Is your financial advisor worth it?
If you rely on a financial advisory firm to manage your assets, how do you know if you’re getting what you pay for?
We think the answer to this question comes down to several specific points, one of which (an important one, but by no means the only one) is investment performance. If your advisor hasn’t at least outperformed broad market indexes by the amount of his or her advisory fees, ask yourself whether it might have been simpler to invest in broad index funds on your own.
But if you do need (or prefer) to use an advisor, what’s the best way to judge the value of the service you’re getting?
Staying the course
First, you may need to broaden your view of value. It’s not limited solely to absolute performance generated in any one period. Consider not only performance over time, but also whether your advisor added value by encouraging you to stay with a sound investment plan and cautioned you against chasing performance, regardless of market conditions. We’ve all been nervous about how we will make up what we lost during the 2008–2009 market downturn. The almost irresistible urge to change your asset allocation and take a chance on riskier investments—or to pull out entirely and “lock in loss”—should have been successfully deterred by your advisor.
A solid framework
Second, consider whether your advisor has constructed your portfolio from the top down rather than bottom-up. Left on their own, many investors work from the bottom up, starting with manager and fund selection. This is very difficult to accomplish because of the diversity of available managers. It’s generally not enough to just pick a fund according to its “style box” (like “large-cap growth,” for example), since funds within a classification can have very different characteristics. Repeating this process several times in different categories could ultimately result in a disappointing aggregate portfolio.
Your advisor should be able to explain the asset allocation framework he or she developed for you. Listen for your advisor’s expectations of risk and return, and an explanation of how those expectations are tied directly to your goals. Your asset allocation should start at the broad level (stocks, bonds, cash), and then, if you’re investing in mutual funds, move on to actively managed vs. index funds, or a combination of both. Your advisor should also be able to explain your portfolio’s stock sub-asset allocation—market capitalization, growth vs. value, and domestic vs. international. For bonds, he or she should be able to talk about maturity, duration, and credit quality. And if your portfolio weightings differ from the broader-market weightings for a particular asset class, you should know this—and why.
(By the way, this explanation shouldn’t take your advisor more than 10 to 15 minutes. One lesson everyone should have taken to heart over the last two years is that if you can’t understand what you’re invested in, you probably shouldn’t be in it.)
Location, location, location
Finally, your advisor should be very mindful of asset location by positioning assets between taxable and tax-advantaged accounts with the objective of maximizing your portfolio’s expected after-tax return. The extra return you achieve on an after-tax basis without increasing portfolio risk may be incremental in any given year, but it can make a big difference when compounded over time.
If your advisory firm has prevented you from making ill-advised moves, constructed a reasonable, understandable allocation, and positioned your assets with your tax picture in mind, they have added value. Start there, and then look at relative performance.
Note: All investments are subject to risk. Investments in bond funds are subject to interest rate, credit, and inflation risk. Past performance is no guarantee of future results.
Interesting comments..Advisor is more than performance..How about the future for a mature couple. Its best to find an advisor you can trust for the time ahead before there is a death or sever sickness. Its best to find an advisor before time of need therefore one can “test drive” before the big need.Cost is important but if one only wants index funds its hard to beat the performance of the indexes …so therefore advisor can not make up the difference..My big test is morals and ethics along with performance..Ask Madoff clients what they thought about performance..
I have questioned in the past whether anyone should EVER use an advisor. If one doesn’t understand basic investment principles enough to put together a simple plan for himself, then he shouldn’t be investing at all. I no longer question; I believe it has been completely borne out. People who can not or will not find out how the stock and bond markets work, and understand how they function in varying real-life circumstances, should stick to FDIC-insured savings accounts, CDs, savings bonds, etc.
This recession and the dot com bust of the early 90s prove that many people don’t understand investing, and shouldn’t do it. Ever. How could such people evaluate an advisor? Or if they happened to find a good, ethical one, how would they stick with the discipline the advisor was trying to impose (not selling out at market bottoms, etc)? I’ve got relatives with advisors who have not heeded good advice– and lost out big time– because they didn’t educate themselves and really aren’t investors.
Having retired young (55) -I finally had the time to focus on taking care of my portfolio vs. relying on 3rd party management/ advice. I always read investing articles etc.and stayed interested . After completing 25 years of my own self taught management of investing and using Vanguard/ John Bogle’s principals of investing and numerous others — and keeping track of my own performance vs. the benchmarks over the years.- I found that I have survived and prospered . I used numerous mutual fund cos but have now concentrated into Vanguard;
Several lessons learned;
Vanguard is at the top of ethical quality investment organizations with outstanding resources available to its members.
Simplify your statements so that you can quickly know what your asset allocations are, the sub classes of assets and what your performance is on a daily basis.
Keep turnover and expenses down to the minimum.
Conservatively allocate your assets — you don’t get rich quickly-rather over time -dividends and interest are important. .
Stay informed about what is happening in the market BUT do not overload yourself with too much data/advice etc. as it can paralyze you.
Make any major moves in asset allocation changes only after sleeping on it.
investing is not a game- it is about survival and no one will take care of your money like you will– If you dont understand the investment clearly then do not buy it
When you feel panicky take more time before acting to change…
I avoid planners by reading this web site, aaii, and The Four Pillars of Investing by Dr. William Bernstein.
There is no need to pay more than 0.1365% as an expense ratio. See http://www.bogleheads.org/wiki/Lazy_Portfolios for examples.
The only thing missing from Vanguard is international bond and socially-responsible funds in all asset classes.
I use ETF’s to save costs.
All of the above comments share a common theme; i.e. they have the time and ability to manage their porfolio. My friend has no interest and therefore ability to manage her money therefore she uses a financial advisor. This has worked very well for her. One example is ; her advisor strongly suggested she sell all stocks in the fall of 2008. Consequently she did very well and has continued to do well as she bought back in. So I would suggest there are cases where an advisor can be helpful.
Do the fees Vanguard receives from the mutual funds in my portfolio qualify as tax deductions on my IRS tax return?
Over the years my money started to grow. Once I exceeded $1M I felt that there was too much to lose by trying to manage this much money myself even though most is in mutual funds. My asset manager keeps me from running off and putting 50% into international, or energy, or health care. Sometimes I regret it but over time I seem to do well. In addition, I am concerned with my wife’s handling of the money. When I die, if she comes into half million from insurance policies, half million dollars from the sale of the house, etc. she would probably put it into a passbook. She will need someone with some financial experience to help her through managing the money. I would like to know what others think.
I have been an advisor since 1987 and a proponent of modern portfolio theory. Unprecidented access, modern technology, automation and effective models make it easy and cost effective to invest for individuals . Vanguard is a good choice but, there are many others.
One less quantifiable but equally important factor is the role emotion plays in investment decisions. My advice is to know thy self (better yet ask your significatn other). If you still think you are up to the task, good luck. If not, look for an advisor who helps were you need help. A good advisor can go a long way in helping you get and stay on track and make thoughtful long term decisions.
It’s a tough call. I used a CFP to get started when I was in my early 20′s. I paid for a financial plan and followed his advice for regular dollar cost average investing over the long term. At some point I felt like I could take it on myself, and did that for many up and down turns in the markets. I was able to ride out the bad times, but like the gentlemen above once my assets got to be over $1 million, I felt like mistakes I might make, rebalancing, etc. was too complicated and too risky for me so I went back to the original CFP. Now his fees are going up again and I am at another turning point wondering whether it is worth the fees. Portfolio is now over $2 million and retirement and college for children are both in the near future. What should I do? I wish his fees weren’t going up and I didn’t have to cross this bridge again, and look into alternatives. Not sure if I should trust another advisor, a large mutual fund company like Vanguard, or do it myself. Any advice out there?