We often hear the following two seemingly contradictory claims:
1. Most investors need financial advice.
2. Most investors should get rid of their financial advisors.
How could these both be true? The answer boils down to what we mean by advice. If you imagine the advice coming from a savvy investor who has your best interests at heart, then you would do well to listen. In this case, even experienced do-it-yourself investors could benefit.
Investors need good advice, not just any advice. If someone suggests that you borrow $100,000 and bet on red at the roulette table $1000 at a time until the money doubles or is gone, this qualifies as advice, but not good advice. (By the way, your chances of doubling your money this way are less than 1 in 30,000!)
Unfortunately, in the mutual fund world, “advice” means whatever tactics a mutual fund salesperson uses to get your money into a set of funds. Typically, the clients pay about 1% of their assets each year for this so-called advice.
So, if you’re in a debate about the value of financial advisors, you should happily concede that most investors need advice. Just be clear that this doesn’t mean that most investors need to pay 1% of their assets each year to a salesperson. There are cheaper ways to get advice of higher quality, such as paying a competent expert for a couple of hours of his or her time.
Unless people want to do a lot of research and/or they have a complex financial situation a financial plan makes sense. Even if they pay $2500 they many times can end up saving much more than that. A plan of course goes into a lot of aeas. In the U.S. it is about when to take Soc. Sec., how to funds kids' education, insurance needs for the family and ends up with an assessment of what needs to be done to meet retirement goals.
ReplyDeleteA subset of this in investmets and many financial planners want to manage your assets and will charge between 1% and 2% MER, put you into actively traded funds that take another 2% or so. This takes a humongous chunk ot of the nest egg.
In my opinion people should search for low cost managers that use low fee, low turnover indexed funds. Support for this approach is provided by Buffett, Bogle, Ellis , Malkiel and many, many others who have spent their lives investing and studying the results of those who try to pick stocks and time the market.
Most people can actually learn how to do it themselves once it is up and running, including the rebalancing when appropriate.
@Financial Cents: Thanks!
ReplyDelete@Thicken and @DIY Investor:
Even if we take the high end of Thicken's figures ($2500), a mutual fund investor will pay about this much in about 2 years on $50,000 invested. For anyone with less than $50,000 to invest, I have a hard time seeing why an advisor couldn't give useful advice in an hour. Then, when the portfolio grows above $50,000, the investor could go for another hour of advice. I just don't see how the advisor costs should ever get to be as large as the mutual fund MERs. So, I agree with DIY Investor. But, Thicken is right that most investors are likely to go the apparently-free route.
Of course, things look very different from the advisor's point of view. The advisor may not wish to simply sell his or her time. Meeting with a client for an hour and then charging for additional time to go away and prepare a detailed plan is a great way to make more money, particularly if these detailed plans are largely comuter-generated from just a few numbers collected from the client.
The second reply above is (in part) to Thicken My Wallet's comment:
Delete...but this is where structural factors shape investor behavior for the negative. An investor is paying anywhere from $500-$2500 for a comprehensive investment plan in Toronto. If given a choice between "free" advice (imbedded in the MER and could cost you more than $500-$2500 if the fund is held onto for a long time)and paying out of pocket, what will most average investors do?
I would be interested in seeing what the fee comparison would be between paying for a plan and then buying low cost products as a DIY investor or investing through a conventional ia (perhaps a post topic for you). I suspect the former is a lot less than the latter over time but the industry knows we often adhere to the penny wise, pound foolish outlook on life.