We’ve discussed previously how financial advisors don’t generally ascribe to the Hippocratic oath. People don’t go to work on “Wall Street” for the same reasons that other people become firemen and kindergarten teachers. There are no essays where they attempt to come up with a new way to say “I just want to help people.”
But there is another reason financial advisors aren’t doctors. Financial advisors like to compare themselves to CPAs, attorneys, physicians and other professionals who spend years in training and pass difficult tests to get advanced degrees and certifications. Most advisors, if they took a test at all, took one that required little training and even less experience. Yet they still use lines such as “You wouldn’t let just anyone operate on you, would you?” or “I’m like your family physician for your finances. I might send you to a specialist for a few things, but I’m the one coordinating it all.” These lines are designed to make us feel good about trusting them with our hard-earned dollars and, more importantly, to think of personal finance and investing as something that “only a professional can do.” Unfortunately, believing those lines can cost you hundreds of thousands of dollars and years of retirement.
A more apt comparison, perhaps, would be something such as this:
“I don’t need a professional to mow my lawn, why would I need one to manage my finances?” Just because there are people who would like you to pay them to mow your lawn, doesn’t mean you NEED to hire one. It just doesn’t take much knowledge to run a lawnmower, set it to the right height, and make straight lines. I know, I spent a few summers doing it. My training, like that of many advisors, lasted just a few minutes.
You don’t hire someone to pick out your groceries, select a restaurant for you, pump your gas, clean your house, shovel your driveway, plunge your toilet, organize your garage, plan your vacation, or pick out your furniture. All right, it’s possible you DO hire someone to do some of these things for you, but only because you feel your time is better spent doing something else. Unfortunately, when it comes to your finances, YOUR TIME IS NOT better spent doing something else. It takes so little time to design, implement, and manage a simple yet successful portfolio, that the amount you save/earn by doing it yourself, make these the most profitable hours of your year.
Let me explain. If you have a $500K portfolio, and your investment costs are 2% as a result of your advisor’s fees and the management fees of the investments he has put you in, that is equal to $10K per year. Let’s say it takes you 10 hours a year to manage your portfolio. (I’d say 5 hours a year is closer to what I spend, but I’m being generous.) That’s about $1000 an hour. I don’t care what field of medicine you’re in, there’s nothing else you can do that consistently makes you $1000 an hour. That’s after-tax too! Sure, you have to put in some time up front educating yourself, and you have to design and implement a portfolio, but after that’s its pretty much on autopilot. And as that portfolio grows to $1 Million, $1.5 Million, and $2 Million you’re now making $2K, $3K, and $4k an hour.
So the next time you hear an advisor’s sales pitch, ask yourself if you’re hiring a trained professional like a doctor, or someone like a very expensive house cleaner.
So true…
Just wish i had realized it sooner.
Completely agree with you on this article. It doesn’t make sense to give away 1-2% of your investable net worth each year especially as your assets grow with savings and wise investing. Also, I think it’s rather enjoyable to learn about personal finances and investing. In addition, only you will have your own best interests at heart(not necessarily true for financial advisors).
This is a misinformed commentary. The author clearly hasn’t enjoyed the benefits of a highly competent, sophisticated advisor who has offered returns that exceed those of the general market. Just as there are good doctors and bad doctors, the same can be said for advisors. It is true that there are people who misrepresent themselves in the industry, and it is up to an individual to do their homework and choose someone who has a proven track record with regard to outcomes, ethics, and customer service. As I often tell my patients, ‘you don’t know what you don’t know’, which is why you need the assistance of a professional to help you navigate the complexities of whatever you are endeavoring to manage in your life, whether it be your health or your finances.
I would guess that there are many opportunities the above contributors have missed due to their attitude that would have resulted in much greater benefits than saving the 1-2% on their overall portfolio. But of course, they wouldn’t know that! :)
Perhaps these individuals do have the extra time to spare monitoring the market on a daily basis (to do this properly to ensure you are not losing opportunity or to confidently dodge a disaster requires doing that 2-3 times per day for 5-10 min which equates to at least 10 hours per month, resulting in hundreds of hours per year spent ….you are fooling yourself if you think you can do it right in 5 hours per year….if you can, you don’t have a very sophisticated portfolio and likely are getting mediocre returns). I personally do not have the time to do this in my busy practice with the multiple and extensive demands on my time.
I think the bottom line is this. Any service has a value. You just need to determine the level of personal value that it has for you. Assuming you do your homework and have the opportunity to choose a high level advisor who is well respected in the industry and who has a proven track record for their clients, do you really want to do it yourself, invest your valuable and limited time and make less? I don’t. I will happily continue with my Bay Street advisor and continue to see my assets grow consistently and at great rates that most people I know haven’t been able to achieve on their own.
Ahhh…the dream of successful active management. It lives on. Is it possible? Sure. Is it likely? No. No interpretation of the data suggests that it is. If there are these “high-quality” advisors out there, why are they wasting their time running your $1 Million portfolio instead of a $1 Billion hedge fund? They wouldn’t. So, let’s assume the best advisors are running the biggest portfolios. How does the record look? On average mutual fund, pension fund, and hedge fund managers underperform the relevant indices…before expenses and taxes. The longer the term and the more managers/funds used, the worse the performance gets in relation to the indices. Rather than ending up being “mediocre”, they end up outperforming the vast majority of active investors, especially after considering expenses and taxes.
Simple can be surprisingly sophisticated. When the world’s acknowledged most successful investor suggests buying primarily index funds, you’ve got to wonder if there’s something to it.
The arguments you espouse are those continually put forth by advisors who want to make 1-2% of your money reliably every year, no matter their performance. “Every service has a value.” “You need to monitor the market every day, multiple times a day to avert disaster (despite the fact that disaster in the markets only shows up every few years.)” “You don’t know what you don’t know.” “You should spend your time in your practice and let me do all the heavy investing work.” These all try to capitalize on the investor’s fear (and greed) that there is a magic investing method out there that somehow produces continual outperformance and most importantly, that HE isn’t using it.
The chief value of an advisor is in keeping the investor from shooting himself in the foot due to his own fear and greed. Yes, a completely unsophisticated investor may benefit from handholding to develop a reasonable portfolio and taking an appropriate amount of risk, but that’s awfully easy to learn how to do on your own. The value is not in trying to beat the market. That effort is much more likely to backfire.
Some people feel their advisor is giving them market-beating returns. In my experience, most of these people don’t know how to calculate their returns, or how to compare them to an appropriate benchmark. Once they do, they are generally much more disappointed in the returns produced by their advisor, especially after expenses. Even those few whose returns turn out for a few years to be beating an appropriate benchmark leave you with the question- lucky or good? Unfortunately, it takes decades to really answer that question, and by then, you’re too late. But mostly, if you’re carefully monitoring, you realize after a few years that your advisor is now underperforming and switch to a new advisor, only to see the pattern repeat.
It’s okay to use an advisor, and to be willing to pay for the service you value. But you should realize the price you’re likely paying for the service, and the value of the service you’re likely getting. The service likely isn’t “only choosing the good stocks” and beating the market. And the price is usually far higher than realized. Consider an investor whose advisor costs 2% a year. He invests $50K a year for 30 years. The advisor manages to match the market before expenses (no easy feat over 30 years), so after expenses, he gets 2% less than the market (let’s say the difference between 6% returns and 8% returns.) How much money did the “service” your advisor provided cost you? $1.7 Million, or $57K a year. More than you were investing in the first place. That’s a pretty high cost.
So if you this is what you’re paying, you’d better be darn sure your Bay Street Advisor is really outperforming an APPROPRIATE benchmark by at least 2% a year year in and year out. Perhaps he is, but I doubt it.
“Any service has a value.” Of course, but that value can be zero, or in the case of financial advisors, more likely negative.
I would love to see some data on the out of sample performance of financial advisors, performance predictability, risk adjusted returns after fess, expenses, and taxes. I have asked many people, including advisors, and no one has been able to come up with any evidence on their performance.
Hard to pay someone thousands of dollars a year on faith that there work is worth more than negative thousands of dollars.
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This is extremely bad advice. Statistics show that on average advisors bring an extra 6% over what the do it yourself investor would bring. As the previous individual said. You are fooling yourself thinking that you can do this on your own with ease. A person can go to WebMD and diagnose themselves with 7 different illnesses, Or they can go to a Doctor who does it for a living day in and day out and have their issues solved for a fee. The long term benefit is there. People who dont have advisors tend to get “sold” and react mostly out of emotions. They buy Facebook for no other reason that they are a user. They invest in Iraqi dinar because the concept makes sense. Its hard for the average person to know about an execute 1031 exchanges, oil & gas drilling programs that have a 90-100 tax write off, DSTs, and good quality muni bonds. There is more to this business than just picking a good stock and hoping hat it goes up.
I am glad to learn that you know of the data I requested. Can you provide the citations?
Thanks
I’m really surprised I’ve never run across those “statistics.” I would expect that if there were a high quality study showing it were true that the study would be heavily advertised by advisers…..
Perhaps this is the only piece on the site you’ve read, but the approach championed here is far different than “picking a stock and hoping it goes up” and “investing in Iraqi dinars because the concept makes sense.” (Which it doesn’t, by the way.)
Are there some investors who will do better with a good advisor? Absolutely. In fact, most probably would. But getting paired up with an average advisor is likely to be very bad for the average investor.
I did find this
What is the Impact of Financial Advisors on Retirement Portfolio Choices and Outcomes?*
John Chalmers, Jonathan Reuter
They studied a retirement plan in which participants could manage their investments themselves, or engaged financial advisors. The people who used advisors had higher risk and lower returns.
That’s an interesting study. Here’s a link for those interested.
Basically, those using advisers had a return of 1.81% (Beta of 0.832) and do-it-yourselfers had a return of 3.35% (Beta 0.618 so “lower risk”) for 1999-2009.
It is interesting to note that both groups would have been better off just picking a target date fund (5% a year with an intermediate beta) though! Three cheers for simple investing solutions.
There was a really good comment from Paul after this article here:
Think of this in evolutionary terms. Insofar as the financial advisor is paid directly by you, the fees they can charge up front are way too small to cover researching anything other than “go buy a mutual fund”, yet the average person isn’t going to pay at all for “go buy a mutual fund”. So the advisor is going to have to be paid at least in part by other people. And the other people are going to pay the advisor according to a) how much money they can trouser by getting to hold your money, and b) how unlikely you would be to place your money with them absent the advisor’s recommendation.
Run any kind of simulation with these rules forward a few cycles, and you’ll see that the advisors who give the simple advice have either starved or gone into other lines of work, and the advisors who give complicated, anti-customer advice are the ones who are left. With the most opaque advisors tending to survive longest because customers are less likely to figure the scam out.
This is, not surprisingly, the same kind of pattern that we saw with the MBS bubble, where anyone who thought it was a really bad idea was no longer managing significant amounts of assets.
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Hello, I am a financial planner and a husband of a physician. I feel this post is out of line with what we (financial advisors/planners) really do. Yes, some of us charge between 0.5-2% for assets under management. But we also add a lot of value elsewhere. Here are a few examples….. I coordinate taxes with my client’s CPAs, I coordinate wills and estate planning issues with my client’s attorneys. I structure shelters to help protect my client’s funds from creditors and lawsuits. I help make sure that my client’s funds are protected from volatility in the market with collars, spreads and other derivative instruments.
So, if I am so good why I am I not managing billions at a hedge fund???? Well I went down that path and to be frank I did not want to sell my soul to my career and help no one except for clients with well over a million in assets to invest.
Uneducated….. well I have a degree in Engineering and a degree in Financial Management and passed Series 7, 63, 66 and CFP exams. Let me tell you the CFP is just alphabet soup, some of the most seasoned and brilliant advisors I know have no alphabet soup behind their name.
Furthermore, passive investing…. Yes, I believe in passive investing and I believe one can sometimes get comparable or better results than in an actively managed mutual funds or SMAs. Passive investing is typically done through Index Funds, ETFs, or DRIP plans. However you do fail to acknowledge that there are hidden cost to passively investing also. For example… There is a “turnover cost” in indexing, wherein an index’s pre-announced addition of a new stock allows for opportunistic traders (not advisors) to buy the stock before the indexes do. The cost to S&P 500 index funds was at least 21 basis points annually from 1990-2005 and somewhere between 38-77 basis points annually for Russel 2000 indexes during the same time period.
Lastly, I did not get into this business to sell snake oil or push products or launder money from my clients’ accounts. My job is to manage expectations, emotions, risk and finally money or insurance. Many people who have managed their own finances for many years who meet with me often say the same thing…. “boy I wish I had known that 15 years ago!”
The problem of losing to investors who anticipate changes in the index only appears if one uses narrow indices. If you invest in total stock market funds then these changes in composition take place only with the small stocks that appear and disappear quite commonly. But they are a tiny portion of the total market, so there is not much money to be lost. Index funds are also not obligated to trade instantly. They can use futures and options to attain full exposure to the index without having to completely replicate. They can also use these approaches to accumulate issues newly added to the index, just as would those who seek to exploit the known change in composition.
When I hire a lawyer for help with estate planning I do not pay a percent of assets for this service. I pay for the specific work done, and then nothing unless/until I come back for more help.
The services other than picking investments certainly have some value. One has to wonder whether it makes sense to pay a percent of assets, rather than a simple hourly fee.
JH-
Thanks for reading. As you are well aware there is a very large amount of variation among those who call themselves advisors/planners. A small percentage are well-educated and put their client’s interests first. If you are among that small percentage, then much of this post doesn’t apply to you.
I do have a few comments regarding issues you bring up.
1) 2% is highway robbery.
2) What does it mean to “coordinate taxes?” Really. You send the paperwork to the CPA? You call the CPA when contemplating buying and selling investments?
3) Same questions with regard to wills and estate planning. I’m not sure I understand why one would need an additional advisor to “coordinate” anything. I think that’s marketing. Perhaps if the 1-2% I’m paying the advisor also covered all the costs of the accountant and the attorney then it might be worth it to me.
4) What’s wrong with advising clients with more than a million? It seems like many docs ought to get there at least by halfway through their career! (Just giving you a hard time, I see what you’re saying.)
5) SOMETIMES you can get “comparable or better” results using passive investing? Surely you mean most of the time (nearly all the time over long periods) or you’re not that familiar with the academic literature on the subject.
6) S&P 500 index funds and Russell 2000 index funds do lend themselves to “front-running.” I generally avoid these whenever possible. As mentioned above using total market funds pretty much avoids the problem. Most of the hidden costs of mutual fund investing are far lower for a passively managed fund vs an actively managed one.
7) You and I know that what you do best is manage expectations, emotions, and risk (although I disagree with you about the value of regular use of derivatives.) But most unsophisticated clients think they’re hiring you to get higher investment returns than they could otherwise get. No wonder they get so mad when they realize that not only can they do just as well by investing auto-pilot into a handful of various index funds, but they can have a better post-fee return. Most clients aren’t willing to pay you 1-2% of their assets every year to “manage their emotions” (even though many should.)
I agree that most people in the financial services industry are merely salesman working on commission or selling products they gain from financially. But if you are able to find a good, relatively low-fee investment advisor working for a fee-only RIA firm that only uses passive portfolio management and spends time on education, counseling, and promoting discipline even during the most strenuous periods, they can be worth their weight in gold. Case in point: we know that over $1T has left equity mutual funds in the last 5 years (much of it after the stock market rebound), and almost $400B has gone into bond mutual funds (despite record low interest rates). A good advisor would be fighting to keep their clients from making similar mistakes, just as they kept them from indulging in the 1990s tech bubble, panicking in 2002, overweighting real estate and emerging markets in the mid-2000s, and gold and other currencies today.
Further, advisors can often achieve more complete diversification across equity markets because some asset classes aren’t available in retail index fund form and traditional indexes fall short in other areas such as smaller stocks and value companies.
Most individual investors, to the extent they do possess the discipline to stay with their plan over time and the knowledge to index their portfolio and not give into the performance chasing bug will still hold mostly US total stock, Int’l total stock, and total bond indexes.
David Booth wrote an excellent article over 10 years ago discussing why this approach isn’t the only way to “index”, and why more diversified portfolios are superior: http://www.seiler-associates.com/downloads/DFA2/IndexEnhancedIndexFunds.pdf
From 4/2001 (date the article was published) through 7/2012, if we compare a 42% Russell 3000 Index, 18% MSCI All Country World ex.US Index, 40% Barclays Total Bond Index (no fees) with the portfolio listed in the article above (net of DFA fund expenses), we see an annualized +7.3% for the asset class portfolio and 5.8% for the total market mix. Both portfolios had 3 negative years since 2001 (01, 02, and 08 for the total market mix and 02, 08, and 11 for the asset class portfolio) with the total market mix declining -11.5% on average vs. -9.3% for the asset class mix.
And, mind you, 40% of both these portfolios were in bonds, yet the total bond index has an average maturity of almost 7 years, which benefited extensively from the anomalous period of falling rates, vs. just a 2 year average maturity for the DFA short and ultra short bond strategies. If rates had risen, and not fallen, the asset class advantage could easily have been double the 1.5% over this period.
Most investors would find, if they could find an advisor who meets the criteria above, has expertise in assembling balanced asset class portfolios, managing taxes through tax-managed funds, asset location, and periodic tax loss harvesting, and charges something in the 0.5% to 0.75%, they’d be incredibly fortunate.
Also, on the topic of “if advisors were any good they’d run a hedge fund or be managing multi-billion dollar pensions/endowments”. Unfortunately, the world doesn’t work that way.
HFs mostly charge 2% and 20%, which is far above the 0.75% I mentioned above that is reasonable. And these large pools of wealth do not believe in index fund investing, and if they do, are unwilling to tilt to small cap and value stocks globally despite their diversification benefits because of the “tracking error” that comes from deviating from the market. So this isn’t really an option as many of these plans are still stuck in the dark ages.
Don’t believe me, lets just look at the last 10 years of returns for college/university endowments through 6/2011 (see here: http://www.nacubo.org/Documents/research/2011_NCSE_Press_Release_Final_Embargo_1_31_12.pdf) +5.6% vs. a +5.9% return for a 20% TBM, 24% Total Int’l, and 56% Total US Stock Index and +8.6% return for an 80/20 version of the asset class portfolio I mentioned above.
And big state pension plans are no better, (see here:http://www.cliffwater.com/research/Cliffwater%20Research%20-%20Trends%20in%20State%20Pension%20Asset%20Allocation%20and%20Performance%20June%202012.pdf) with the median fund returning +5.7% over the last 10 years, with the top performer at +7.1%, which all pale in comparison to a 60/40 version of the above asset class portfolio earning +7.8%
Good posts Eric. I agree that paying something in the neighborhood of 0.5-0.75% is a reasonable price for GOOD financial advice and investment management. I also agree that there’s a high likelihood that using a riskier (and in some ways more diversified) small and value tilted portfolio instead of a total market portfolio could more than make up for the advisory fees. I also agree that one of the chief benefits of using a GOOD advisor is enforcing discipline. You only have to buy high and sell low once to eliminate the benefits of saving years of management fees by doing it yourself.
I think you missed my point about running a hedge fund. I’m not suggesting that hedge fund managers or endowment managers are particularly smart or possess the ability to outperform the market. I agree the data doesn’t seem to agree with that. My point was that your financial advisor can’t predict the future. That gift is so rare, that if he could, he’d be running a lot more money and collecting the AUM fees on that larger sum rather than sitting across the desk from you and talking about your budget and your $250K portfolio.
WCI,
I think you’ve done an incredible job at organizing a great deal of relevant financial information (budgeting, savings, insurance planning, etc) for doctors. Even as a former advisor to residents, I agree with a great deal of your opinions regarding the profession. The old phrase was “if you could fog a mirror” you’re allowed to be an advisor. This surely doesn’t add credibility to the industry.
With all that said, I do somewhat disagree with some of your stances regarding the “value” of an advisor. When it comes to investing, you are 100% correct by saying that it is relatively easy for anyone, not just doctors, to set up a strong portfolio after a brief understanding some simple investment strategies. Also, how very few advisors can pick investments that will “outperform.” I’ll take that point a bit further by saying ZERO advisors can consistently do this.
As it relates to managing your money, an advisor’s biggest responsibility is to manage the emotions of an investor when times are really good and really bad (selling at the bottom and buying too much at the top). There is a great company out there called Dalbar. They focus on measuring the behavioral effects on investment returns. According to their data, between 1991-2010 the average investor had an average annualized return of 2.6%. The S&P 500 did 7.7% per year on average and a “standard diversified portfolio” earned 7.99 (data was sourced from J.P. Morgan’s 2011 3Q publishing). Clearly there is something going on here. The black and white S&P 500 had an additional 5.1% annualized return difference. There in lies the value of having an advisor. It is no different than having a personal trainer. You’re just as capable to manage your finances as you are to force yourself into the gym to stay fit, but as I’m sure you know, very few people stick to a healthy workout program. From an investment standpoint, an advisor’s job is to make sure you don’t cut your foot off. If you’re perfectly capable of doing this on your own, then I agree why pay 1% (you keep referencing 2% when standard advisor fee is most likely between 1-1.25% depending on account size and decreases as your balance grows) for something that could have been handled in a couple minutes?? The problem is that most people cannot manage their emotions when it comes to investing as the data suggests.
Keep up the good work with your informational posts. Your target audience needs you!
-D
I agree with you that this may be the primary benefit of an advisor. While I agree that 1% is a commonly charged fee (and at the upper limits of what I would consider an acceptable fee), I see far too many advisors charging 1-2%, then tacking on another 1-2% in expense ratios on actively managed funds.
Why Doctor’s aren’t astute businessmen should be your next blog post.