Should I Hire An Investment Manager? Friday Q&A Series

I get versions of this question all the time so I thought I’d formally address it.

Q.

I’m trying to decide whether I can or desire to go on my own and create a balanced index portfolio and stick to it or enlist the help of [a reasonable low cost advisor] to aid in the process. I just don’t know if the value is there to hire advice when funds are so accessible and the process doesn’t seem too complicated.  What do you think?

A.


I obviously believe it is a reasonable option to manage your own investments, since I do it on my own.  It certainly helps if you have an interest in it. In fact, as the typical financial planning tasks go (financial planning, estate planning, asset protection, tax preparation, insurance etc), I think investment management is without a doubt the easiest to do on your own.  There are really only 3 components to it, none of which I personally find to be very difficult.  First you develop a reasonable, low-cost, diversified plan that includes saving enough money in a tax-efficient way.  Second, you maintain the plan, directing new contributions as needed and rebalancing periodically. Last, you avoid doing stupid things, like selling out after the market plunges, chasing hot stocks, or trying to time the market.

Most physicians and similar professionals find they don’t have the time, the interest, the (admittedly low level of) expertise, or the emotional fortitude required to do these three tasks. That’s okay.  If they hire someone good that just means they earn 0.5-1% per year less than they would if they could do it on their own.  This can be made up for by saving a little more or working a little longer before retiring, neither of which many doctors find difficult.  For example, if you needed $2 Million to retire, were saving $50K per year, and could make 5% a year without an adviser or 4% a year with an adviser, using the adviser would mean you’d need to either work 2 years longer or save an extra $7000 per year.  One other benefit of doing it on your own is that due to the lower expenses you can actually take less risk and end up with the same outcome.

The worst possible thing you can do, however, is to try to do it yourself, then fail spectacularly after a couple of decades.  This is usually due to an inability to control investor behavior.  Now, using an adviser doesn’t always prevent this (in fact several docs I know who sold out in 2008 had advisers, some of which tried to prevent this behavior and some of which encouraged it), but on average a solid adviser provides the most value here.

If you think you’d like to try it on your own, I encourage you to give it a try early in your career.  It’s much easier to make mistakes (or just lose money due to market fluctuations) when you’re dealing with a 4 or 5 figure portfolio than when you’ve got hundreds of thousands to lose.  In my experience, it gets much easier as time goes on.  I looked at my portfolio daily when I was first starting out, but after passing through a couple of bull markets and one big bear, now I only look when I need to add new money (in fact as I write this the stock market is having its worst day of the year so far).  Reading sites like this one or the Bogleheads forum and reading a good investment book or two a year will help you accomplish the necessary tasks and develop the habits and investor behavior necessary to be successful over the long run.

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Comments

Should I Hire An Investment Manager? Friday Q&A Series — 10 Comments

  1. im surprised somebody hasnt created a program that lets you answer some questions and then invests you in index funds based on those choices. Over time that should greatly reduce the costs of the advisor. When you try and sell low, it can pop up with information that this isnt typically a good idea and then if you are really still worried about what to do links you to a consultation for a fee. That person would in essence again try and convince you to stick with the plan. The costs you mentioned arent that trivial to me. Im amazed at how some docs will use cheap suture or under pay a good employee but for something of questionable value (which is what i think this is personally), they actually will be willing to over pay.

  2. Hey Jim- Thank you so much for this thorough and remarkably even-handed post. I agree with you, especially the part about “avoid doing stupid things.”

    Yesterday I had a meeting with the first doctor who I ever served, going on 15+ years now, and we did a post-mortem of all the investment stuff we’d done together over that time.

    She started investing with me when she was still wet behind the ears in practice, and she started at probably the worst time in the past 50 years: Jan 12 of 2000. And at that time, I was admittedly more dangerous and less wise than I am today. Fortunately, I (we) stuck pretty much to index funds, including ETF’s, and “didn’t do anything stupid”.

    Given that she lived and invested through The Lost Decade and, given that her accounts today are worth more than the sum total of her contributions, we both agreed that this was “success.”,Today she’s on track for a very comfortable retirement, even after fees and expenses are accounted for (and fully disclosed).

    As I stood up from that meeting, I told her I believe the reason we were successful has as a lot to do with what we did but it has everything to do with what we didn’t do: the stupid stuff.

    And as we reminisced about stupid things not done, we made a list–a remarkably long list–and for every item on it, we both knew at least one doc who had succumbed to the stupidity.

    In the end, I believe that was the greatest value I could deliver as a financial planner who also wears an investment manager hat. And now I believe that if this is the only thing an advisor does for you, they’ve pretty much earned their pay.

    Thanks again for a clean post, and for giving us investment managers a fair shake, too.

  3. Great response. I too agree investment management is the easiest and probably lowest value added area surrounding personal finances. I’ve also wondered if “reasonable low cost advisors” actually do the 3 components you mention. Do they assist with tailoring your portfolio for tax efficiency, deciding what the proper saving/spending rates and level of risk to take is, and keep you from making stupid mistakes? I’ve beat around the bush asking this on a couple of forums, but maybe I should just call one directly. I was hoping to hear from an unbias source though. My take is they seem to be a portfolio management service that once you pick their model portfolio they will rebalance for you. For me the problem is I believe this is the area of least importance.

    For the same reasons mentioned above I think Rex’s computer program idea has little value. In fact I think a number of them exist, but to be successful the key is to focus on what you can control relative to your unique situation.

  4. Rex-

    The more docs I talk to, the less faith I have that they can manage their own investments 1% worse (or less) than a good portfolio manager could. That’s what we’re really talking about. Can it be done? Sure. Will most docs do it? I have my doubts. Lack of interest, lack of knowledge and willingness to acquire it, and lack of emotional fortitude are the key missing ingredients. Start talking to your colleagues and you’ll see what I mean. Even just reading a handful of investing books is “just too hard” for many. Sad, but true.

  5. Investing is just like coding. At first docs want nothing to do with it. Once they realize however that they will work a lot more because they dont understand coding, they sing a different tune. Sometimes it takes a while for them to see that. They hire some professional service to do all the coding but find out that it really isnt done that well and the service is expensive. Once most docs realize that IF they find a good advisor (and the odds are against them) that they will need to work 2 more years and that most likely they will work a lot longer since its next to impossible to find one worth the costs, they will sing a different tune. Try talking to your friends and you will realize every one of them thinks their advisor is helping them to beat the market and that most have been pitched whole life as an investment.

  6. @ White Coat Investor

    once someone has read the top 15-20 good personal finance books you’ve talked about or recommended, what do you recommend as “ongoing” reading to keep someone up on the latest trends and happenings?

    I don’t like CNBC… they seem to geared towards daily or monthly or quarterly action.. . not long term investing.

    But I have a subscription to Kiplinger’s Personal Finance, Money Magazine, Barron’s, read this website and my local daily paper has a weekly business section.

    What do you do to “keep up”?

  7. You may want to hire an investment manager but be very sure that the manager is not receiving any commissions or kickbacks from anywhere. I think it is very difficult to find an investment manager who is working for your best interest and not his own best interest.
    Do you know of any evidence based studies that would support your contention that median investment managers are 1% more successful than a index based target mutual fund? Of course, in hindsight a “good” manager will be more successful, but I do not believe that one can choose one prospectively.
    Anecdotally, some advisors are much worse than average. Do you remember Bernie Madoff?

  8. Penguin-

    I’m not suggesting an investment manager can do it 1% better than an index based target mutual fund. I’m suggesting an investment manager can do at least 1% better than an index based target mutual fund held by someone who buys high and sells low. Figuring out a target retirement fund is a good solution is 50% of the battle. The other 50% is staying the course.

    Dr. Cheap-

    I think you’re doing plenty. In fact, I’d drop at least half of what you’re doing. Just like CNBC is pretty low yield (perhaps negative) so is Money, Barron’s, Kiplinger’s etc. Honestly, once you’re set there’s not much else you HAVE to do. Every year or two something new comes up, such as the backdoor Roth IRA or HSAs or a significant tax law change. Personally, I find internet forums like Bogleheads or blogs such as those in my blogroll are far higher yield than mainstream investing TV, magazines, and newspapers.

    For example, Fox business first talked about a backdoor Roth in July 2012. Forbes first mentioned it in January 2012. Wall Street Journal? April 2012. But you could learn about it from the Bogleheads forum in December 2009, before it was even possible (January 2010). The Finance Buff had a complete “how-to” guide on the web by December 2010.

    Add one good book a year and I think that’s plenty.

  9. I am having trouble wrapping my mind around paying an advisor 1% per year for 60 years. That means that the advisor ends with more of my money than I do (actually I keep 55%).
    You suggest:
    If they hire someone good that just means they earn 0.5-1% per year less than they would if they could do it on their own. This can be made up for by saving a little more or working a little longer before retiring, neither of which many doctors find difficult. For example, if you needed $2 Million to retire, were saving $50K per year, and could make 5% a year without an adviser or 4% a year with an adviser, using the adviser would mean you’d need to either work 2 years longer or save an extra $7000 per year.
    I think the number $2 Million to retire is calculated assuming that you need $80,000 per year and multiply $80,000 by 25. But wait, if you need $80,000 per year to live on and you have to pay $20,000 per year to an advisor then you need to withdraw $100,000 per year to keep $80,000 for living expenses. Multiply $100,000 x 25 and now you need $2.5 Million to retire. That means an extra 5 years longer to work. Instead of retiring at age 65 now you have to wait until age 72.
    This is getting out of control with paying an advisor, or are you assuming that you no longer have to pay him after you retire?
    I think a more realistic real return would be 3% per year, 2% if you pay an advisor. My reference is here: http://www.bogleheads.org/wiki/Historical_and_Expected_Returns

  10. It’s scary just how much 1% adds up to. It’s also scary what a large percentage of your gains that is in a low-return environment. This is one reason I learned to do it myself.

    I do think you’re a little overly pessimistic though (as are many Bogleheads.) Think of it this way. If you do nothing with your retirement portfolio but buy 0% TIPS, your absolutely guaranteed safe withdrawal rate for 33 years of retirement is 3%. Yet lots of Bogleheads are trying to convince people they should only be withdrawing 2% a year. Give me a break. Likewise, if it turns out you’re only getting 3% real returns over a period of 20 or 30 years, are you going to quit working at the time you planned? And are you then going to take the amount of income you previously planned on having? No, of course not. You make adjustments, just like you do with everything else in life. And you console yourself that no one else is doing any better, so you’re still relatively just as rich as you previously expected to be.

    That link suggests expected real returns on stocks of 3.5-9% and expected real returns on bonds from 0 to 5%. Those are awfully big ranges, but if you take numbers in the middle of those ranges (2.5% real from bonds and 6.75% real from stocks) and a 50/50 portfolio, you’d end up with an expected return of 4.75% real, which is about what my portfolio has made over the last 8 years through what is billed as the worst market since The Great Depression. So yes, I understand the arguments for lower future returns, I just find them a little too pessimistic. But I do have plans if that future turns out to be the one we live in- mostly working longer and living on less in retirement.

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