I am often asked for recommendations both on how to choose a financial advisor, as well as people asking specifically for recommendation for a specific financial advisor. My mantra with financial advice is “Good advice at a fair price.” However, when it comes down to specifics, I am often left with a conundrum of one sort or another. You see, I haven't yet found the perfect financial advisor to send blog readers to.
The Do It Yourself Financial Planning Solution
Sometimes people asking for a financial advisor recommendation are simply asking the wrong question. Perhaps what they should be asking is, “Do I need to hire a financial advisor, or if I am willing to put in a reasonable amount of effort and discipline, can I do this on my own?” You see, although I often recommend advisors, and have sold ads to many of them, it is pretty easy for readers to see that I'm not paying anybody else to do my financial planning or asset management. “That's fine,” you may say, “but you're The White Coat Investor! Of course you don't need a financial advisor.”
Well, the truth is that you don't have to know everything (not that I do) about finance to take care of your own finances. You only have to know the parts that apply to you. For example, I would have never learned anything about how student loans or student loan refinancing works if I wasn't writing this blog. It just doesn't matter to me. Likewise, once you have a mortgage you don't need to follow all the new developments in this space. Once you have a reasonable investing plan, you don't have to learn a dozen other ways to get to the same goal. Estate planning doesn't have to be done every year and you don't have to know the asset protection laws in any state but your own. Disability insurance and life insurance only has to be bought once in your life. You don't have to know how whole life insurance works if you don't want to learn, you can simply ignore it along with dozens of other optional financial products. The amount of knowledge you have to assemble in order to do your own financial planning and investing can be surprisingly minimal, especially when you consider two factors.
The first factor is that you want to make all your mistakes, especially your investing mistakes, when you're young and have a small portfolio. Hopefully by the time you're in your 50s and are faced with a decision about what to do in a stock market downturn, you've already been through 3 or 4 bear markets. Perhaps you went through your first one at 30 with a 4 figure portfolio.
The second factor is that it's okay to make a few mistakes that cost you real money, because it isn't like financial advice is anywhere near free. Good advice is pretty expensive stuff. For example, at a pretty typical 1% of assets under management fee, a doctor saving $50K a year for 30 years will end up with $5 Million instead of the $6 Million he would have had if he had done it (correctly) himself. The way I look at that is that I can make up to a million bucks worth of mistakes and still come out ahead. I'm a slow learner, but I'm not that slow. That also assumes, of course, that the advice you are getting is good and that your advisor doesn't make any of the mistakes you make on your own.
My Perfect Financial Advisor
I have a list of recommended advisors (who are also for the most part advertisers on the site.) I think they're all good people running a great business. However, none of them are perfect and I don't think their businesses are either. Here is what the perfect advisor would look like to me:
# 1 A fiduciary duty
This means the advisor's first duty is to do only what's right for me. A Hippocratic Oath if you will. You would be surprised how many advisors are only held to a lower “suitability” standard instead of a fiduciary one.
# 2 An up-to-date academic understanding of the field
Financial advising and investing isn't physics by any means, but there is an academic literature containing important concepts. The perfect advisor is familiar with all of it. He probably subscribes to a journal and reads a blog like Michael Kitce's regularly. He could discuss the weaknesses of The Trinity Study, knows the difference between Fama and Bogle, and is an expert on financial history.
# 3 A meaningful designation
There aren't very many designations in the financial field that mean much. My list is very short- CFP, ChFC, CPA/PFS, and CFA. The perfect advisor ought to have one. Heck, if I'm going to pay someone for financial planning, they'd better have one of those first three designations. If he wants to manage my investments too, he'd better have a CFA. Personally, I think it's criminal that someone can practice in the financial advisory field BEFORE getting what should be the minimal education. He certainly won't be practicing on my investments. Even the CFA, probably the hardest of these designations to get (not counting the CPA portion of the CPA/PFS combo) only requires 15 weeks of studying over a 2.5 year time period. An advisor without one of these designations is telling me he isn't committed enough to his profession to do less than a semester's worth of studying about it.
# 4 A clientele just like me
Doctors have a few unique things going for them and the perfect financial advisor knows all about them. He knows the ins and outs of PSLF, has walked multiple clients through each of the student loan refinancing companies, knows what to look for in a physician contract, has designed retirement plans for many small practices, and does 8606s in his sleep. It would also be nice if the advisor had the ability to evaluate many of the alternative investments doctors are pitched- imaging centers, surgical centers, syndicated hospital shares, practice buildings, life settlements, and other investments only available to accredited investors.
# 5 A reasonable investing strategy
Every advisor (and investor) invests a little bit differently. Maybe he uses DFA funds, or a combination of low-cost ETFs. Perhaps there is a little bit of an active management tweak based on valuations or momentum. Maybe he includes some alternative investment classes like peer to peer loans, commercial real estate, or (gasp!) some type of cash value life insurance. Fine. I can live with all that. There are many roads to Dublin. But the overall strategy needs to be reasonable. If the entire strategy is based on buying massive quantities of whole life insurance, avoiding “Wall Street” entirely, picking individual securities, or some market-timing scheme, beware! The perfect advisor is laser-focused on the cost of his recommended investments. Advisors who are not cost-focused like to preach that “Cost is what you pay, Value is what you get.” I disagree. Cost may be what you pay, but value is a fraction, with cost as the denominator and “what you get” as the numerator. In investing, you get what you don't pay for.
# 6 Unbiased
I often have “financial advisors” who are paid on commissions try to convince me that is an acceptable way to pay for advice. “How else can you get advice until you have a half million?” they say. “I only do what's best for my clients.” I totally disagree. Commissions are a terrible way to pay for advice. Look at professionals you go to for advice. Lawyers aren't paid that way. Accountants aren't paid that way. Doctors aren't paid that way. (Can you imagine if your only reimbursement were 5.75% of every lab, CT, and prescription you ordered?) Why in the world would you pay a financial advisor that way?
Don't get me wrong. I like commissioned salesmen just fine. In fact, my business manager is paid on commission (plus an hourly rate for a lot of the behind the scenes work she does.) If she sells more ads for this site, she makes more money (and so do I.) But I think you'd be stupid to go to her to ask “Where should I advertise my business?” or “How much should I pay to advertise on The White Coat Investor?” It isn't that these commissioned “advisors” are bad people (usually.) It's that they are continually facing a terrible conflict of interest that even a highly ethical person cannot completely resist forever. They have kids to feed, and the worse the financial product, the higher the commission that the company designing the product must pay to get it sold. To make matters worse, even if they sold you a halfway decent product the first time, they're constantly tempted to churn or at least tinker with your investment plan to generate a new commission. It is simply a terrible model that should be avoided.
Some fee-based (paid by commissions AND fees) advisors are less bad if the only thing they're taking commission on is the life and disability insurance they are selling you. But I would much rather see them rebate the commissions (I'm told this is illegal, but I'm sure there is a way to discount your fees for someone who buys insurance from you, perhaps just a lower fee that first year or something.) Or at least refer you to an independent agent (making sure you only purchase what you really need.)
# 7 Fairly Priced
I'm not a huge fan of paying for financial advice based on your assets under management (AUM) for three reasons.
The first is that an advisor has a bias against recommending financial strategies that remove money from the pot they're managing. This might be commercial real estate, a Roth conversion, paying off your mortgage/student loans, or simply spending more.
The second is that the advisor simply won't take you until you have a meaningful amount of assets such as $500K-$1 Million. That takes many investors a decade or more to reach that point. You need the advice most at the beginning of your investment career, or you may never get to $500K!
The third reason I don't like AUM fees is that they can become ridiculously big as your portfolio grows. It simply isn't any harder to manage $2 Million than $200,000. It certainly isn't 10 times as hard. Many advisors will give you a bit of a break as your assets grow, but it's usually nowhere near as big as it should be. For example, you might pay 1% on your first million and only 0.8% on your second million. But managing that second million didn't take any more work, much less 80% more.
A much better way to pay for asset management is with a flat annual fee in my opinion. I think a reasonable hourly rate is the best way to pay for financial planning. However, I can live with an advisor you pay using any of these three methods. The key is to actually add up the cost (whether it's based on hours, a retainer, or your assets) and make sure the total price is fair. I could really care less if you're paying $5K a year for asset management as an annual fee or 0.5% on a $1 Million portfolio. It's all the same.
My idea of fair pricing is an annual fee in the $1000-10,000 range for asset management and $100-500/hour for financial planning. I like to see the fees as low as possible provided the advisor can still provide good service and stay in business. But if doctors are willing to pay $20-50K a year for financial advice, I can't blame the advisors for taking it. I certainly don't price the ads on this site or my fees in the ED based on what some random blogger thinks I should charge for them. I charge as much as the market will bear.
# 8 Tied in with other services
Many naive doctors think one financial professional can be their “money guy” and take care of all their needs. The truth is that they probably need 5 or 6 including a financial planner, an investment manager, a tax strategist/preparer, a practice accountant, an insurance agent, an estate attorney, an asset protection attorney, a healthcare attorney/contract negotiator, and a retirement plan consultant. Some advisors can do 2 or 3 of these things well, but nobody does them all. Ideally, all these people will be under one roof and are seamlessly tied together. Some of the larger firms are trying this, but I don't think anyone is doing it perfectly yet.
Recommending Financial Advisors
So, knowing all that, I'm now left with a dilemma when people ask me for a recommendation for a financial advisor. These are not usually people who read this blog (or any blog) religiously, nor do they have the time or interest to read even a handful of books on investing. Chances are very good that even if they were paying 1% a year for advice that they would be better off with an advisor. Look around your hospital, you know who I'm talking about.
My usual go-to is to use the list of recommended advisors that I have already vetted. I've swapped emails with them, spoken to several, followed up with clients who have worked with them, and even been to some of their offices. I've reviewed their website, and their filings with the SEC. Some of them have a had a formal complaint which I have had to ask them about. I also see comments and receive emails about these advisors from readers of the site. If I get significant bad feedback from clients, I remove them from the list.
Despite these occasional negatives, I still feel comfortable recommending each of these advisors to the right doctor. However, not a single one of my recommended advisors meets all the criteria I have spelled out above. To make matters worse, many readers would like a recommendation for an advisor in their hometown. That's easy in some towns with a quick internet search and a little time on the SEC site, but very difficult in a small town in the middle of nowhere.
So, at the end of the day, if you want an advisor at the lowest possible cost and with the fewest financial conflicts of interest, go take a look in the mirror on your way to the library to get some good investing books. If you're not willing to do that, then realize that while I can help you get a very good advisor (especially if you're willing to look outside your local area,) I can't help you get a perfect one.
What do you think? What criteria did you look for in an advisor? How do you decide who you send colleagues to? Do you think objective investment advice can be given by an advisor paid with commissions? What about one paid with AUM fees? Comment below!
Jim:
Outstanding article about “Finding a Good Financial Advisor.”
Taylor
Nice article
Best to know the basics before interviewing advisors and look for the red flags noted in article
If they are not using no load passive funds, go elsewhere
Great post, Jim! I think the three most important things are fiduciary duty, practicing evidence based investing (kind of like we do in our field!), and a flat annual fee model for portfolio management with an hourly rate for financial planning. The industry gets away with the AUM fee model because people just don’t get how a small number like 1% becomes a massive transfer of wealth from those who own it to those who manage it. Unfortunately in my area, (Toronto), they’re all AUM fee model, so when referring collegues I have to compromise on that one.
I hate to be self I promotional, but it seems that I check just about every one of those boxes.
Indeed you do, James. Any chance of opening a branch office in Canada, or convincing one of your Canadian colleagues to do the same?
Thanks Grant, but no Canada for me. My favorite Canuck is Sandi Martin. Her firm is Spring Personal Finance: https://springpersonalfinance.com/
Are you asking why I don’t think you’re the perfect financial advisor? I agree you’re a very good one (that’s why I allow you to advertise here) but you are younger, less experienced, and have fewer physician clients than other advisors. See the issue- no such thing as a perfect financial planner or investment manager. The good news is that “good enough” is probably “good enough” for most docs!
Jim, hopefully you didn’t take my comment too seriously as it was partially tongue-in-cheek. But if being young is the biggest strike against me, I’ll keep working on that part one day at a time.
It’s interesting. When you poll patients on how old they want their doctors to be, the answer is 40. Any younger and they don’t think you have enough experience. Any older and they think you’ve forgotten too much from your training or you’re out of date. I turn 40 next month. On that day, maybe I’ll be the perfect doctor.
Lots of good stuff in this post! Thanks!
I’m fortunate to have the credentials of CPA & CFP(r) and will be sitting for the final lvl 3 of the CFA exam in a few weeks. I can honestly say the CFA is by FAR the most difficult certification to obtain. It is highly respected by institutional investors, but my clients (retail) have never heard of it.
Great list.
Would add the correct temperament. Especially if you’re referring to the financially un-savy, the most important thing an advisor may do is talking you out of selling in a panic.
Regarding surgical centers and buying practices, while I guess it would be ideal, I wouldn’t think of this as a job for a financial advisor. It sounds far more in line with the core competencies of a financial accountant or consultant. Where You find the right one of these, I have no idea.
I have no idea either, but wouldn’t it be convenient if the guy managing your investments and/or helping you with your planning could handle it?
I agree that helping you avoid doing stupid things is a key role for an advisor.
Matt – we have assisted many physicians in ASC buy ins and practice integrations/sales.
WCI – great article. I would only add being readily available and a great communicator. I do use an advisor and enjoy calling/meeting regularly to check in, discuss performance, and talk about any changes short or long term. I would assume some firms are large or prioritize ‘high account balances’ clients and some clients may feel left out.
I am amazed at how many physicians have no interest in educating themselves on personal finance. Even when told that not educating themselves can cost them a million dollars.
Also, the basic knowledge needed to do your own financing can be easily attained from just a few hours of reading.
1) live below your means
2) pay off debt
3) save 15-20% of your income
4) buy low cost index funds from Vanguard or Fidelity or their ETF counterparts.
5) buy safer assets such as bond funds to minimize risk
6) stay away from permanent life insurance.
7) stay the coarse and don’t sell until ready to retire.
That’s it.
shhhhhh…… dont say it loud
Investing can be pretty simple, can’t it? It’s when you throw in issues like student loans and taxes that it gets a bit more complicated.
Nice to be reminded that the best one, and the cheapest one, I can find is me!
Easily the most lucrative hours I’ve spent are reading and learning about finance. Way more than even health care when you look at it from an hours spent compared with income generated!
Ask to see the advisors fiduciary standard in writing to make sure he is acting in your best interests, not the suitability standard
a big difference
Besides using the information on the website here is another good questionnaire to use when interviewing planners.
http://www.napfa.org/UserFiles/File/ComprehensiveFinancialAdvisorDiagnosticUpdatedAugust2011.pdf
Many of these ideas rely on using heuristics or a short cut when what you want to know can more directly be found out by looking for different facts. I’m going to break these comments down to each issue to make them shorter.
#1 – Fiduciary Standard/Hippocratic Oath —
On American Greed there is a story of a dermatologist in Grand Rapids who performed countless unnecessary procedures causing patients to lose their skin elasticity and reused needles and other medical instruments to save money exposing his clients to hepatitis. He took the Hippocratic oath.
His patients would be silly to rely on the hippocratic oath as protection. Similarly, lots of people who are not required to state the hippocratic oath conduct their business as if they did, showing extraordinary care to their clients. Legal standards probably don’t mean much in terms of advisor behavior so I wouldn’t overstate their value (just as a doctor’s hippocratic oath won’t protect you if they are a corrupt person). Similarly, you don’t need the higher standard if you are working with an honest and well meaning broker – they will probably treat you the same.
Bad actors can be more easily spotted by their lifestyles (a better heuristic than the oath). The doctor in Michigan lived in a $7 million house and had nice cars, R. Allen Stanford and Bernie Madoff lived extravagant lifestyles, Mark Drier (the lawyer who stole from his clients) worked and lived in exceedingly expensive real estate and the new breed of accountants who helped cook Enron’s books lived quite a bit nicer than the standard auditor. It is worth your time to investigate your advisors. You don’t want people close to your money who are thiefs or whose lifestyles require them to act against your interest just to maintain their standard of living. If anyone is interested, I’m happy to show you show how to do it in five minutes or less.
How do you find out how your advisor is living, sometimes I am curious and just want to know how my next door neighbor is affording this.
If you know the city they operate in you can reverse search someone’s address on a site like white pages. You don’t have to click on a link that make you pay – you can click on an free link and it will often give you their address. From there you can use Zillow to see what they paid for the home, the quality of the school district ect.
Another good option is to consider going to your county’s superior court website. Often times you can do an online case search (court records are public record) and you can see from the causes of action (fraud, unlawful detainer ect.) whether they get into trouble a lot or pay their bills.
So are you suggesting there is no value in a “fiduciary oath?” I hope not, but it sure sounds like it.
I think what he is saying is that just because you took the oath doesn’t mean you adhere to it. There are corrupt doctors, as he demonstrated. There are greedy dentists who always are selling crowns. Registered Investment Advisors can also have brokerage licenses, and sell you that annuity in your IRA because the commission is triple that of the mutual fund they should be selling. Having a designation that comes with some kind of fiduciary responsibility doesn’t guarantee anything. Many firms in the brokerage industry encourage, and may even pay for, their brokers (now only called financial advisors, vice-presidents, financial planners) to enroll in the CFP program . This program, by the way, has one course on investing. Once they get the CFP designation for credibility sake, they still sell products for their firms. Your best bet, as Jim mentioned, may be to simply do some reading and invest on your own. That may make you more knowledgable than the average brokerage salesperson.
Hey Jim,
What Steve said is right on and what I believe. But I also believe that market forces make it that brokers have to far exceed the suitability standard simply because if they didn’t try to act in the best interests of their clients and try to put their clients interest first. If you don’t do that, eventually you’ll be fired. Therefore most brokers are already living up to the fiduciary standard even though they aren’t legally required to.
And Steve is right – the fiduciary standard is no free lunch. You can be terrible at helping your clients and still not violate the fiduciary standard. You can charge high fees and still not violate the fiduciary standard. You can sell a limited line of products and still not violate the fiduciary standard.
I know WCI had a bad experience with his first broker (or insurance salesman) but technically what that guy did (selling you funds with high expense ratios) doesn’t violate the fiduciary standard.
So personally, I have little faith in these standards and the difference of behavior to expect from an “oath.” I believe with the overwhelming majority of good, well intentioned advisors and brokers, you don’t need it for them to act in what they believe to be in your best interest. And for the bad ones – the oath will provide no real protection that you won’t get hurt.
You have an interesting idea of what fiduciary means. I suspect your idea is shared among many in your industry. However, I disagree with it.
The courts stringently examine transactions between people involved in fiduciary relationships toward one another. Particular scrutiny is placed upon any transaction by which a dominant individual obtains any advantage or profit at the expense of the party under his or her influence. Such transaction, in which Undue Influence of the fiduciary can be established, is void.
http://legal-dictionary.thefreedictionary.com/fiduciary
Suggesting the inappropriate sale of whole life insurance to me and the inappropriate sale of high expense, loaded mutual funds to me when I was already paying a flat annual fee would not violate a fiduciary duty is simply wrong. A fiduciary has the duty to do THE BEST thing for me and my finances, not simply a GOOD thing. My “advisors” did not do the best thing for me. Luckily for them, they had no fiduciary duty to me.
Of course expensive funds are a violation of fiduciary duty, for exactly the reasons WCI gave. This month’s Tibble v Edison ruling sheds some light on that: http://www.natlawreview.com/article/tibble-v-edison-international-us-supreme-court-erisa-plan-decision
and of course Nationwide paid a $140 million settlement for the same reason: http://www.benefitspro.com/2014/12/15/nationwide-agrees-to-140m-erisa-settlement
Hey James,
Thanks for posting the case. I’ve never seen anyone use non retirement or institutional shares in retirement accounts (although Edison clearly did in their case) – which was not a good deal for their clients.
Have you actually come across people with retirement accounts that don’t use retirement class or institutional class shares for mutual funds?
Wow! I didn’t realize you paid BOTH a flat fee and a sales charge (load) on your mutual fund. I didn’t even think that was even possible — typically loads are waived in fee based accounts at most brokerage firms. The way most brokers are paid is either they get a little bit of the annual fee you pay to the mutual fund or they get a portion of the annual fee you pay for advice (it is often split between the firm and the adviser).
I’ve never even heard of what happened to you happening to anyone. Where on earth did you go to buy that mutual fund? I don’t want you to name names but did you buy through a traditional brokerage house or did you simply use an insurance agent for your investments?
Neither. This was a financial advisory firm specializing in physicians. I got to learn the difference between fee-based and fee-only. I didn’t lose a large sum of money due to it before I learned the lesson, thankfully. But yea, I paid an annual retainer fee and loads.
I agree with Dan that having a fiduciary standard will not make advisers do what’s in the best interest of their clients, regardless of how strict such a standard is. So you can have a CFA who sells Index-linked Annuities and a CFP who sells Variable Annuities, and that does not violate the rules as they are currently written. Also, excessive fees seem to matter only in retirement plans (where they can still be quite high, as long as the industry average is also high) – any CFA or CFP can charge a 2% asset-based fee, and they would still can be acting in a fiduciary capacity. Nothing in the laws or advisory code of conduct forbids this. Acting in a fiduciary capacity does NOT mean acting in the best interest of their clients!
The question I would ask is, what types of services and products would I use for myself if I was in my clients’ situation? The answer to this question will lead to the right attitude on the part of the advisers. To make sure that your adviser is working in your best interest all the time, you have to make sure that:
1) They charge no asset based fees at all. This eliminates excessive fees that most high earners such as doctors and dentists pay for no added benefit, and the conflict of interest associated with getting paid based on the level of assets.
2) They use low cost, passively managed investments, and they pick the best available product or strategy to solve a particular problem.
3) They are independent, and work for their clients only – no third party affiliations that can bias their decisions.
Dan also raises an important point: the quality of advice. This is something that is very difficult to measure, but it has a direct impact on the bottom line (and on the financial well-being of the client). In my experience, there is a tendency for a cookie-cutter one-size approach with larger advisory firms (and by firms that tend to provide ‘modular’ advice, such as asset allocation advice only). This is the only way they can be profitable, but often at the expense of their clients. I think that this shortchanges some of their clients who can benefit from more involvement from their advisers.
Let’s not forget – advisers are trying to make money, lots of money, and sometimes they simply don’t want anything to get in the way of making money. This is why there are many opportunities for good, healthy competition as new advisers start offering services to fill the holes in the current advisory offerings by the established firms. The only problem is, offering good service for a fair fee is not the best business model, and the survivors tend to be the ones who are best able to sell their higher fee services.
#2 An Up to Date Understanding on the Financial Field
Success in investing comes from having superior information. I agree that they should be deeply knowledgeable about published research, but they also should know things that are not published.
For example, I know how, in the past, to add several points to an index return by simply reformulating the index. Will I ever publish that? Why would I? If other people knew it they would run up the price for these assets and I couldn’t use it for me and my clients.
Deep knowledge is critical but it must be focused on the areas that count and it’s easy to tell how knowledgeable someone is by just asking about their beliefs and then asking for the evidence.
If I had a way to reliably and safely add 4% to index returns, I’d be running a hedge fund and raking it in rather than advising clients. I’m curious why you have decided to manage “small money” with such talent?
A couple of points here:
1) You aren’t a mutual fund and neither am I. Few investors realize how big of an advantage this is! In a mutual fund when you have short term underperformance the clients usually redeem shares and you have liquidate your portfolio at bad or fire sale prices. When things are good, clients flood you with money and you have to invest it according to the mandate quickly even at premium or nose bleed prices. A large portion of mutual fund underperformance is due to this flow of funds issue. But no individual investor faces this. When you’re stocks fall in 2008 you don’t get redemption requests from yourself. And if you have a good year, you don’t automatically have twice as much cash to invest. Many approaches that work well for investors don’t work well in mutual funds because short term market timers can destroy the effectiveness of the approach and can skew the outcomes. But individual investors, without these influencing factors, can do well if they are disciplined and I’ve seen it with my own eyes. If you ask retired brokers who have no incentive either way many of them can tell you of cases where individuals used a particular knowledge advantage to benefit them over time (and those individuals were not professional money managers and did this despite not running mutual funds or hedge funds).
2) The hedge fund is the same concept but to a greater extreme. My friends who work for hedge funds have told me that basically as an analyst of those funds you have six months for your investment idea to work or you could be fired. Their investors, many of them institutional, may have tremendously short time horizons. Individuals don’t need to have a short time horizon but many hedge funds are measured not be annual performance but monthly performance – giving them a tremendously short time horizon in what they try to do. I don’t think the things I try to do to make portfolios more productive would work if my clients fired me after a six month period of underperformance.
3) Really good long term investors, try to have low turnover and can play on longer time horizons where there is less competition. They benefit precisely because they know they aren’t mutual funds or hedge funds, and they don’t compete with them, their competition is other investors and if they are long term oriented they can have a really good natural advantage. Individual investors also typically have some information asymmetry between those and others in the field. For example, you might understand drug companies better than I do, and I might understand financial companies better than you do – just because we have better working knowledge in our own fields and so information can be more meaningful in our own field, when used correctly.
4) You notice that my words were “I know how, in the PAST, to add several points to an index return by simply reformulating the index” This is from private research that I won’t publish and I won’t share with anyone who isn’t a client. What I don’t know is whether it will work in the future. My guess is that it will likely work over time but it may not. But many people don’t even know what I know about past returns and investor preferences because they didn’t bother to try to figure this stuff out, especially when there was a gap in the academic research because the products are newer and not as well studied. Moreover, it could stop working for lots of reasons but one of which is that too many other people might discover it and drive up the price of the asset and take away the spread between what I can buy it for now and what I can sell it for later.
One of the most common (and wrong) arguments I hear from indexers who don’y fully understand indexing is that because they don’t know something it is impossible for anyone else to know it. I know from my experience that I only possess a narrow range of knowledge, and I’ve put tens of thousands of hours into learning everything about securities and I don’t believe I know everything. I’m learning new things all the time and trying to expand my knowledge. The idea that someone who isn’t really trying to be knowledgeable could have anything but an information disadvantage over an equally talented person who is trying doesn’t make sense. It isn’t true in your field, I don’t think, and I certainly don’t believe it’s true in securities or almost any other area of life.
My belief based off seeing so many investors do well doing things that you wouldn’t even imagine would work is that there is strong information asymmetry in the securities market and they securities markets reflect the real world in this way. And because there is money to be made in this information asymmetry you can be certain that things will be known by some investors years before they make it into the academic research (if they make it into it at all – because academics seem to have schools of thought and the tend to not be that forthcoming about the stuff that contradicts the premises of sometimes a 20-30 career in research advocating a certain point of view). What’s the old saying – science progresses one death at a time? Based off my reading of the academic research on securities markets I think there is some truth to that.
Luckily as an individual investor you can simply try to do what works, and if that is something different from what you’ve done before, you don’t have 2 or 3 decades of published research that you have to eat crow about to switch your position.
The data is quite clear that the vast majority of actively managed investors cannot outperform a simple, passive approach by enough to make up for their costs. The active investor needs more than a little extra information. He needs enough of it to overcome the costs of getting it. It turns out that’s really hard to do.
The idea that I know more as a doc than a wall street financial analyst who spends 60 hours a week analyzing health care stocks is silly. And that’s who I’m trading against when I buy and sell individual stocks, even in “my field.” Peter Lynch wrote a very popular book about that idea, but it turns out its wrong. Don’t believe me? Go spend some time in the doctor’s lounge, then start interacting with thousands of docs.
Your comment about active investors in the same asset class not being able to do better than index funds is quite true – I don’t dispute that. But most investors (including passive investors) don’t achieve results as good as a typical active equity manager because their asset allocations dampen long term returns. Maybe there is good reason for that – but I’ve seen a lot of dampening of long term growth that is done without thinking it through.
I can’t take on the doctor point – you know them better than me. I do know from watching them as clients however, that there is a distribution even amongst doctors in outcomes and being a doctor is not a guarantee that you will be a bad investor.
Your point about who you are buying and selling too is not quite right. The latest data I’ve seen shows that 56% of stocks are owned by households directly. Public Pension funds and institutions own around 25% and the rest is owned by other investors. Institutional investors do more trading and make up more of the daily volume but the people who own the stocks are still individuals. Vanguard, which I think is #1 or #2 in mutual fund assets only controls 5% of the voting rights of stocks currently and so you may actually be exchanging with other individuals and households as owners.
I like your points though – as usual your view is well laid out.
It’s not so much how much is owned by institutional investors vs private ones, but how much is traded. According to one source I saw, this is the data:
Ownership
1980 = 20% institutional
2004 = 53% institutional (Presumably now even higher)
Trading volume
1989 = 70% institutional
2002 = 96% institutional
So when you’re making trades, the guy on the other end of the trade is a professional 19+ times out of 20.
Please explain adding points to an index
Some secret you know of, really
Sorry that information is too marketable and I only use it for clients and myself. I only share that information with those who pay me.
With all due respect, you may be doing something that works now, but at some point it will not work. Many out there now are adding small cap and small cap value funds in preponderance to standard asset mixes, saying it enhances returns. It is cyclical, and will revert to the mean. We now have index funds that aren’t based on capitalization, and proponents are positive they are better than traditional indices. If what you are saying is true, you would be as wealthy as Buffett, and probably as well known.
Also, you say you have superior information? Come on. All the thousands and thousands of analysts and professionals in the market, and you have superior information that all the greats out there are not aware of? What does “I know how, in the past, to add several points to an index” mean? Are you simply back testing.
Hey Steve,
I can tell you are a smart guy based off how well you read the comments. Almost all knowledge about securities pricing is from back testing (and so is mine). A Monte Carlo simulation is a form of back testing. Insurance underwriting comes essentially from back testing too. So far there is really no more reliable method – that I know of than to back test and to recognize patterns before others do.
But you are right – it will totally stop working if others do it. And it may stop working even if others don’t. I really have no idea whether it will work in the future. But the truth is that any expected return or any asset class is just a guess of how people will value it in the future. People like to say that the price of a stock should be the dividend yield plus the earnings growth rate – and sometimes that’s the case and sometimes it isn’t. Any asset is kind of worth whatever people say it is worth at that time.
For that reason, I have no idea whether what I do today will work in the future. I also don’t know if the Fama French 4 factor model will be predictive in the future (neither do they) nor do I even know that growth assets will do better than defensive assets over time. But back testing indicates that certain approaches are more probable and working with probabilities is the tool we currently have – so that is the one I currently use!
Great comments though – you immediately picked up on the weakness of my argument!
#3 A Meaningful Designation
We all want to take short cuts but this is a bias that hurts us. If you are asking whether someone is skilled at investing or planning it is much easier to just verify by looking at their statements – you’ll see how they personally invest. They are going to look up your skirt financially and so it is okay if you look up theirs.
It isn’t clear that those with designations are any better at their job than those without. In fact, there are countless bad investors and planners with those designations and there are countless good investors or planners who never sat for one of those tests. I searched hard for it and I could find no empirical evidence that those with these designations perform better as investors or give better advice than those who don’t. Like with the Grand Rapids Doctor and the Hippocratic Oath – I believe that smart investors must look much deeper than credentials – and these types of credentials are weak predictors of your outcome compared to looking at whether you financial advisor managed their own life well – which I think is a better predictor of how they will act when it really counts. If your advisor has a messy financial life, overpays too often for things, is emotionally biased, they will have a lot of trouble helping you if they can’t even help themselves.
Being a good investor or planner requires major research and knowledge and a commitment to the job. You can figure out whether someone is committed by exploring their knowledge base. It takes a little more time – but when they are dealing with something as important as your money it is worth being thorough.
I realize I misspoke when I said this. I meant to say that certifications cannot be taken as a guarantee that someone will do their job well (no more than the hippocratic oath guarantees that the doctor in Michigan won’t hurt you).
I say this based off my experience of watching those with designations and those without and the outcomes of their advice. Often times, well educated investors who make sound investment decisions create more productive portfolios than those who took tests but make less sound investment decisions. I believe people without designations may make good planning decisions as well and there is probably somewhere in the world who has these designations but is bad with money – albeit I don’t know them personally so that is just my guess.
I believe the most important keys to being a good investor are 1) objectivity 2) temperament 3) education (formal or self education are the same in my book) and 4) an information advantage.
I’m sure others may view other factors as more important and my theories here are just anecdotal. But I do think it is important to emphasize that I couldn’t find a link at all between these designations and being a more productive investor – and in fairness to those who support them, I did try very hard to find that link. If you found something let me know and I’m always open to changing my view.
Who would you rather have giving you tax advice?
1) A CPA
2) A person with an AA in accounting from your local community college?
There’s no evidence I could find on the internet that people with the CPA designation give better advice than people with an AA in accounting. That must mean it’s silly to want your tax person to have studied a multitude of hours to set themselves apart from their peers. Let me know if you find anything though.
See what I did there? Of course there’s no hard & fast rule…
Hey Chris,
What matters is that you study the right information. You should be able to figure this out with a five or ten minute conversation with an advisor.
I’m always looking for a specific knowledge base or skill when I hire someone. For my CPA, it is their experience and knowledge about how the IRS is likely to respond to various courses of action I might take. I don’t think a brand new CPA would have much value to me because despite their education – I need to know how the IRS responds to other customers so I need someone who has lots of experience. And I totally expect whomever I hire to do significant self education so that they know things I don’t.
When it comes to investing, certifications can sometimes be like a bad proxy. A person may be exposed to good research but if they ignore it in practice they are of little help to me. I value people who will see the world how it is, be temperamentally suited to deal with it, and have deeper knowledge in a field than I do.
Knowledge about investing is extraordinarily marketable. If you had knowledge that was better than mine and you told it to me I could use it immediately to benefit myself and my family. I’ve read a lot of the books used for certifications and while there is a lot of information there, I don’t believe that most of it is marketable information. This is the reason why someone with little formal education (a high school degree) but good judgement can often do better as an investor than their much more educated peers. And I say that from experience — I’ve seen it first hand — and so I simply caution against an over reliance on credentialing when other factors may be more predictive of results (and there is published evidence on those factors).
Obviously its possible to become an exceptional investor and financial planner without any designations. But really, what’s so hard about a CFP? It seems like an awfully easy way for an advisor to say to his clients, “I’m serious about my profession, staying up to date in it, and will be in it for the long haul.”
#5 A Reasonable Investment Strategy
Jim did a good job laying this out. We don’t agree philosophically about costs and I believe there is some degree of bias in his thinking.
There are empirical factors that are known to move portfolios by 4% a year, those by 3% a year, those by 2% a year, those by 1% a year, and those by a fraction of 1%. My advice is to focus more on the factors that move a portfolio 4% than those that move it 1%. The reason is that you don’t have unlimited time or resources and money tied up in strategies that add 1% a year, may keep you from implementing strategies that add 4% a year. The one thing that we don’t know how to make more of is time – so you want your portfolio to be productive during the limited time that it has to grow.
Fees generally cost less than 1% a year. This means that they are a factor – but they are one of the smaller factors. You should try to invest in a fee efficient way, but never at the cost of sacrificing a more important factor.
Think of it like being a ER doctor. If someone is bleeding out and has strep throat – which gets your attention first? You got to focus on the things that matter first and concentrate your efforts and resources around then. When you’ve done that you can focus on things that have an impact but a smaller one.
I agree there are things more important than fees, such as asset allocation and adequate diversification. Better to pay 2% a year and have a good portfolio than 0.2% a year and have a bad one. But it’s true that every dollar paid in fees is a dollar no longer compounding for you.
Actually Jim, when the experts in the field talk about how to do well in investing, they say keeping fees as low as possible is the first and most important step. Then of course you follow all the basics such as asset allocation. The reason? Very few who charge 1 or 2% a year beat the market consistently. Many don’t even match it. That’s a problem with actively managed mutual funds, who have talented managers and unlimited resources. Anyone think someone like Dan has an “information advantage” over these guys?
I actually agree with you Steve!
I don’t think I can beat the market. And expense ratios are critically important when comparing funds or stocks with the exact same asset allocation. The more similar you invest the more important it is to get your fees down!
But not everyone invest similarly, and if you can buy things at good prices you can often make your portfolio a few percentage points more productive each decade. So if the average investor earns 5% you may earns 7 or 8% with a diversified portfolio by simply searching out and buying at good prices. It doesn’t require as much market timing as people think but it does require the effort to look for what is a good deal – and once you’ve found it you may have an information advantage over the person you are buying it from.
John Bogle is right – if everyone had the exact same goals, buying at good prices would be a fool’s errand. But, I really don’t think that when someone is panic selling in 2008, I don’t think they are selling because they think it is a bad long term investment – I think they just can’t take the losses anymore. The buyer may have an advantage of 1) a different investment objective or time horizon or 2) they may realize if they buy from this panic seller they know they are getting a steal! In that way the seller may not know or may not care that he is dumping assets in a fire sale but those types of markets (which are more common than people think) really show how investors can have different objectives which lead to materially different outcomes. But I guess we all have to be on our own judge on those facts!
Obviously buying “cheap assets” that later appreciate is going to work out better than buying “expensive assets.” The difficulty is in recognizing a priori the cheap assets that will later appreciate. It turns out that is extraordinarily difficult to do, especially after-costs including taxes.
How did you come to the conclusion that it is extraordinary difficult to identify cheap assets?
Why do you believe that identifying cheap assets involves theoretical deduction rather than simple observations or experience? Can’t you just look at what people are paying for them and just pay a lot less. Do you not believe there is regression to the mean in securities markets?
This is a difficult discussion to have in the abstract. It will be difficult to have in reality given your reluctance to reveal your special method. But there are lots and lots of professional investors out there trying to identify the cheap assets and buy them before anyone else does. The track record of them doing so sufficiently well to overcome their costs is not pretty. Even Warren Buffett’s record the last few years isn’t so hot.
This idea of “looking at what people are paying and paying less” sounds great, except no one is willing to sell the assets to you for less than the current market price. I mean, if Apple is trading is $131, and you can somehow buy it for $89, then sure, it’s a great deal. But good luck finding someone to sell you Apple today for $89 when they can easily sell it for $131.
Sorry. What I meant to say is that you can look at what people have usually paid for an asset and find environments where you can pay a discount for that.
Take U.S. stocks for example, you can buy them for a discount in 2009 or anytime in the late 1970’s or 1980’s and sell them for a premium when people are overpaying. There is almost always an undervalued asset in the global market of assets as long as you are willing to look for it.
I don’t believe that an investor who is not searching out for good deals can do as well as someone who is and is behaving in a way that maximizes long term outcomes
If people want to take the lazy approach and not look, that’s their choice, but I think their financial position will be a lot less good than if they made an effort and did it right. The empirical research is clear that those people who buy good assets at discount prices get better returns, with lower risk of investment loss, than those who don’t.
Of course stocks bought in 2009 are going to have better long term returns than stocks bought in 2007. The question is what do I do with my money right now. Do I leave it in cash or do I put it in stocks? Unfortunately, knowing the answer to that question requires a working crystal ball.
You might be surprised what the data shows about being lazy and long term outcomes. While it isn’t intuitive, the evidence is very strong that a lazy portfolio is the way to go, especially after costs, after taxes, and after accounting for the value of your time.
Really there is no crystal ball required to decide what to invest in because there is strong regression to the mean in asset prices. Expected returns are also heavily linked to the price you pay for an asset. The empirical data is very clear on both those facts. You simply have to know what people usually pay for an asset and what it is going for now.
The investible universe extends far beyond stocks, cash and bonds and if you look hard enough you can often find things that are selling for a discount and have good expected returns. Mathematically those assets are almost certain to generate better compound growth over the next decade than assets that are really overpriced in this environment.
If you find yourself in an environment, like we are today where many popular asset classes have very low expected ten year returns due to their high prices it can often be beneficial to broaden your universe and do some looking around.
The lazy portfolio free lunch in investing isn’t really free – the empirical shows there is a huge price in terms of opportunity cost to not paying attention to what your paying for and what you are getting. If the environment isn’t right and the asset classes that you are weighted towards are overpriced at the beginning of the period you can end up having a bit of a lost decade (whereas you could have doubled your money in other assets over ten years).
If you have one or two lost decades over 50 years of investing you will have 1/4 to 1/2 the money you would have had if you continued to invest in good assets at cheap prices. If you are a good saver, having 1/4 or 1/2 as much money is a heck of a cost.
Nonetheless, I actually like how you focus a lot on advisor fee’s, expense ratios, taxes and other costs related to investing – I think it presents an interesting analysis. But I wish you talked about opportunity cost which actually dwarfs any of these fees. Just using Fama and French numbers opportunity costs can be as much as 3-5% a year which compounds to a huge number.
So if we focus on cost – my suggestion is to start first with opportunity costs of our strategies (which is maybe twice as large as the next largest cost) and the work down to taxes, fees, expense ratios ect. I’m not opposed to cost sensitive investing – I just want to make sure that we don’t ignore the biggest costs in order to focus on smaller but easier to measure costs (and the lazy portfolio has tons of opportunity cost in it because it focuses on buying at average prices as opposed to good prices).
I have no doubt you disagree with this argument since I don’t see you discuss opportunity costs much on this blog. But like inflation – the opportunity cost is a hidden tax on the growth of your assets and those who adequately contain opportunity cost by making good investment decisions often have materially better outcomes than those who ignore it completely.
It’s all great in theory. But when the rubber hits the road, you’re required to decide every day what to invest in NOW and valuations provide only a partial clue as to what will perform well in the future.
It’s a fact that most, if any, investment managers don’t beat the market by 4%. Heck, most don’t beat it at all consistently. That is a fact. Almost all of the well known investment gurus out there are telling you the best way to simply match the market is to keep fees down. Hence the popularity of index funds. Also, you keep referring to an information advantage. There is no information advantage. Analysts and money managers and everyone else out there gather all the information available. Whatever you have access to, they have access to.
Steve,
If you read the analyst research reports at major brokerage firms you’ll see them often make a prediction about what a stock will do over the next 2 weeks to three months. They often don’t talk long term. I think this is because they are trying to get hedge fund commissions which because they trade more than individuals. I think a huge portion of the analyst community is focused on either 1) short term trading or 2) longer term investments that retail clients might want to buy because they are familiar with them.
Also, it’s really important to point out that – I never say beat the market by 4% a year. I think beating the market is not the goal, but making your portfolio a few percentage points more productive is worth at least a million and so that is worth it. The market return is actually much higher when the prices are cheap and much lower when prices are expensive. I think the range is about 3% a year when the market is most expensive, around 7%-9% when the market is average priced, and around 13% when the market is its cheapest. But it isn’t linear and sometimes low prices don’t yield high returns and vice versa.
All I’m saying is that both common sense and the empirical research indicate that your returns will be better and there is more profit in there for you if you try to buy at good prices, whenever you can, as opposed to buying at average prices over your lifetime. You’ll still get the market return (or less) but that market return will typically be higher if you buy the market when it is overvalued than if you buy it at an average price.
Sorry I meant to say that your return will be higher if the market is Undervalued.
#6 Unbiased
This represents a degree of bias. As an investor – what difference does it make to you whether you pay someone in commission or a fee? If you walk the emotions back out of the decision you’ll see that what really matters is 1) what you pay for and 2) what you get in return. I could care less if my accountant made me pay him in Apples or Oranges. It is a simple question of what you pay and what you get.
I think a better distinction is whether the relationship is one off or ongoing. If you have a one off relationship that incentive to not act in their best interest. But if you have to seem them year after year, you don’t want to make your life hard or hurt your livelihood by screwing your clients.
Any fair analysis of any service simple goes like this: what do I have to pay and what do I get in exchange? If you don’t get more than you put in it isn’t worth doing. If you can get more elsewhere relative to what you put in you should do that, or negotiate with your advisors.
If you focus on getting productive advice and your outcomes after taxes and fees and evaluate them as fairly as you can you’ll be a lot happier with how that turns out than if you overly focus on the method of paying as opposed to what you pay and what you get.
The problem with paying via commissions is you get put into bad investments. As a general rule, the best investments don’t need people to sell them, they sell themselves.
“The problem with paying commissions is that you get put into bad investments”
I really think that statement is a stretch. Consider all the products sold by commissions: exchange traded funds, term insurance, direct ownership of high quality assets, even real estate.
I’m surprised that you don’t think that what you pay versus what you get isn’t a better way to look at these things. But I guess if form is really important to you, I could see how you’d arrive at that opinion even though I don’t think it is factually accurate.
Finding a rare exception does not invalidate a useful general rule. The vast majority of investments that have a commission (loaded mutual funds, most annuities, cash value life insurance etc) are terrible investments. The companies that produce them have to pay fat commissions to get anyone to sell them.
“The vast majority of investments that have a commission…are terrible investments.”
Is that really true? I understand the desire to stick to your guns once you’ve publicly defended a point – but one of the things I’ve most admired about you is your willingness to move off positions when the evidence doesn’t support them (like your previous position that people shouldn’t own bonds in taxable accounts).
One of the things people don’t realize is that products are often cheaper when sold via commission versus a flat fee. If you buy a lot of an ETF, you only pay the $10 commission once but if you pay on a fee basis you could be paying for that ETF forever. That is something worth thinking about.
You make so many strong arguments on this site – but respectfully I think this is one of your weaker ones. That’s just my opinion of course – I’m sure others may disagree with me.
First, we’re talking about paying for advice with commissions, not paying for the transaction. When you buy an ETF lot, you pay $10 for the transaction to Schwab or Fidelity or whoever. This is very different from paying for the advice with a load. For example, let’s say you want to buy $50K of a mutual fund. Well, if you’re a DIY investor, you pay $10 for the ETF transaction or if you go to the mutual fund provider and open an account, $0 for the fund. If you go to a commissioned “advisor” (i.e. mutual fund salesman) who is charging a 5% load, you pay $2500 for his “advice” to buy some crappy fund. If you go to a fee-only advisor charging you 0.8% of assets, you pay $400 that year for all the advice you can get. You’ll pay $400+ again next year and again the next year etc etc. Eventually, it is possible for that fee-only advice to cost more than the commissions, assuming you don’t get churned like you usually do. But that’s not the usual case.
Second, and more importantly, the fee-only guy will tell you not to buy the crappy fund in the first place. He’ll teach you/help you to buy a no-load fund or ETF for a trivial cost. So you end up with a much better investment and you probably pay less for it, even in the long run given typical broker behavior.
I don’t see this as a weak argument at all. I think arguing against it is rather foolish.
This is a straw man argument.
You’ve changed the terms to say that an investor who uses a commissioned advisor will inherently get worse advice. There is no evidence of that I know of.
The problem with bad advice and bad products are that the guidance or the product just isn’t optimal for the client. The advice and or product is the problem.
Good advice and good products would be equally good to a client whether you paid by commission or fee. The simple math of the equation is:
The quality of what you get – how much it costs to acquire it = how good your outcome is
You may not know of any evidence saying that, but I see it every day in my email box. In fact, I don’t recall ever seeing a physician who brought a portfolio to me that had been designed by a commissioned advisor that I thought was a reasonable portfolio. Not saying it couldn’t happen, but I haven’t seen it yet. You can wait for a scientific paper if you like, but it seems awfully obvious to me.
And I’m not sure what terms I’ve changed. Perhaps we’ve been talking past each other about something, don’t know. I am not aware that I’ve changed any terms in this conversation.
Then why do so many lifelong clients have annuities and high cost mutual funds sold by their advisors? Why are they constantly being 1035’d from one annuity to another after the surrender period is over? The reason is because most clients know nothing about investing and they trust their advisor/ broker. They also have no idea about their true performance. They also think their advisor is this all knowing guru expert who is a Vice Prsident and who has the backing of all the resources of that huge brokerage firm that advertises all over the place. They must be legit, right?
The clients I saw were a lot smarter than that. I did see a few annuities, but I also mainly saw people pay prices right in the range of what fee based advisors on this site cost.
Most clients if they had mutual funds, had either the C shares, where you don’t pay the 1% load if you hold it for at least a year, or the had some form of wrap account where they got A shares but didn’t have to pay any load at all. But most commonly, they invested in assets directly. I rarely saw any mutual funds in accounts above $500k (they were only common in accounts beneath $100k) and they usually bought stocks or bonds directly – paid a few hundred dollar commission at the time of purchase and had very little to no carrying costs on those investments.
I don’t really think they saw the brokers and advisors as gurus, but I do think they thought they were knowledgeable and they did turn to them to bounce ideas off of or to go to for advice. It seemed like a pretty healthy long term relationship to me and the clients didn’t act at all like they were getting a bad deal. I think the reality is that for many brokers and advisors – you probably won’t get cheated (there are always exceptions) but I believe most people are good and I do think the advisors were genuinely trying to help their clients – and if they didn’t they knew the client would find someone who would.
But generally, the richer a client is the more likely they are to hold an asset directly (instead of a fund or ETF) because the commissions become nominal as a percentage of the asset and it is cheaper to just buy directly and have no real carrying cost than to use a fund structure.
C shares and wrap accounts are almost always a bad deal. People paying for them are generally getting bad advice and a bad price. Even if the price were good, there is no price low enough for bad advice.
I disagree that a relationship with a broker or a mutual fund salesman is a “pretty healthy long term relationship” to me.
There’s no reasonable portfolio value where picking your own stocks and bonds instead of using a very low cost, passively managed mutual fund or ETF makes sense. That’s just taking uncompensated risk.
Well Jim, if that was true you would expect different client behavior.
Only about 40% of people in their 30’s with $250k use an advisor. But 70% of people with $10 million (they are usually around 65) use an advisor. So the richer and the older people get the more likely they are to use an advisor.
I understand that you had a really bad experience and I can understand how that could shape your views on the advisory industry. But most really rich people use an advisor and they get them even when they are older and more experienced. I don’t think people who have $10 million and are 65 know less about money than those that have $250k and are 35. If it was such a bad deal – you’d see less advisor usership as assets and age went up. In fact – you see the opposite.
I fail to see the connection. Are you arguing that because older, richer investors use an advisor that picking stocks is smarter than using a broad-based, low-cost ETF or mutual fund? That seems a rather easy argument to pick apart. If you’re arguing something else, it’s not clear to me what it is.
What I’m saying is that if advisors were so terrible people would be less likely to use them as they got richer and had more experience. The opposite is true – productive people become more likely to use advisors over time because the consequences of getting it wrong are higher. Good decision making becomes more critical the more assets you have and the further you are in your working career (because investments will move the needle more than additional savings at that point).
Finally, there is a strong correlation between using expert advice and being financially productive.
Individual stocks, when bought under a commission model have lower costs than ETF’s which is why I think most people prefer the individual security at that level.
As for the intelligence of the investing – the way people invest is more important than the vehicle you use. I can easily show it empirically that if you pay too high of a price for an asset you’ll generally get a lower return than if you buy other higher expense ratio assets but get them at a low price. The benefits due to broader diversification, lower expense ratios ect. are empirically known to have less of an effect than buying at a good price. So ideally people do both – buy good assets at good prices and try to do in an efficient manner – but if they are going to not try hard and just wing it – I believe it’s better to pay attention to pricing information and/or momentum information because these types of factors are known to have a bigger impact on your long term compound rate.
“Buy good assets at good prices” = market timing. If it were so easy, all the people trying to do it would be outperforming just buying and holding and buying and holding and buying and holding with each paycheck. The evidence shows that doesn’t happen.
I’m curious to see the study showing strong correlation between expert advice and “being financially productive.”
Maybe older people use advisors more frequently because the information and products required to do it themselves in an efficient manner weren’t available to them when they were forming their financial habits. Correlation is not causation.
I guess in your mind buying at a good price is market timing. And in some sense of course it is – but it is the good type of market timing – the type that increases expected returns and lowers risk. The empirical evidence is crystal clear on that.
As for the relationship between seeking expert advice and being productive see Thomas Stanley’s “The Millionaire Next Door.” The book follows a number of mostly self made millionaires and finds that those who are more efficient at accumulating wealth are more likely to seek out expert advice and often pay handsomely for it. This contrasts to people in the book who have good incomes but aren’t really good at building wealth or financially security – often they are less likely to pay for advice or value it.
No, the question is this. I have $6K to invest this month. What do I invest it in? If I’m agnostic to values, I just invest into my set asset allocation. If I want to try to “buy at a good price” I have to decide what’s at a good price. That means either individual security picking, which brings in uncompensated risk, or trying to divine what asset class is “undervalued” (meaning going to rise in the future.)
Since you feel no crystal ball is required, what should I invest this $6K in this month. And if you’re so sure, why shouldn’t I sell all my other asset classes and invest in that with my entire portfolio?
#7 Fairly Priced/#8 Tied with Other Services
It’s more important to focus on the value you ultimately receive, relative to the price you pay than any other factor.
People sometimes try to focus on the work involved by that is a mistake. A farm worker who picks tomatoes in the scorching hot sun works a lot harder than a dermatologist or an endocrinologist but I don’t pay the farm worker more. I don’t pay them more than a lawyer or accountant who sits in an office.
An accountant’s advice is really valuable to me. They’ve specialized and seen so much more than me that it would take me a lot of effort to get to know what they know. And it isn’t worth it to me since I don’t like reading the IRS’s website and structurally I’m not in the right position in the social network where everyone shows me their tax returns and lets me see their interactions with the IRS.
Our nation is richer because we specialize. The holy trinity of financial matters is (an accountant to interpret how to deal with the IRS, a lawyer to defend you from those who try to make your money, and an investment advisor to make sure your money is productive). Relative to the physical labor involved in the work, lawyers, accountants and investment advisors are well paid – because we all protect or expand the use of money which can be exchanged for a lot of things in society. It makes sense to pay up for good advice provided you are getting good value for your money. People get more likely to pay advisors as they become better off and those who are more knowledgeable may command better prices in the market.
I’ll never fault anyone for trying to get a good deal, but remember what really matters is to maximize the quality of your defenses after accounting for costs (through your accountant and lawyer) and acquiring new productive assets and territory (through your own efforts to acquire superior information or through hiring the most productive advice you can get – while considering taxes and costs).
How to find a perfect financial advisor: Don’t listen to anyone who alleges to have a “secret sauce” to deliver market-beating returns and won’t tell you how they do it, and who minimizes the value of advance education and professional designations.
How true. The above sounds exactly the kind of advisor one should run from as fast as possible in the other direction – using strategies that are “not published”, diminishing the importance of costs, thinks he should be paid the same as a lawyer and an accountant? Really?
Hey Grant and James,
I disagree with both of your points of view (although I respect your right to have them). In James case the issue I raised is that there isn’t a proven relationship between being certified and being a good investor. I would never knock advancing your education – but my argument is that certification is not the same thing as knowing useful information. My argument is that the certification is a short cut or a proxy to stand for when someone has knowledge but it is better to actually just check and see if someone really is knowledgeable. If you talk to them for a while you’ll get a feel for how deep their knowledge is.
I also never said there was a secret sauce. I said some things are more likely to work than others and its in your interest to focus on those things. I’m not going to publish those things for free because 1) people could use them to make money themselves with no compensation going to me for my work 2) there is limited capacity in the investments and if everyone knew them I’m not sure they would work anymore.
As for Grant’s comments – I never diminished the importance of costs – I said that a rational person has to view it in the proper context as the smaller factor that it is. I neither expanded or diminished the factor – I just stated the facts as they were. It is good to save some money – but make sure to focus on factors that are empirically proven to make portfolios first.
That seems like a rational analysis to me and I think smart investors will see it as that.
I disagree that “talking to someone for a while” is an adequate way to judge their quality as an advisor. The issue is that if the client knows nothing about investment any scheme the fast-talking advisor proposes is going to sound awesome. The truth is that by the time you know enough to recognize a quality advisor by just talking to them for a while, you know enough to do it yourself.
You know what – I think you might be right on this one. A brand new investor may not know the difference between a good advisor and a bad one.
For a brand new investor my advice is to pay attention to pricing (mostly the price of the asset but also the price of the advice), to consider growth assets for retirement accounts and low volatility assets for other needs, and to maybe start with a target date fund or ETF right out of the box. It’ll give you a chance to experience highs and lows when someone else is setting up a defined structure.
But within the first five years, I would look around for alternatives because good investment decisions are mathematically worth millions and the better decisions you make the more you’ll have for all that is important to you. Please don’t minimize the impact of compounding and the investments you choose – it is probably the biggest factor other than your earnings and savings in determining your financial outcome!
Dan-there is nothing you know that is not already published in many excellent books by the well known giants in finance
Dinner last night with an advisor hawking fixed indexed annuities and brandishing all his licenses and credentials and ethics-What BS
and billions being poured into these terrible annuities
Hi Ken,
I wish your thinking were more expansive. I think when you turn off learning about financial matters we can end up penalizing ourselves. There is a lot of growth most people can do in their knowledge base and there are lots of benefits to growing.
You can discover things other people don’t know and not all information has been discovered in the world yet. The financial markets have some similar characteristics throughout history but technology and new product offerings cause them to evolve and change in sometimes unpredictable and initially counterintuitive ways. But if you work really hard at it, have the right temperament and are open minded it can be an enormously productive resource for you and your family.
The thing I love about investing is that even a total amateur, if they are somewhat smart about their approach, usually makes some money above the rate of inflation. It is far from a Loser’s Game in my opinion and can be a really great resource. Not everyone agrees with me, but the more you learn about it the better resource it can be.
Sorry about your unpleasant dinner with the annuity salesman. Annuities are not my favorite part of the market but I guess it is good to have some basic level of financial education about them.
Investing in stocks and bonds and a little in RE(reits) is not that difficult to grasp(MPT)
Many doctors are not interested or think they can actually trade and beat the mkts but we know how only a fool would pursue that path
All information is out there and there is NO MAGIC BULLET
Ken,
There is no magic bullet – we agree on that. But I think even you would say that there are some strategies or tools that are more effective than others.
Dan, I hate to be the one to point this out but if you really had the “secret sauce” for beating index based investing (besides well-known tweaks like small/value tilts and non-cap-weighted indexes, etc.), you wouldn’t be trolling on WCI looking for clients, you’d be running a very large and successful mutual/hedge fund.
Your replies to Jim’s list would be Exhibits A-E in “Financial Advisor Red Flags” in my book.
That’s silly. I’ve run a successful investment advisory practice for years and I don’t know how I would be trolling for clients without even using my last name.
I’ve learned a lot from this blog and occasionally I contribute when I think the arguments aren’t quite nuanced enough to reflect reality. My original argument is that not all information is public, which makes sense if you think about it. Companies don’t disclose trade secrets, you don’t know the recipe for Coca Cola, and not every piece of information out there is published in journals. That isn’t really controversial if you think about it.
The second thing is there is a distribution of outcomes for investors. Some indexers like to frame it as if it binary (you beat the market or you earn market returns) and that is because they want to sell you something. They need to convince you that despite intelligence, education, playing on your natural advantages you can’t possibly move yourself to the right of the distribution at all (you’ll notice moving yourself to the right of the outcome distribution is not the same thing as beating the market which I have never ever encouraged as a goal). It is sort of like saying if you get an education and do well at your job maybe instead of $30,000 you’ll earn $70,000 or $120,000 or even $150,000. All of that is about moving to the right side of the distribution – which is both possible and worth doing.
And the published research shows that there are things you can do to move yourself to the right that are not at all controversial and yet not all advisors use those approaches. So doing this well requires both knowing the information (ideally both published and some unpublished information) and applying it. That’s all I’m saying – no red flags in that – just cold hard logic.
I’m not sure why self improvement raises red flags for you, but people on the right sight of the distribution act fundamentally differently in my experience and they are always trying to give themselves a little bit of an edge. The result is not that they beat the market its that they make their portfolio 1 or 2 or 3 percentage points more productive over time which basically can put several hundred thousand to a million dollars in your pocket. No magic there – just cold hard math, the right mindset and a little bit of effort.
It is very easy to move to the right side of the distribution- by simply getting the market return! Since most investors, with or without advisors, dramatically underperform it due to bad behavior and high costs.
That’s True!
But remember we invest in multiple markets – so you’ll want to spread your assets across those markets in a way to capture good deals (which often yields better market returns than what other investors are getting). You can do this completely using ETF’s and without an advisor – but you do have pay some attention. Those who pay no attention, if their asset allocation doesn’t match what is a good deal may find themselves not on the right side of the distribution!
More than 90% of ones returns are dependent on asset allocation
Picking a basket of passively invested funds is quite straightforward
Maybe adding some small caps will boost your yield but future performance does not reflect the past always
From personal experience, the problems many doctors and dentists run into is that most advisers are either
1) Asset aggregators who typically charge asset-based fees or
2) Asset allocators, who primarily provide advice on asset allocation, often asking the client to move their money to their broker/dealer, but rarely providing any other type of advice (while charging significant fees for their limited services).
The role of a good adviser is not only to provide services such as financial and tax planning, investment management and retirement plan advice, but also to serve as the point of contact for (as well as coordinate the work of) the CPA, insurance broker and estate planning attorney, and be able to find the right CPA, insurance brokers and attorneys for the clients based on their specific needs, and to provide a second opinion on tax planning, insurance and estate planning, and other matters as such advice can often be sub-par (because cutting corners is rather widespread and not just in the financial advisory industry).
So while an adviser can’t be an expert at everything, they should at least know what they don’t know and be able to put everything together as well as to oversee the entire financial situation starting with basic planning all the way to setting up and managing a practice retirement plan, so their expertise has to be significantly more in depth in many more areas than for advisers serving general population of W2 employees.
It would be nearly impossible to for a small firm to have the best professionals under one roof and to charge low fees for that. They will also have a conflict of interest to steer you to ‘their guy’ and potentially their overall fiduciary standards will be significantly lower than those of the best advisers. So I find that it is much better to have the best professionals in the business available virtually – not only does this eliminate the overhead (as many high end professionals have one-person offices), but this also eliminates any conflicts of interest, and it is possible to put together the best team cost effectively without having to pay big firm prices.
Jim,
Great list! My profession should read it with an open mind. Only question I have – how do you achieve #8 while balancing convenience and conflicts associated with referring your internal guy? I guess the same issue exists in medicine – My doc works in a hospital system – how do I know his intrahospital referral is in my best interest as a patient? Conflicts will always exist. We must do better in my profession working to avoid them when possible.
Great question. I guess the best thing to do is get the best possible internal guy you can!