What A Financial Advisor Can And Cannot Do For You
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:
- 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.
- 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.
- 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.
- 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.