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 invest in a Vanguard Target Retirement fund closest to the year you will retire. Done deal.
If you can’t invest in a Vanguard Target Retirement fund because it’s not in your 401k, you can mimic it. Look at how much it invests in stocks versus bonds, and how much in the US versus international. You will end up with three mutual funds in your 401k: a US stock fund, an international stock fund, and a bond fund, like this:
How hard can it be?
However, the average investors don’t invest that way. My co-workers 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 a group of people, a woman told the group around the camp fire she switched everything in her 401k account to money market because she thought a crash was coming.
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 the 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 a Vanguard Target Retirement fund?
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. You can’t just go by who appear to be knowledgeable and trust-worthy. When you don’t know much, a good salesperson who talk a good talk will appear to be knowledgeable and trust-worthy. Their training makes them master the art of making you trust them.
You can use a robo-advisor such as Betterment or a human-robo hybrid service such as Vanguard Personal Advisor Services or Schwab Intelligent Advisory. Fees run in the neighborhood of 0.25% – 0.3%. The problem is their computers are a little too quick in coming up with a recommended allocation, based on very limited inputs. The number of questions asked before they return a recommendation is as few as two! Computers are fast and efficient but I don’t think they can know things they don’t ask.
The best model is to use an advisor who only provides advice (“advice-only”). You then take the advice and follow it. See Advice-Only: The Best Model For Financial Advice People Need And Want. If you don’t know where to find this type of advisors, I can help. See Find Advice-Only Financial Advisors.
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 fees we pay to an advisor. I think most investors will be better off if they get advice from an advisor. Only the advisor has to be advice-only.
[Photo credit: Flickr user SalFalko]