Developing an investment policy statement
I’m in the process of consolidating all of my investments under one roof. This includes:
- My Roth IRA (currently with Sharebuilder)
- My profit-sharing pension through the family box factory (currently with Vanguard)
- My self-employed 401(k) (now at Fidelity)
- My non-retirement accounts (scattered hither and yon)
Between these accounts I have a large sum to invest. I don’t know the exact total (the market fluctuates daily, and I don’t really know the value of the Vanguard stuff), but it’s over $100,000. That may not be a lot to you, but it’s a lot to me. When I was struggling with money, retirement saving was one of the only things I got right. (And that’s because it was automatic; I had no control over it.)
Because I have so much to invest, I’ve begun to speak with financial advisors. Some advisors aren’t interested in taking on clients unless they have very large sums to invest (over $500,000, for example). But others are willing to help those who are building wealth. I’ve spoken with advisors at my business bank, at my credit union, and at Fidelity. I intend to call others, too.
Note: It’s not certain that I will work with a financial advisor. I may decide to do this on my own. But I want to explore my options, and I want to experience the process so that I know what it’s like.
The problem I keep facing is that I’m not sure what my investment goals are. Advisors ask me, “What do you want to do with your money?” This is difficult to answer. Do I want to protect the money I’ve already earned? Or do I want it to grow as much as possible? I need to determine my investment goals.
One of the best pieces of advice I’ve found comes from The Quiet Millionaire by Brett Wilder. This book has been on the top of my to-read stack for months, but I’ve only recently begun to plumb its depths. Wilder encourages readers to develop an “investment policy statement”:
The investment policy statement should provide specific investment guidelines for you and your investment advisor to follow. The policy should specify how the portfolio is to be structured, the targeted rate of return, the time horizon for expected results, the risk tolerance level parameters, the amount and timing for anticipated contributions and withdrawals, and the emergency liquidity needs.
Having a written policy statement enables you to have a clear reminder about your personal expectations for the portfolio, and it will help you to monitor the performance accordingly. By being organized and prepared, you are less likely to fall into the “emotional investor” category and more likely to stay focused on monitoring the portfolio’s performance relative to meeting your specific planning goals and objectives.
I’ve never made any sort of formal declaration of my investment objectives. I’ve kept a sort of rough internal guide to the things I want to do (invest in index funds, retire early, etc.), but I haven’t written down my objectives or how I mean to reach them.
Do I want to build as much wealth as possible? Do I want to protect the wealth that I have? Am I interested in income? And what is my investment philosophy? Am I willing to accept greater risk in exchange for greater possible returns? How do I feel about administrative costs? Taxes? Diversification?
These questions are not easy to answer. We all want high investment returns with no risk. But those aren’t possible. So how do we compromise? How do we develop investment policies that match our values and our goals?
I’m not sure, but I’ll be sure to share with you as I find the answers.
For more info on investment policy statements, check out Morningstar: Creating your investment policy statement from Morningstar and Making an investment policy statement from tools for Money.
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There are 46 comments to "Developing an investment policy statement".
I’m curious about your decision to hire an investment adviser after managing to reach the $100,000 all on your own in self-directed accounts. I’ve been thinking about this topic for a while and I’m curious when and why someone decides, “OK, enough of me doing this myself. It’s time to bring in an expert.”
I’m a fan of an investment policy statement but I would suggest for someone who is starting out or just doesn’t have any clear financial goals – then don’t worry about it since it’s not essential.
“And that’s because it was automatic; I had no control over it.”
That says so much about how to successfully build wealth. Automation is the way to go. 🙂
I agree completely about automation. My husband and I are building a decent retirement savings and a large reason for that is the automatic system of investment. We should probably take a look at the specific investments, though, and make sure we’re on the right track to meet our retirement goals.
The only problem with automation is not knowing what’s going on. I completely agree that paying yourself first is one of the smartest financial moves you can make. But be sure you aren’t blind to what’s going on with your investments, bills, or over all financial life.
It’s awesome to see J.D. stepping up to the plate and going through some serious introspection. Helps anyone else that has been putting this off (me) maintain focus.
Oh, this one is easy for me to help you with. May I ask that you do NOTHING with the money until you do two things for me:
1. Contact the BalwdGuy (Jeff Brown) and read his blog at http://www.bawldguy.com
2. Contact David over at Uncommon Financial Wisdom and read his blog at http://shaferfinancial.wordpress.com.
I personally guarantee you that you won’t be sorry you contacted and worked with them.
JD,
I think you should trust your own instincts and go with that. It is always a good idea to get your goals (you can call it a Policy if you like) down in writing (and if you need more encouragement to reach it, you may even put a copy of it on your fridge or somewhere you will notice it everyday).
The thing with goals are that it is personal and should reflect your own style. If you need to see it growing you may need to invest in some cash instrument, if you also want to enjoy it while it is growing you may invest it in some property (by the way, NOW is the time to BUY BUY BUY. the slump will not last forever and the good buys will be gone (just make sure you can afford it when the interest rate goes up again or buy for cash now).
Some people like investing in the stock market as it also gives then a sense of achievement and some feeling of control as they can buy or sell whenever they want to (at least in theory).
In the US there are lots of legislation and litigation about investment advice and therefore most financial advisers will want you to provide them with a written statement of your investment goals to minimize potential future litigation.
My suggestion is to find something you love doing and invest in that. You should already know a lot about the subject, you like it and it can provide you with a sound investment if you do it wisely, only you will know.
I would say that you don’t need a financial adviser. After all, you ARE a financial adviser to thousands of people in the US through yourr site. It doesn’t matter that you are not a CFA or a certified investment advisor..
I say you can do it and – GO FOR IT on your own 🙂
“I’ve begun to speak with financial advisors”
Financial advisors, as in you pay them an hourly fee, or investment salespeople, as in they get paid commissions for selling you something? There’s a big difference, and both call themselves financial advisors.
JD, am sure you’re already on this – but be sure to use only “fee only” financial advisors. Other guys only make their money by selling you their products, by racking up sales fees,etc. A family friend is (finally) going to see a fee-only CFA this week — he does a free visit and collects all kinds of info in advance so he can give you advice aligned with your goals — bet you can find the same near you, which will also help you clarify what you want to accomplish.
Having a solid vision for where you want to go is always a good idea.
My current retirement (401k and Roth IRA) value is a bit higher than your’s, and just like you most is from automatic savings and reinvestment. Even at the bottom (if we truly have hit bottom) my 401k was still worth more than my personal and company match investment. I’ve kept watch on the investment options available through Fidelity and have moved most of my funds into target date and investment funds. Traditionally Fidelity and Vanguard keep their expense ratios low on retirement focused funds.
I don’t like the idea of consolidation into one company though. As strong as Fidelity and Vanguard are, they still could fail and take a good portion of your nest egg with them. That’s why my Roth IRA will stay with Vanguard and my 401k with Fidelity.
I will admit that I lowered my 401k contribution in February and am using that extra money to pay down my mortgage. Where else can someone get a guaranteed 5.58% return? With luck and a little perseverance my home will be paid off in 29-34 months.
Personally, I take my gambling money and use it in my non-retirement funds and stay more or less safe with the retirement. Then again I’m 46 and closing in on retirement.
Oh, I should also mention that my Roth IRA will be fully funded for 2009 by the end of June and if I work things right 2010 will be fully funded the first week of Jan 2010.
Early this year, I drafted a “financial plan” (which I used to educate my husband on investing). It’s nice to hear the experts suggest having something similar. Basically, I just wrote down our goals, each with the corresponding timeframe, target amount and financial instruments we can use. Now, I use it as guide for our savings and investments.
“Fee Only” does not equate to “Value”.
I am a financial advisor and we do both fee based business and transactional business. Here’s a little secret for you (I’m whispering in your ear now).. IT DOESN’T MATTER.. I’ve done the math, you will be paying easily around 2% to have someone “advise” or “manage” your money. The industry changes the fee structure just so people think they are getting a deal. We don’t work for free, folks, and you need to be comfortable paying if you use our services.
NOW..
I really don’t think you need an advisor. You have enough interest and know-how that I don’t think you would get enough value to justify the cost. You have brought up the exact right questions, now it is a matter of answering them honestly.
@Chris:
Do some types of funds or investments you deal with give you higher or lower transaction-based income than others do? If you are advising your client to choose the proper investment and the investment you choose for them affects your personal income, isn’t that a conflict of interest?
This is why I think fee-based advising makes everything more clear-cut since it reduces the opportunity for conflicts of interest.
JD – I agree with #8 Dividend Growth Investor – You are helping people make these decisions through this website.
Be weary of the financial advisors who get paid by commission – those advisors may have a conflict of interest. They are not obligated to inform you. While often, fee-only advisors are required to inform you of conflict of interest or full disclosure.
No matter whether you pay as a fee-only or percentage of your investments, make sure you know who is offering the advice. It’s like anything time you are hiring a professional – check their credentials. It is important to note that there is no education requirement for someone to call themselves a financial advisor.
$100,000 sounds like a lot to me!
I’m pretty sure JD knows about advisors and their potential conflicts of interest.
One thing about getting financial advice is that it doesn’t have to be all-or-none. You can do part of your financial planning yourself (ie picking investments) and then use an advisor to evaluate your asset allocation or taxes or retirement planning or any other topic that you either don’t feel comfortable with or just aren’t interested in doing yourself.
I agree that JD probably doesn’t really need an advisor but maybe visiting a fee-only advisor every 5-10 years for a “checkup” might be an idea.
I picked up Ernst & Young’s Personal Financial Planning Guide used from Amazon and found about 5 pages on setting goals in the first chapter. It was handy.
Something else I did was to open an account with Vanguard, and a money market account. We put everything “extra” at the end of the month into the money market account. This is for vacations, emergencies, property taxes, etc. Then I have the same amount every month automatically transferred from the money market into a Vanguard index fund to take advantage of dollar cost averaging. Our goals factor into the amounts that we put into each account.
The book I’d recommend is called “Smart women finish rich: 9 steps to achieving financial security and funding your dreams” by David Bach. It is at the local library here in Portland. Look for the chapter on setting goals. Bach takes you through a great goal-setting scenario that gives you a bigger vision of why to save and invest (and it’s not just specific to women)
Oh this is so timely for me…I just got off of the phone with our fin. advisor to have her cancel our next automated ira contribution, not because we are stopping completely, but I am taking over control of our iras and going with Vanguard. I don’t want to pay the high fees anymore. In a few months, I will transfer all of the money at the high priced actively managed fund company over to vanguard. I know our timeline and our goals. My heart is pounding, but I feel very empowered!!
Two things JD:
1)You need an investment advisor who is aligned with your interests (maximizing return while minimizing risk), not one whose primary interest is making money off of your investment portfolio. The only advisors I know of whose interest will align with yours are those that do not collect any transaction fees or a yearly percent of your portfolio. You need an advisor that you pay by the hour similar to a lawyer. They have no incentive to promote excessive churn or risky bets and instead they will be focused on doing what is best for you so you will perhaps refer them to others.
2) The most important thing to remember when developing an investment plan is that there is a difference between speculating and investing. There is no room for speculation in your portfolio. I encourage you to read a short piece I wrote on the difference, which includes a real life example and a definition of Investment from the great Benjamin Graham (Warren Buffet learned quite a deal from Benjamin).
http://www.twentysomethingsense.com/2009/04/speculating-is-not-investing.html
J.D:
As you know, I’m a financial planner (CFP) and a “fee-only” investment adviser. So there is the disclosure…
Anyone here who “advises” you why or why not you should hire an adviser is completely unqualified to give that advice, especially assuming they do not have intimate knowledge of your finances, lifestyle, emotional disposition, and personal preferences.
Hiring an adviser has the same logical premise as automation — both limit self-defeating behavior and free more time for meaningful pursuits.
Of course, advisers are susceptible to human error, but here is how to limit that potential for error:
1. Hire a “fee-only” adviser so there is no bias to products. Ask if the adviser is a “fiduciary.”
2. Be sure the adviser has both experience and knowledge. 10 years experience and a CFP demonstrates both.
3. The adviser should be able to write the Investment Policy Statement for you (and do so as a standard practice).
4. If the adviser tells you how they can “beat the market,” then you should be concerned of their values (and truthfulness).
5. With $100,000 in assets, you should not pay more than 1.50%.
6. A planner who understands “life planning” would be a plus. Life planning, done correctly, helps guide clients to making money a tool for a life plan, rather than continuing to use your life as a tool for a money plan.
Finally, extending upon number 6, be careful to avoid planners who simply provide “money plans,” which are the conventional means of quantifying how much you need to save per month, for how many years, and what rate of return to reach a specific money goal.
Life is not about making money — money is about making a life…
Let me know if you have other questions…
Kent
You clearly need to write a plan for your investment goals. You have investigated and written about personal finances for several years and now you need to condense all that stuff in just one or two pieces of paper. It’s going to be simple and you’re going to have some doubts but Betrand Russell said
“Not to be absolutely certain is, I think, one of the essential things in rationality.”
And about the financial advisor. I bet the name of the one you’re going to hire is JD.
This truly IS a timely post!
10% of my income is vested in PERS via my employer, and I have no control over the PERS investment. Bugs me, but it’s free money, so I can’t gripe.
For my Roth IRA, I’ve been using an FA, and make automatic investments every month. I’m paying a 2% fee, which bugs me, and I recently considered doing it on my own via Vanguard or Fidelity.
The truth is, I am afraid that I would be too emotional of an investor. I’m concerned that I’d make irrational decisions during downturns, or chase higher returns. Conversely, when I see the things that my FA has me invested in – I think to myself `For crying in the mud, I could do THAT without paying a d*mned fee!’.
It’s a terrible conundrum for some of us, I’ve twisted and turned over it myself and I don’t know what the answer is! I’ll be very curious as to how you proceed. THANKS again for sharing!
I have gotten full financial advice, with recommendations, from my IRA custodian.
Most of them will do this no charge if you have enough money with them.
As it is, I use T. Rowe Price. And for the record, they did not push their products. I have other monies elsewhere as well as stock I own, and never once did they try to get me to transfer anything to them.
I think that an Investment Policy Statement is a great idea as a guiding thesis behind your investing goals.
I also think that some part of your Investor Policy Statement should refer to making a commitment to start and continue your investment education on an ongoing an consistent basis.
Totally not on the topic of an investment policy but I found this bit kinda amusing:
“I’ve never made any sort of formal declaration of my investment objectives. I’ve kept a sort of rough internal guide to the things I want to do (invest in index funds, retire early, etc.), but I haven’t written down my objectives or how I mean to reach them.”
Some folks might suggest you’ve already retired early, since you quit the job you really didn’t enjoy, and are now doing something that seems to bring you pleasure–and has the added benefit of making you some money, too!
Planning and discipline are key– you are heading in the right direction. A fee only planner may be helpful.
I agree with the others. With that much money, it’s time to leave commission-based “financial advisors” behind you. You’ve moved on to the fee-only “financial planner” stage.
JD,
There’s nothing wrong with contacting a fee-based CFP for help in this matter. I do recommend investing the time to learn about Asset Allocation and crafting a plan of your own before you speak to a CFP, however. If you feel that you’re being “sold” anything, you probably are!
Too often we hear advice such as “stick all your cash into an index fund!” By this logic you would be paying low fees, but you’d also be exposing your entire portfolio to the risk of the market. As the current downturn has shown, too many people near retirement were way too invested in the stock market. With proper asset allocation you should be able to choose a mix of investments (primarily low-cost bond and stock mutual funds) to minimize risk and maximize your return. Good Luck!
I wonder at the logic of hiring an financial planner. Why is it that few ask the right questions as to why they would want to hire a financial planner? For me there is only one basic question to ask. Will the financial planner obtain a greater NET rate of return for me than what I can get doing it myself? The reason I believe that no one asks that question is that the financial planning community has done a great job at obscuring financial reality. Why is it that with all the talk of ethics [fee based planners make a huge thing of this] that there isn’t a general policy to make public the rate of returns achieved by planners? I let the readers answer that for themselves!
Going a little further, it should not surprise folks that research has been performed on this fact and the data has pointed out that financial advisers actually lower the rate of return [slightly] for folks compared to their DIY peers! So there is a real cost to hiring a planner [duh, how do they make their money]. Additionally, research has pointed out that whether the planner is fee based or commission makes no difference in their performance! See the dirty secret is that fee based planning is merely a marketing ploy.
The author of this blog has done a great job with it and apparently is satisfied with his returns. Maybe I haven’t looked around enough but don’t see where his returns are listed???? Anyway, since he is apparently satisfied, then why should a planner be used if the evidence indicates that a planner will lower returns? Only one reason, the investor is too lazy to continue to do it themselves. And for the financially lazy their are a host of other ways to obtain moderate returns without having to pay another middleman [woman]! But the author does not appear to be in that category. Remember, there is only one person in the world that will put their interest totally in-line with your money. That is you! Educate yourself, think outside the box, strive for success.
We started using a paid financial advisor (through Schwab) when we were moving from “accumulating money” to the “soon to be living off of our money” stage. I am very good at accumulating money, and keeping it well diversified (the planner was shocked how good my numbers were in terms of diversification), but what I wasn’t good at was getting ready to retire and live off of this money. I think when you feel over your head, it is time to get some advice. But we remain in control of our money – we just get quarterly “checkups”.
Di gives you sage advice, if you feel you are over your head, get advice!
By the way turning wealth into income is a huge issue for most folks approaching retirement.
@ Dave Shafer, comment #31:
You make some valid points but your argument is self-defeating. Here’s why:
You say: “For me there is only one basic question to ask. Will the financial planner obtain a greater NET rate of return for me than what I can get doing it myself?”
I say: Financial planning, done right, has very little to do with getting higher returns on money, but has more to do with getting higher returns on quality of life. If an individual gains personal satisfaction from the acquisition of skills necessary and from the processes of tax planning, estate planning, cash flow, investment research, selection and monitoring then yes they should do it all themselves…
You say: “Going a little further, it should not surprise folks that research has been performed on this fact and the data has pointed out that financial advisers actually lower the rate of return [slightly] for folks compared to their DIY peers!”
I say: You state a claim without supporting evidence. Even assuming your statement is correct, you make the fatal error of assuming that the sole purpose of using a financial adviser is higher monetary returns. Hiring an adviser is a form of prudent “outsourcing,” which is a means of freeing more time for the individual to focus on their personal strengths and/or to focus on those things in life that matter more to them than money.
You say: “…then why should a planner be used if the evidence indicates that a planner will lower returns? Only one reason, the investor is too lazy to continue to do it themselves.”
I say: Once again, where’s your evidence? I’ll remain charitable and assume you are correct that a planner will lower returns. Your statement, however, that the only reason to hire a planner is because “the investor is too lazy,” is bordering on ridiculous. My clients are some of the hardest working, successful individuals I’ve ever witnessed in my life time. Once again, hiring a planner is a form of outsourcing, which is a matter of efficiency and prioritization — not laziness.
Finally, you say to “think outside the box.” I humbly submit to you that thinking outside the box involves the consideration of making decisions that go beyond one’s self. If you are thinking that the only reason to hire a financial planner is because of laziness or to achieve higher monetary returns, you are firmly placing yourself inside “the box.”
“In the case of any person whose judgment is really deserving of confidence, how has it become so? …. Because he has felt, that the only way in which a human being can make some approach to knowing the whole of a subject, is by hearing what can be said about it by persons of every variety of opinion, and studying all the modes in which it can be looked at by every character of mind. No wise man ever acquired his wisdom in any mode but this…. ” ~ John Stuart Mill
@Kent,
I need to point out what I said was “Only one reason, the investor is too lazy to CONTINUE to do it themselves. And for the FINANCIALLY lazy there are a host of other ways to obtain moderate returns without having to pay another middleman [woman]!”
In no way did I imply that your clients were lazy individuals.
Since I was addressing the question the blogger posed, and he is apparently a do-it-yourselfer, my post was an answer to why he should stop doing what he has been doing and turn over his money to a financial planner.
You should also note my original question was “For me there is only one basic question to ask. Will the financial planner obtain a greater NET rate of return for me than what I can get doing it myself?”
Implicit in that question is what people “can get doing for themselves.” If folks don’t have the ability, confidence, or time to do it for themselves, then outsourcing [your verbiage]makes sense. Just understand what the true cost is.
As to the data out there on performance, it probably wouldn’t take folks long to find it for themselves and I suggest they do for whatever strategy they choose.
Perhaps I am inside the box when I suggest that folks should look at results to determine whether a service is valuable, but my experience is that box is of critical importance. I don’t want to generalize from you to the entire financial planner world, but I must comment that there seems to be much similar thinking in your world. I, for one, find it humorous that financial planning folks try very hard to not be judged by the real world results of their advice, like the rest of the business world.
My friends in your business are all very intelligent, like you, and give their clients what they ask for, but rarely disclose their investment results. But I haven’t heard, “Financial planning, done right, has very little to do with getting higher returns on money, but has more to do with getting higher returns on quality of life.”, from them. I’ll have to tell them about that line next time we get together!
Perhaps you really are a financial philosopher/swami and your clients get much more than just money management from you. Do you also offer financial psychoanalysis? [The previous paragraph was meant as a humorous attempt to make a point. Please don’t feel like I am attacking your or your profession, like I said before I have friends in your profession and don’t question your professionalism or how well you take care of your clients!]
Bottom line where I come from, if you hand your money off to someone, then you should expect to do better than what someone in a indexed mutual fund does.
“My friends in your business are all very intelligent, like you, and give their clients what they ask for, but rarely disclose their investment results.”
Seriously? Because I am in the industry too, and almost everyone I know discloses their performance…Its the first thing that comes up at almost every meeting, even before the financial planning topics–or what you call the financial psychoanalysis… 🙂
“Bottom line where I come from, if you hand your money off to someone, then you should expect to do better than what someone in a indexed mutual fund does.” Agreed if you are hiring some one to actively manage the portfoli, but again, most true financial planners would only consider this one portion of the total services being provided.
Again, I see alot of wrong information out there about who truly is a financial advisor vs. an investment managers.
Thyanks Kent & Swami for your response to Dave’s Comments in #31. I personally, don’t feel Dave has any valid points in his post.
I would love to see the research done that proves financial advisers actually lower the rate of return [slightly] for folks compared to their DIY peers! Since
I agree with Kent and Swami that planning is just as much qualitative as is quantitative. (Both are important)
I would assume it is impossible to provide that research since most investment clubs and DIY investors are not required to report their returns. Not to mention, it is the manager of the fund or RIA that reports returns and not the financial planner who placed the funds with the manager.
The only scenario I can think of is what you kind of stated in the end of your last post. A planner is advising or placing client’s investment in an index fund or ETF and then charging additional fees on top of the fund expenses. Then yes, that client would be charged more than just investing in an index fund themselves. Though, I would argue index funds were designed for the DIY and are not used as the primary investment tool for financial planners.
Now, when you are looking at managers returns (Either a fund or Independent) you could ask yourself if it is worth the cost or not to be with that manager and if it complements the portfolio quantatively. Something a Planner could help you with which would be qualitative.
Oh, and for those who believe so much in Indexing, you should ask yourself what quartile or percentile the S&P finished against the universe of large core peer funds in 2008. The answer: roughly 75th percentile, meaning 75% of the universe of large core equity managers out-performed the index last year. If you look at the 3-year and the 5 year returns you get roughly the same answer (Data provided from Zephyr). Also ask yourself how much of the index was weighted in Technology back in 2000 or financial stocks in 2007. You will find the answer to be over 30% (Go Market in being diversified!). Of course there are times you can argue that only 25% of the managers were able to beat the market returns, but I would prefer a manager that can react and take action to avoid further losses in bear markets.
“roughly 75th percentile, meaning 75% of the universe of large core equity managers out-performed the index last year”
Is there a link for that information? According to S&P it’s the other way around, where the index beats 70-80% of the managed funds.
http://www2.standardandpoors.com/spf/pdf/index/SPIVA_Report_Year-End_2008.pdf
For the DIYers, here’s a simple strategy to avoid the large drawdowns of a bear market.
Abstract
“The purpose of this paper is to present a simple quantitative method that improves the risk-adjusted returns across various asset classes. A simple moving average timing model is tested since 1900 on the United States equity market before testing since 1973 on other diverse and publicly traded asset class indices, including the Morgan Stanley Capital International EAFE Index (MSCI EAFE), Goldman Sachs Commodity Index (GSCI), National Association of Real Estate Investment Trusts Index (NAREIT), and United States government 10-year Treasury bonds. The approach is then examined in a tactical asset allocation framework where the empirical results are equity-like returns with bond-like volatility and drawdown.”
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=962461
Great points, everyone.
The greater point with investing is that a financial planner, specializing in investment management, can in fact use indexing and provide added value for their clients. This value is obtained through asset allocation.
A Certified Financial Planner (CFP), can go beyond investments and asset allocation and save clients thousands of dollars on tax strategies alone. Even further, as Ralph Waldo Emerson said, “The cost of money is often too high.” How much is your time worth?
I believe a financial adviser’s greatest value is in the ability to view their clients’ money logically, and largely without emotion.
The greatest risk to an investor is not market risk but the risk in submitting to self-defeating behaviors (greed, fear, complacency, inertia, lack of motivation).
There are certainly those rare individuals that enjoy doing all of the research themselves and also happen to have the capacity and knowledge that can make the use of a financial adviser unnecessary.
If we are going to generalize about financial advisers, however, we must also generalize about the average investor, who is likely to be their own worst enemy.
“The investor’s chief problem — and even his worst enemy — is likely to be him self.” ~ Benjamin Graham (Warren Buffet’s mentor)
The definitive study is the BCT study done by Harvard/Morningstar researchers [2006]: synopsis at this link: http://www.people.hbs.edu/dbergstresser/dbjchpt_morningstar.pdf
You will note that the investors without advisers outperformed those with advisers 6.6% to 2.9% in the period studied. Do advisers outperform index funds? No. Do advisers provide superior asset allocation? No. Do advisers help investors correct bad behavior like chasing performance? No, they actually contribute to that behavior!
I will let the readers decide what to do with this information!
I’m looking forward to seeing what you end up with. I desperately want to consolidate our 6 million accounts, and it’s so hard to choose one place when you’re shopping for the best value in several different categories.
Very interesting debate, folks, and information on both sides of the coin is readily available. For example, here are a couple of studies that state the complete opposite of your premise, Mr. Shafer:
http://stockmarketeers.blogspot.com/2005/07/why-investors-underperform.html
(For more recent commentary, select the Mauldin link at the bottom of the above article.)
The fact is, investing is a very long-term initiative, and individual investors often treat the area like a “Fruit of the Month” club. I for one have multiple clients who have tried to abandon their long-term strategy over the past months. Any one of them on their own would have significantly underperformed the “market”. Seven phone calls the week of March 6, all telling me there is no sign of anything getting better; it will not get better for at least the next three years; please sell me to cash now. In each case, I reminded the investors of the number of years they have until retirement and the long-term goals they are working towards. I was able to update forecasts for a band of possible amounts they could plan on using for retirement, depending on the strategy they moved to. They all stayed the course.
Individuals act on their fears. when they have a trusted advisor to work with, there is a calming effect. If you can ignore the fear on your own, by all means: go it your own way.
There are other reasons to work with a planner, though, and sometimes a planner who receives some commissions can actually be OK. I sell insurance, because it makes sense to do: I trust myself more than anyone else to do right by my clients. I have a weighty responsibility of being a “fiduciary” for my clients: I take that word seriously, but I am comfortable with it.
Client X called me several months ago, stating the diagnosis was cancer — possibly six months or less to live. Terribly sad diagnosis, but the family should be OK financially: large life insurance policy that should protect them. Ah, but the client did not purchase that policy through me: purchased on own, and kept me out of the funding responsibilities. Come to find out, the client had decided to stop paying the premium a few years earlier without telling me: felt it costed too much. That never would have happened if the insurance had been purchased through me, even though I would have received an “evil” commission on the sale. I would have flagged the premium for payment every year, and if the client had a question of whether to pay or not, we would have had an open discussion of potential consequences. (And should you think the client already understood the consequences, they didn’t: just told me they wanted to buy a new policy now. What a difficult discussion to say that was no longer possible with a cancer diagnosis.)
Yes, planning is outsourcing. So is using a plumber, a doctor, an attorney, an electrician, a pharmacist…I could go on. Oftentimes, you get what you pay for. If you use the services of a Certified Financial Planner (TM) who takes the profession seriously and stays current on all the important changes that regularly take place in the areas of life, disability, and long-term care insuramce, investments, retirement planning, and estate planning, I would say you have a better chance of reaching your long-term goals than if you’re mixing your own medicines… Just a thought.
Since I seem to be the designated bad guy, I must point out that the studies you linked had almost nothing to do with performance comparisons between advised and non-advised investors.
Again, in this forum I was posting about a DIY who was considering hiring a financial planner. Now I am sure you do a great job for your clients, but the studies demonstrate that, on average, financial planners don’t do as well as DIYs nor index funds. That’s the facts.
Spin them anyway you want, but you can’t change the facts.
Here is another fact, the numbers the BCT study demonstrated were average performance, so that means that many financial planners underperformed even worse than the average! After all this isn’t Lake Wobegon!
Here is another fact, beating the market is very difficult, but it can be done, and is done everyday [even over the long term] by individual investors even though EMT says it can’t be done.
Now I know it is sacrilege on this site, but the idea of investing in index funds is a failing strategy as the Dalbar Studies [you indirectly pointed to] pointed out. Not necessarily because people behave badly [as financial planners insist], but because things happen to people like layoffs, sickness, death, etc. that causes them to need to access their retirement plans. They may know that they shouldn’t but if you need that money to survive you are going to access it. And secondly, as the research points out, financial planners as a group are no more immune to fear and selling low/buying high than the average person. IMO, this is the result of passive investing strategies like buy and hold mutual fund investing [or dollar cost averaging] that has been pushed by the financial community for two generations now.
Finally, if you really want to be a passive index fund investor, then you are best choosing the lowest cost alternative and not paying an additional middle man/woman! But beware, if you had invested $10K into the vanguard S&P 500 low cost mutual fund 10 years ago you would have $7,793 now! And if you are planning to retire anytime in the next 10 years you are unlikely to make up for that lost decade of performance with a mutual fund. That is the real danger of course!
I use to be a mutual fund investor. 10 years ago I changed and sold my mutual funds over the course of 7 years [took me awhile because I was locked into an employers 401K for some time]. Instead I started buying Berkshire Hathaway Bs [mainly, but also bought other stocks and made some mistakes along the way!]. It’s 10 year perfomance? $10K invested 10 years ago would be $12,230 today, not great but quite a bit better than any index fund. Of course 10 years ago people were doubting the stock as they are now. Based on my thinking and research then and decision to become an active investor I have made a very satisfying total return in the last 10 years. Am I an investing genius? No. Am I lucky? Maybe a little. But the point is if I can do it over 10 years than many other people can too! So there is another way, beyond what the financial planning community prescribes to and beyond what the DIY community thinks is the way to go. There are costs and risks no matter which way a person decides to go. And I think people should be told about all the costs and risks, including the one’s involved with using a financial advisor!
That’s all I am trying to say!
Interesting discussion. Given all that has been discussed here I’m curious to know why is it that financial advisors are so focused on investing (helping clients select & purchase investments)? Perhaps overly focused on that? I wonder also, on average, if the financial advisors out there DIY investors? Or do they subcontract to another financial advisor? Why / why not? If they are DIY investors, aren’t they too susceptible to self-defeating behavior? Would subcontracting to another financial advisor solve that issue, if they too have the same condition? How can people identify that type of behavior in someone else?
If you are writing up your IPS, I recommend that you have a look at a couple of great examples at http://www.bogleheads.org/wiki/IPS . I particularly like Sonny’s which I am adapting for my own use. I highly recommend the Bogleheads forum if you are interested in the investing side of personal finance. I have learned a tremendous amount just in a couple of months by reading the forum.