Should the average investor use an investment advisor? I used to think no, but now I would say yes.
I thought no because investing well isn’t that hard on the surface. In its simplest form, you make just one decision: how much in stocks and how much in bonds. If you don’t know better, there’s that “age in bonds” rule to help. Then you pick a target date fund that matches your decision the closest. Done deal.
If you want go one step further, make two decisions: (1) how much in stocks; and (2) how much stocks in international. You invest in three mutual funds: a US stock fund, an international stock fund, and a bond fund. How hard can it be?
However, the average investors don’t invest that way. The colleagues sitting next to me sometimes talk about their stocks. They talk about when they bought this or that stock and whether it’s time to sell. When I went camping with some other people, a woman told the group around the camp fire she switched everything in her 401k account to a market money fund.
If you ask random people at your workplace “what’s your asset allocation for your retirement?” How many do you think will be able to tell you? If you get to see their investments in their 401k and IRAs, what percentage do you think have a risk-appropriate portfolio that’s within plus or minus 10 percentage points of “age in bonds”?
These average investors will be better off if they use an investment advisor. Not just any random investment advisor, but a good one at an affordable price.
That’s the other hurdle of using an investment advisor. If you don’t know where to go, it’s very easy to find a salesperson as an investment advisor. The average investor isn’t necessarily better off with a salesperson. Some advisors are good but they charge a lot. Investors with moderate-size portfolios can’t afford their service. How do you find a good advisor at an affordable price?
I read a 3-part series on Portfolioist on how to pick an investment advisor. It says one should use trust as the primary criterion in selecting an advisor. I disagree. If you look for trust it’s very easy to end up with a salesperson because salespeople master the art of making you trust them.
Instead, you should look for an advisor by their strategy. If an advisor says he/she will “watch the market” for you, don’t hire that advisor. If an advisor says he/she will find the best performing stocks or mutual funds for you, don’t hire that advisor. Instead, find an advisor who uses a passive investing strategy.
The best deal in financial advice comes from the Vanguard Financial Plan service. If your household invests $50,000 with Vanguard, you can get a financial plan from a Certified Financial Planner for a one-time $250 fee. The plan will cover not only your investment with Vanguard but also your investments outside Vanguard. $250 is very reasonable to have a professional look over your investments and give you advice. It’s a shame Vanguard isn’t marketing this option more aggressively. Many people don’t know this option exists.
Some may quibble about how the Vanguard financial plan isn’t perfect. But consider the alternatives for the average investors. I would say it’s more than adequate. It’s better than what the average investors are doing now and it’s better than what they will likely find if they throw themselves out to the open sea.
For a portfolio size between $50,000 and $500,000, AssetBuilder offers investment advisory service at 0.43% – 0.45% a year. For an investment of $100,000, the fee is $450 a year. It costs more than the Vanguard plan but it’s still reasonable.
FPL Capital Management charges a flat fee that starts at $1,000. Cardiff Park Advisors and Evanson Asset Management also offer their services for a flat fee. Portfolio Solutions offers its service at 0.37% a year, subject to a $3,700/year minimum.
Although most don’t like to admit, it’s very easy to be overconfident in one’s ability to resist behavioral mistakes. The hidden cost of such behavior can be many times the investment management fee we pay to an advisor. I think most investors will be better off using one of the advisors mentioned in this post. I’m considering using one of them myself.