What A Financial Advisor Can And Cannot Do For You

2011 March 3
by Kyle Bumpus
from → Commentary

Being that I write about personal finance and interact with a lot of very knowledgeable people on a regular basis in various investing forums, I sometimes forget how inadequate the personal finance education most people possess really is. I live in a world where terms like tracking error, alpha, and the three factor model are part of everybody’s elementary vocabulary. A world where the pros and cons of investing in commodities are likely to be discussed at least as often as football (slight exaggeration, maybe). People in my world generally don’t need a financial advisor or, if they do, it’s generally more for complicated tax or estate planning purposes than investment advice.

It’s easy to forget that most people don’t live in that world. Indeed, most people live in a world where money is never discussed in polite company. A world where blindly buying the three best-performing funds in your 401k is what passes for asset allocation. A world where most people will spend more time agonizing over where to go to lunch than planning for their retirement. The vast majority of people in this world need a financial advisor.

That said, financial advisors are not miracle workers. In my mind, financial advisors have one very important duty and several almost-as-important duties and responsibilities. But there are also some things most people seem to believe financial advisors can do for them that just aren’t realistic.

What A Financial Advisor Can Do For You

  • A Financial Advisor can help calm your nerves. This is by far the most important job of any financial professional, in my opinion. They should keep you grounded and your emotions in check. Did you panic and sell everything when the market dropped a few years ago? A good financial advisor’s primary responsibility is to keep you from shooting yourself in the foot.
  • A Financial Advisor can help you keep disciplined. It’s often been said the biggest enemy of a good plan is the quest for the perfect plan. A good financial advisor should help you come up with a reasonably good financial plan, implement it, and most importantly, help you stick to it over the long haul! It’s the sticking-to-it part that’s the most important. And most difficult. It’s counterintuitive, but constantly tweaking your portfolio and jumping in and out of various investments is one of the worst things you could do.
  • A Financial Advisor can help you choose an asset allocation - This one is important. How much should you allocate to stocks? What about bonds? Real estate? More than anything else, the mix of assets you choose to invest in will determine whether or not you meet your retirement goals (But only if you can stick with it – see above).
  • A Financial Advisor can help you choose investments – Most people would rank this one highest on a financial advisor’s list of responsibilities by a long shot, but it’s actually one of the least important things they can do for you. It’s your asset allocation that will determine the vast majority of your portfolio’s performance over the long run. Choosing the right mix of assets will boost your risk-adjusted returns a lot. Choosing the very best mutual fund within each asset class will only boost your risk-adjusted returns a little. Of course, I highly recommend low-cost index funds over actively-managed funds.

What A Financial Advisor Can NOT Do For You

  • A Financial Advisor can NOT beat the market – I should qualify this by saying that yes, I realize there will inevitably be some financial advisors that do end up beating the market. The problem is, you won’t be able to pick them out in advance. Beating the market should not be any financial advisor’s primary goal. Rather, their goal should be to get you where you need to be with as little risk as possible. If an advisor tells you they can easily beat the market or promises large returns with little risk, run don’t walk to the nearest exist, being sure to keep a hand on your wallet the entire time. Anybody claiming they can easily and reliably beat the market is either a.) Warren Buffett, or b.) a liar. And if you manage to talk Warren Buffett into managing your portfolio, I want in on that.
  • A Financial Advisor can NOT do better than a knowledgeable and disciplined individual investing by themselves – If you have the the knowledge to intelligently design your own portfolio following the principles of modern portfolio theory and the discipline to stick to your chosen plan no matter what, a financial advisor probably can’t help you. Why? Because of costs. Advisors don’t work for free, and no matter how invaluable sound financial advice can be for unsophisticated individuals, it’s not worth much to experienced DIY’ers. All else being equal, the portfolio with the lowest costs will always come out ahead, and very few honest advisors are going to be able to earn enough excess return to compensate for fees they charge. A word of caution, however:  be sure you don’t overestimate your abilities! There’s no shame in asking for advice if you need it.

So Who Needs An Advisor?

You definitely need the services of a good advisor if you:

  1. Panicked and sold out after the last market crash. If you sold out after the last crash, you don’t have the discipline required to invest effectively on your own. There’s nothing embarrassing about that. As it turns out, most people don’t. It is what it is.
  2. Can’t name at last  3 different asset classes and how they fit together in a portfolio. If you can’t name at least three different asset classes (the fewest I would ever recommend anybody owning) and explain what each brings to the table relative to the others, you aren’t knowledgeable enough to invest on your own. You should either educate yourself by reading a few basic books or seek out a qualified financial advisor. For books, I recommend The Four Pillars of Investing by William Bernstein, All About Asset Allocation by Richard Ferri, and Oblivious Investing by Mike Piper.
  3. Just plain aren’t interested. Most people probably fall into this category. If you simply aren’t interested in the topic, chances are you’ll never learn enough about it to do it effectively. After all, people tend to have a hard time studying a subject they don’t enjoy. Financial advisors were invented for people like you.
  4. You have unusually complicated estate or tax issues. Some people just have more specialized needs than others. An example of a complicated situation that begs for the involvement of  a professional would be if you were the primary guardian of a disabled child or adult and wanted to make absolutely certain they were provided for if something were to happen to you. This just isn’t a situation most people are going to be able to handle on their own.

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10 Responses
  1. 2011 March 3

    Great post. Too many people think that a financial advisor’s role should be picking market-beating investments, which is bound to end in disappointment for everyone. I wish advisors would do a better job at making a value proposition. Rather than showing clients lists of great funds they have supposedly picked, they should go through the points you listed.

    Unfortunately, investors are part of the problem. They expect market outperformance, and they’re unlikely to admit that their own bad behavior is the biggest obstacle to their success!

  2. 2011 March 3
    Rob permalink

    Nice post.
    Foe me, part of the confusion is all the titles out there and what they can and can’t do for you. Do I need an Investment Advisor, Financial Advisor, Financial Planner. My Bank and Insurance Co. say they can do it all too.
    A Financial Plan based on Asset Allocation is not much of a plan. The more diversity in your plan forces you to the mean return, historically 6-8%. I’ve had Financial Advice that started with the disclaimer, “If we can 10, 11, 12% returns you will be OK”. Really!!!!

    Find a Planner that can attract additional cash flow in the form of Tax Savings, Interest deduction, Investment Growth, Tax Compression etc to a realistic investment strategy. This way rate of return from the market is secondary to you reaching your goals. Realistic growth in that 6-8% range over a long period (15-25 years).

    Find a planner that really knows and understands the power of Math. I did, and I can believe how much money was being left on the table.

  3. 2011 March 4

    I’m planning on getting my CFP. It actually seems like a great career choice.

  4. 2011 March 5

    “A Financial Advisor can NOT beat the market” Very true but most clients should not be 100% in the market. If your 80% or more in the market you should be able to beat it. My followers do!

  5. 2011 March 5
    dmac permalink

    I think you are confusing financial advisor with investment advisor. A good financial advisor will talk about much more than investments – in fact, investing is a small piece of the overall pie, albeit an import one! A good financial advisor will look at your cash reserves, your income and expenses, your insurance, your estate documents, your taxes, your investments, and much more. If you advisor is not doing these things, you need to find a new one. If all your advisor talks about is investments, then he does not have your best interests at heart and is just wanting to make money off of you. What good is an advisor who has “beat the market” if he has not helped you take advantage of all of the tax-deferred and tax-free investment vehicles offered? What good is an advisor who has an elaborate investment scheme – whether active OR passive – who does not help you adequately plan for your insurance needs and you have a tragic, life-changing event that catches you under-insured??

    Tragically, the myth is that if you understand investing (proper asset allocation, low cost index funds, not chasing returns, etc), you can do your own finances. You might be able to do your own investments but you will fall terribly short of the comprehensive financial planning that is offered through a Certified Financial Planner with your best interests at heart.

  6. 2011 March 5

    I’m pretty certain I covered all that towards the bottom. I absolutely believe a sizeable portion of the population can do everything a CFP can do and more, including all the non-investment related items you mentioned. For example, I do just fine. The type of comprehensive financial planning you can get from a CFP really isn’t all that complicated or difficult to do yourself provided you know the basics. You also have to take into account the fact that good financial planners are extremely difficult to find. Saying something like “work with a good financial advisor” is not particularly useful advice if a person is then likely to go out and find a bad one (not knowing the difference). But I could write a book on that subject alone.

  7. 2011 March 7
    A.J. Horst permalink

    I would advise people to be vary weary of financial advisers. Make sure they either have strong recommendations, or you know them personally before trusting them. I know a few financial advisers, and they are more salespeople than anything else. Their incentive packages all revolve around getting their clients to do what is most profitable for the firms they represent.

    Take a look at this article in the Wall Street Journal tittled “Copying Wells Fargo, Banks Try the Hard Sell”


    Essentially, banks are trying to increase their profits by “hard selling” profitable financial products to their customers. Believe me, YOUR best interests are not their biggest concern. Unless your net worth is over a million dollars, your “financial adviser” will be someone with very little experience, and probably just out of college. They look to hire people with marketing degrees, or with sales experience. They are not looking for individuals with financial expertise.

    They will tend to advise you to take mutual funds and other products with high fees and high commissions. As this article points out, they won’t beat the market, and you will lose in the long run by paying those fees and commissions (compared to the market, I’m not saying you’ll lose money). If you don’t have an idea on how to strategically invest your money, you’ll likely be better off putting it in a few random low-fee ETFs than putting it in the control of a salesperson.

    -A.J. Horst
    President – 3Boost

  8. 2011 March 7
    dmac permalink

    Kyle, I agree that financial advisors have a bad reputation – and with events like Bernie Madoff, they should. However, I imagine that even you could have some weak areas in your financial life that could be analyzed by a highly-respected, highly-recommended financial planner. From insurance to taxes, investments, retirement planning, social security, estate planning, and so on, there is just too much to know for everyone to be good at all of it. There is a reason that half of the advisors that take the CFP test fail it. It’s because it’s extremely detailed – there is so much to know. I know nothing of your background but I sit down with people every day – both rich & poor (i’m not one of those financial planners that won’t see you unless you have $500,000; i’ll see anyone irregardless of their financial situation; I never charge for a meeting so if a client is not in a healthy financial position to be investing money, i don’t make a penny and all of the planning was completely free). All of these people – both rich & poor – could not do the complete job that a financial planner could do. As I said earlier, I know financial advisors have a bad reputation but it’s unfortunate that there are some really good planners out there who really want to do their best to help people and keep costs as low as possible (I don’t run a non-profit; I have to feed my family).

    As I said in my first post, investing is easy. I think anyone can do it – anyone that can keep their emotions in check and not follow last year’s hot fund. However, the investing means very little if they have no estate plan, or they’re under-insured, or they’re not taking advantage of every tax-free or tax-deffered investment account offered to them, or they are not utilizing the most effective social security method given their situation, and the list goes on…

    All I’m saying is that the average investor understands very little about financial planning. They might know a good bit about investments but it fails in comparison to the benefits of professional financial planning – that is where the real value is added. The dollars and cents are added with the investments but the life value is added with the financial planning.

  9. 2011 March 7

    Passing the CFP and managing your own finances are totally different. The CFP tests, unless I’m mistaken, are closed book; you can’t bring reference materials and you have to finish the test before you leave. By contrast, I have all the time and all the resources in the world to learn about a particular issue before pulling the trigger. In fact I enjoy doing so. Most people probably DO need an advisor, but saying the average person CAN’T do it themselves and the average person probably WON’T do it themselves are two different things. I agree that most people won’t bother. Those people need a good advisor. I do not agree that most of those people CAN’T do it themselves. They merely lack the motivation, not the ability.

  10. 2011 August 22
    Jean rakoske permalink

    i inherited a portfolo of stocks, bonds, and cash from my mother; i also agreed to use her particular CFP, who is in another state. So i have never met him, just talked on the phone, At the time my mom passed away, i was just in too much grief to cope with trying to find another advisor. Now, however, although this CFP is very qualified, i want to make a change. This man just makes all the decisions, and i want a more active role in my own finances. V feel very uncomfortable with this arangement. i have been readinga lot of books so that i can be more informed anout what’s going on with my own money.AND portfolio

    i have been interviewing advisors here in my own area, and after speaking with 5, i find none to be what i want. There is a discomfort, and part of it is i don’t want to hand my finances over to someone else! Maybe i just want a different experence than my mother, who left all the decisions up to her CFP. i am sure they communicated and she had initial input as well as access to the CFP when she wanted. Maybe this is because i inherited everything pretty much “as vs” i want to begin to take over my own porfoliom but am the tiniest bit unsure of myself going it alone. Everywhere i look, it’s hire an advisor/planner to handle your portfolio for a 1% fee or settle for a broker who basically does transactions. i want an advisor who just advises and supports if i need and ask for it, but i want to manage my own portfolio. Any suggestions out there?

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