I frequently see articles about why you should hire a financial advisor, especially an asset manager. Recently, OJM, a physician-focused financial advisory firm, sent me a link to a newly-written article on the subject. I don't mean to pick on them, because I've seen dozens of articles like this one. They provide some useful information, but the main point of these articles is that # 1 You need an investment adviser, # 2 Your investment adviser should have certain characteristics, and # 3 Our firm has those characteristics. Just about every adviser has written one of these articles at some point, but they are inevitably self-serving.
This article was particularly bad in the nine reasons it gave for hiring an investment adviser. In this post, I'll go through them, point out why a do-it-yourselfer should have no difficulty at all with the outlined issues, and then list a few reasons why I think hiring a financial advisor might still be a good idea for a physician.
# 1 Active Trading is the practice of engaging in regular, ongoing buying and selling of investments while monitoring the pricing in hopes of timing the activity to take advantage of market conditions. Active traders underperform the market.
Okay, if you absolutely cannot resist the urge to day trade your investment portfolio and engage in market timing, you should pay someone thousands of dollars a year to take your money away from you so you quit doing stupid stuff.
# 2 Disposition effect is the tendency of retail investors to hold losing investments too long and subsequently sell winning investments too soon. Most people, especially investors are risk-averse—even more so when handling their own investments.
This problem is easily solved by writing down an investing plan, and following it. The truth is that selling winners and buying some of what has been doing poorly lately (or at least directing new contributions there) is an important risk-management tool called rebalancing. I don't find investors any more risk-averse than non-investors either.
# 3 Paying More Attention to the Past Returns of Mutual Funds than to Fees. Many investors, including physicians, pay too much credence to the past performance of mutual funds while virtually ignoring the funds’ transactional costs, expense ratios and fees. These types of fees can have a significant drag on the performance of your portfolio if they are not accounted for.
I agree that minimizing investment expenses is critical in a successful investing plan. However, the largest fee that an advised investor faces is the one he pays to the advisor. No mention of that here. You want low fees? Do what your advisor is now doing and pocket the the fee.
# 4 Familiarity bias is the tendency of many investors to gravitate towards investment opportunities that are familiar to them. This bias leads to investing in glamor stocks or glamor companies, investing too heavily in a local stock, or employees investing too heavily in their employer’s stock. A good advisor will work to ensure you are aware of being overly concentrated in certain areas and will seek to keep your portfolio properly diversified in order to limit exposure.
Diversification is so easy to obtain that it seems silly to hire an adviser just to keep you from putting all your money into the stock of Apple, a local bank, or your hospital corporation. It only takes 5 minutes on Vanguard.com and only costs 5-20 basis points a years to buy essentially all the publicly traded stocks and bonds in the world in a single fund of funds.
# 5 Mania/Panic. Mania is the sudden increase in value of a “hot” investment, wherein the masses rush to get in on the action. Panic is the inverse, where everyone tries to abandon a sinking ship. What is the next “bubble”? When will there be another “crash”?
The advisor's crystal ball is just as cloudy as yours. Yes, they might be able to keep you from doing something stupid (like going all in to tech stocks in 1999 or going to cash in March 2009), but simply following a written investment plan seems easier and more reliable than paying an investment adviser to hold your hand when the market does what any beginning student of market history knows it is going to do every 5 to 10 years.
# 6 Noise Trading often takes place when the physician-investor decides to take action without engaging in fundamental analysis. When investors too closely follow the daily headlines, false signals and short-term volatility, their portfolios suffer. Long-term plans require picking investments via economic, financial and other qualitative and quantitative analyses.
This reason seems to imply that through high quality analysis, the advisor can figure out what is going to do well in the future and what isn't. I think the extensive studies on the inability of mutual fund managers to beat the market can be applied as well to your neighborhood advisor's ability to do so.
# 7 Momentum Investing is the practice of buying securities with recent high returns and selling securities with low recent returns assuming that past trends and performance will continue. Chasing momentum leads to speculative bubbles with the masses inflating prices. Similar to manias and panics, retail investors are often the last ones to know either way, causing them to often jump on a security experiencing momentum at the wrong time, usually buying high and selling low—with obvious detrimental effects on their portfolio.
Two issues with this one. First, academic data on momentum shows that it isn't necessarily a bad “factor” to exploit in your investing plan. Second, following a written investment plan will keep you from buying high and selling low, no advisor required.
# 8 Under-diversification happens when the investor becomes too heavily concentrated in a specific type of investment. This increases their exposure by having too many eggs in one basket. It goes without saying that any long-term investment plan requires diversification. However, investors, including physicians, generally need the assistance of an advisor to diversify correctly.
We already discussed this one under # 4. You should diversify. I disagree that investors, including physicians, generally need the assistance of an advisor to diversify “correctly.” It's really a pretty simple task.
# 9 Naïve Diversification is the practice of a physician-investor deciding to diversify between a number of investments in equal proportions rather than strategic proportions. Proper diversification in the investment arena is not simply putting X asset classes in X equal percentages. Rather, a proper allocation strategy should weight your differing investments in a manner aligned with your personal risk tolerance in order to build value over the long term.
As discussed in # 4 and # 8, you should design a long-term investing plan where your money is diversified into many different assets in accordance with your goals. If you need someone to help you design that plan, you can hire someone at a fixed or hourly rate, then maintain it yourself. You certainly don't need to pay $20,000 every year to maintain that plan.
Now, here are six reasons why you might want to consider hiring an investment manager.
#1 You are an ignorant investor
One of the best reasons to hire an investment manager is because you don't know what the heck you are doing. There is no doubt in my mind that you are better off paying any kind of reasonable asset management fee (whether an hourly rate, an annual retainer, or an AUM fee) if you are not going to do the job properly yourself. While it is great to save the $1000-$30,000 you may pay an investment manager, you're not saving any money if you're just screwing around with your investments, or worse, not investing at all. Now, I think physicians are plenty smart enough to figure out how to manage their own investments. The knowledge base is far easier to learn and deal with than medicine. But if you haven't bothered to educate yourself about the process, or don't plan to do it, then hire a good advisor. It'll be worth the money. That said, hiring an advisor may only be a temporary step for you while you educate yourself through reading, watching what the advisor does, and peppering the advisor with questions about what he's doing.
# 2 You are an undisciplined investor
Another fantastic reason to hire an advisor is if you are an undisciplined saver or investor. If you can't manage to save 15-20% of your income each year by yourself, but you can do it with a coach, then the advisor is worth the fees. Likewise, if you cannot stay the course with your investing plan during a market down turn (and don't fool yourself-many educated investors bailed out in 2008, locking in retirement-spoiling losses), then you're better off paying thousands a year to get someone who can do so to manage your money. Just one big episode of buying high and selling low late in your career will pay for decades of advisory fees. This, of course, assumes that you can stay the course with the advisor's assistance (and that the advisor can stay the course!)
# 3 You don't enjoy investing
If you don't find investing at least a little bit interesting and you aren't willing to dedicate at least a little bit of time to it, then you're better off with an advisor. In my experience, about 80% of doctors don't really want to deal with their money in any meaningful way. They really just want a “money guy” they can trust. With appropriate coaching they're willing to save enough and they're willing to follow a reasonable plan. But they're simply not going to get off their duff and do it themselves. It's not necessarily laziness. They're busy and would rather use their time and limited brain energy doing something else. Those 80% are probably better off with a high-quality advisor giving good advice at a fair price.
# 4 Your investment manager is providing valuable financial planning
The real bang for your buck from an advisor isn't the investment management anyway. Investment management is not only easy, but it doesn't require much time. Aside from my own portfolio, I manage my parent's large portfolio. It takes me about 10 minutes a year. I'm serious. There just isn't that much to it. You set up a plan, and then you follow it. It seems a little silly to me that someone would charge $10K a year to do it (the “going rate” on my parent's portfolio, although they were paying far more before I rescued them from an “advisor” who was not only expensive but incompetent.)
But financial planning, now that's useful stuff. I'm talking about figuring out what to do with your student loans, how much insurance and what type to buy, how to budget and how much to save, which types of accounts to save in, deciding how much to put toward different goals, figuring out withdrawal strategies, deciding when to take Social Security, how and when to do a Roth conversion, figuring out estate planning and asset protection options etc. That's useful stuff and well worth paying a fair price for.
It requires far more face time and energy from an advisor to do that, of course. They'd rather just rebalance your index fund portfolio (or have the computer do it) mail you a statement or two, and have lunch with you once a quarter while chatting about interest rates and what's going on in China. But if you're getting real, high-quality financial planning thrown in for your asset management fees, well, that's worth quite a lot. However, I think it is far more difficult to find a high-quality, physician-specific financial planner than it is to find a good asset manager. That's because for some reason people aren't willing to pay a flat or hourly rate for financial planning, but they have no problem paying a much higher AUM that seems to come out of their profits. Investment management fees would come way down if people had to physically write a check (or better yet pay in cash) to their investment manager every quarter.
# 5 You wish to use adviser-only funds such as those offered by DFA
If you're going to pay an adviser anyway, you might as well get access to some of the “bells and whistles” passive funds like those offered by DFA, AQR, Bridgeway, and similar firms. I'm not saying your entire portfolio should be in those funds (I once compared a Vanguard portfolio to a DFA portfolio and came away unwilling to pay an advisor JUST for DFA funds), but I wouldn't hire an investment advisor who didn't have access to them.
# 6 You can get high-quality investment management at a fair price.
It seems silly to me to pay someone $30,000 a year to manage my assets when there are firms out there (including several advertisers on this blog) willing to do it for $1-5,000 per year. Investment management should also be shopped (at least partially) on price just like anything else. If AT&T and Verizon provide you identical services, you go with the cheaper one. Same with Jiffy Lube vs Wal-mart, or even a knee MRI when you have a high-deductible health plan. Why should investment managers somehow be exempt from this process inherent in a capitalistic society? They shouldn't. Shop around, negotiate fees, and renegotiate. It's amazing how quickly those fees come down when you mention words like “Vanguard” and “Do it myself.” Good advice is most important, but you want to get it at a fair price. The worst price, of course, is “free,” since that implies the advisor is being paid on a commission basis. That usually results in you landing in inferior investments like loaded, high-cost mutual funds, annuities, and cash value life insurance.
While do-it-yourself investors are the ones most likely to read a blog like this one, I know plenty of my readers, especially occasional readers, would still like an advisor. That's fine, but hire a high-quality advisor for the right reasons and make sure you're not paying too much for the advice.
What do you think? Do you use an advisor? If so, what are the biggest benefits you see from the relationship? Comment below!