulletGive you Access to the Best Mutual Funds.  A good advisor helps you select the very best investments for your portfolio.  Many advisors can give you access to some good institutional class mutual funds which you might not otherwise have access to.  The best example of this may be the mutual funds from Dimensional Fund Advisors.  How much is it worth to get access to these funds?  This paper (in its "Example E") suggests that it may be worth at least 1.285% per year.

Altruist provides fee-only investment advisory services inexpensively in the form of the ALTRUIST Portfolio Management Service.

Here are some excellent articles on the proper roles of good investment advisors:

bulletFrancis M. KinneryJr., Colleen M. Jaconetti, Micael A. DeJoseph, Yan Zilbering, and Donald G. Bennyhoff, "Putting a Value on your value: Quantifying Vanguard Advisor's Alpha," Vanguard research, February 2019.
bulletMichael Lane and Larry Swedroe, "Seeing the Forest for the Trees: The True Role of the Financial Advisor," Journal of Indexes, Third Quarter 2002.
bulletMeir Statman, "The 93.6% Question of Financial Advisors," Journal of Investing, Spring 2000, pp.  16-20 (191kb).  "Financial advisors are investor managers.  They examine the financial resources and goals of investors, diagnose deficiencies, and provide financial education and care."  "[Financial advisors] would do better to explain the importance of their investor management work and the fairness of their fees." 

Is an Investment Advisor Worth the Fees?

Good investment advisors are not free.  We charge $30k annually for accounts of $15M (for an effective rate of about 0.2%; lower fees apply to larger accounts).  Are we worth it?  You will have to decide that.  But keep in mind the following:

bulletOn their own, individual investors tend to significantly underperform the markets in which they invest.  Indeed, one study concluded that the average individual investor's annual risk-adjusted performance was 3.7 percentage points below the market as a whole.  Another study (here and here are articles about that study) concluded that the average stock fund investor's annual performance was about 3.5 percentage points below the S&P 500 index.
bulletOn their own, individual investors are limited to "retail" investments.  However, some of the best-in-class investments are only available to institutional investors and to individuals through selected investment advisors.  One study suggested that access to those exclusive institutional investments may be worth between 1.29% and 1.42% per year in increased risk-adjusted returns, on average.
bullet Vanguard estimates (an older version is here) that a good investment advisor can add an average of about three percentage points per year in net returns by guiding a client through:
bulletPrudent asset allocation,
bulletCost-effective implementation,
bulletBehavioral coaching,
bulletAsset location,
bulletWithdrawal order for client spending from portfolios, and
bulletTotal return investing (vs. investing for income).
bulletDo you worry about your investments?  A good investment advisor will give you additional confidence that you are following a prudent course.  Many individuals feel less stressed after engaging a competent investment advisor.  "Out-sourcing" the responsibility to worry about your investments can be a very liberating experience.
bulletIn investing, the old adage "you get what you pay for" generally does not hold.  In general, the more you pay in fees, the lower your overall performance is likely to be.  So fees are an important consideration when selecting investment advisors.  There is no reason to believe that an expensive investment advisor is any better than an inexpensive investment advisor.  In fact, there is significant reason to believe that the opposite is true—in general, every additional dollar you pay in advisory fees will reduce your portfolio's net returns dollar-for-dollar.  Here's an excellent article discussing this issue.
bulletIt may not make sense to put your assets under management if you have less than about $500k to $1,000,000 or so to invest.  This is because the custodian used to administer your account will generally charge additional transaction fees over and above the financial advisor's fees—and because the advisor will either charge a high fee for small accounts or an annual minimum that makes the effective rate unacceptably high.  Transaction fees tend to be independent of the amount under management, so as a percentage of your assets, these custodial transaction fees would tend to further be an unreasonably high financial burden for small accounts.

Here is an excellent article on the fairness of fees charged by good investment advisors:

bulletMeir Statman, "MANAGING INVESTORS: Fair Fees for Valuable Services," Journal of Investment Consulting, June 1999, pp.  1-3 (162kb).

Going it Alone

It is very possible for well-informed individual investors to do quite well on their own.  In particular, if they have a well-thought-out investment plan and they diligently execute it, they are likely to be well rewarded. 

Our financial planning clients definitely do have detailed well-thought-out investing plans.  If you have read some of the books in our Reading Room, you may have the tools to generate such a plan yourself.  The problem comes in the ongoing implementation stage. 

Sadly, we've found that many individual investors tend to unwittingly sabotage their chances of meeting their financial goals by violating the terms of prudent investment plans.  As discussed above, one study concluded that the average individual investor's annual risk-adjusted performance was 3.7 percentage points below the market as a whole.  The study attributed the poor performance ultimately to people's overconfidence in their investing abilities.  Are you overconfident in your abilities?  Can you follow a prudent plan without deviation?  The very best plan in the world is of little use if it is not followed.

Why don't individual investors follow their plans?  There are several reasons.  Here are a few:

bulletThey aren't adequately educated regards the reasons behind their plans.  If you don't understand why your investment plan is set up the way it is, you may be more likely to violate the plan's terms.  This is why we work so hard to educate our clients regards the rationale behind our recommendations.
bulletThere is a great deal of uninformed "noise" in the popular press urging them to do imprudent things.  Unfortunately, many people actually believe what they read in Forbes, Fortune, Investor's Business Daily, Kiplinger's, Money, etc.  The articles in those magazines are, in general, written with one goal in mind: to get you to buy the publication.  Unfortunately, prudent advice just doesn't sell very well.

Example: Lots of people will buy a magazine whose cover reads, "The ten hot funds to buy TODAY!"  Few people would buy the same magazine if the cover instead read, "Don't do anything new this month!  Follow the plan you set up five years ago!".
bulletOften, they fall prey to various well-documented psychological/behavioral pitfalls, such as overconfidence in their investing abilities, as discussed earlier.
bulletThey are constantly bombarded by "conventional wisdom" from their friends, colleagues, and family members.  Unfortunately, much of conventional wisdom on investing is provably wrong.

Here is an excellent article on the likelihood of succeeding when "going it alone" (the bottom line is that it is possible, but not likely for most people):

bulletWilliam J. Bernstein, "The Probability of Success," Efficient Frontier, Winter 2003.

Going it Alone—Are You Qualified?

If you are intent on managing your investments by yourself, you should first ensure that you are qualified to do so:

bulletDo you know and fully understand the following theories?  If you don't understand them well enough to explain them to someone else, you may not have an adequate understanding of them yourself.  If you don't have an excellent understanding of these important theories, you may be unqualified to competently manage your portfolio.
bulletModern Portfolio Theory.
bulletEfficient Market Hypothesis.
bulletCapital Asset Pricing Model.
bulletFama/French Three Factor Model.
bulletAre you aware of the various well-documented psychological/behavioral investing pitfalls we are all occasionally prone to?  If you aren't aware of these phenomena, you may be more likely to suffer from their adverse consequences.  The most important such pitfall is probably overconfidence.  Are you overconfident of your investing abilities?  Many people are.
bulletHave you read—and understood—any of the relevant research in the various areas of investing which are applicable to your situation?  If not, it may be beneficial to consult with someone who has read it, understands it, and is able to apply the knowledge gained therefrom.  See here for an idea of what sort of relevant research we are talking about.

Bottom Line

Most people can probably benefit from the services of a good low cost fee-only investment advisor.  Even after you take into account the advisor's fees (so long as they are less than about 1% of assets), we believe that most individuals will almost certainly be better off in the end than if they tried to "go it alone."

However, if you are well informed and are able to consistently follow a prudent investment strategy (most people appear to be neither), it is possible to do well without using an investment advisor.

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This web page contains the current opinions of Eric E. Haas at the time it is writtenand such opinions are subject to change without notice.  This web page is intended to serve two purposes:

bulletTo educate the public; and
bulletTo provide disclosure of Mr. Haas' opinions to prospective clients.  We believe that prospective clients are well-served by being made aware of what they are buyingand what they are buying is advice that is based on these opinions.

We believe the information provided here to be useful and accurate at the time it is written.  Information contained herein has been obtained from sources believed to be reliable, but is not guaranteed. 

No investor should invest solely on the basis of information listed here.  Before investing, it is important to consult each prospective investment's prospectus and consider both its risk/return characteristics and its effect on your overall portfolio.

This information is not intended to be a substitute for specific individualized tax, legal, or investment planning advice.  Where specific advice is necessary or appropriate, Altruist recommends consultation with a qualified tax adviser, CPA, financial planner, or investment adviser.  If you would like to discuss the rationale or support for any particular idea expressed on this web page, feel free to contact us.


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