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Fire Your Advisor and Hire My Dog!

By: Investor Solutions

By: Investor Solutions, Inc.

A prudent man once said, “It is unwise to pay too much, but it is worse to pay too little.” [1]

The same holds true in the world of “do-it-yourself” investing. The financial media will try to convince you that paying for financial advice is money out the window. Who needs a professional financial advisor anymore?! With the plethora of available information in the world, it seems that everyone, including my dog Lucy, is an expert investor these days. Need some additional help to map out your life? Just plug your data in a computer andit will tell you how to design the world’s best portfolio and financial plan, without all the fees! Nice idea, too bad it doesn’t work effectively.

For purposes of full disclosure, investment management is my profession. People pay me to manage their assets and map out their financial plans. But, my intention here is not to sell myself or my services. The intention is to educate and inform.

Unfortunately for most investors, bypassing a professional advisory fee does not necessarily translate into a better outcome. A computer model alone cannot deal with all the complex real world financial issues that you and your family face. A certain level of professional oversight by a human is absolutely necessary. Paying for good advice can yield you better results in the long run-here’s why.

Overconfidence

Overconfidence can be hazardous to your wealth! People generally rate themselves as being above average in their abilities. They also overestimate the precision of their knowledge and their knowledge relative to others. Many investors believe that they can consistently time the market. In reality, there is an overwhelming amount of evidence that proves otherwise. The result is that most investors trade too much and those trading costs cut into their profits. For the long term, this has proven to be a losing strategy.

But, you do not have to believe me if you think this article might be self serving. Instead, the proof is in the pudding. In 2003, DALBAR released its study, an update to the Quantitative Analysis of Investor Behavior (QAIB), which demonstrated that investors continue to chase investment returns to the detriment of their wealth. According to the study:

  • The average equity investor earned a paltry 2.57% annually; compared to inflation of 3.14% and the 12.22% the S & P 500 index earned annually for the last 19 years.
  • The average fixed income investor earned 4.24% annually; compared to the longterm government bond index of 11.70%.

Investors are their own worst enemies. Trying to outguess the market does not pay off over the long run. In fact it often results in quirky, irrational behavior, not to mention a dent in your wealth as seen in the aforementioned results.

Lack of Knowledge or Experience

Managing money in a world filled with uncertainty is no easy feat. The financial markets are plagued with obstacles that could easily disrupt one’s financial stability. There are entire academic programs devoted to understanding and overcoming these economic obstacles (the University of Chicago being one of the leading institutions). Academic principles such as Modern Portfolio Theory, CAPM, Tobin’s Separation Theorem and the Fama/French Three Factor Model (to name a few) are the cornerstones of portfolio management. With the exception of few really bright individual investors (say, the Vanguard Diehards) who have the time and interest in keeping up with modern finance, most investors are ill equipped to manage their own money successfully. And reading a how-to-guide on investing or relying on the financial media to wade through the difficult financial issues that you face is just plain absurd.

I thought I would put this theory to the test after reading an article on Yahoo Finance about do-it-yourself investing. The article referred me to a free online tool to “fix my mix” of assets. Four questions later, ranging from time horizon (30+ years) to very weak attempts at trying to gauge my risk tolerance, my portfolio design was produced. The suggested allocation was completely inappropriate: 40% bonds (did not specify long or short duration), 30% large cap stocks, 15% small cap stocks and 15% foreign stocks. A competent advisor would have likely suggested a much more diversified portfolio, including a greater exposure toward equities for a person my age. Over time a professional strategy should yield at least a world market return, well over the returns produced with the computer’s model.

Limited Tools or Resources

A do-it-yourself investor does not have the tools and resources that are available to institutional money managers and financial planners. Planners spend thousands of dollars each year on sophisticated software, continuing education and professional proficiency courses to remain abreast of industry changes. Federal regulations, tax laws and planning strategies are constantly changing and it is the Advisor’s job to remain aware of these changes. It is next to impossible for any individual investor to keep pace.

Further, institutional investors benefit from more favorable pricing for products or transactions, have a greater abundance of investment choices available and have systems in place to more effectively monitor accounts.

Personal Emotions

There is no room for emotion in investing. Unfortunately, when it’s your own money that you are managing, discipline can be overshadowed by irrational feelings. A professional advisor eliminates sentiments from the planning process.

Time Constraints

In today’s hurried lifestyles, it is unrealistic to think that investors will dedicate sufficient time and attention to design, monitoring and updating their financial plans and investments. Designing the appropriate portfolio or plan requires research, time and commitment.

Conclusion

We are not as rational as we think we are and when it comes to money and investing, people do some pretty strange things. Do-it-yourself investing is not a panacea. A small population of individual investors has succeeded with this strategy. But, far too many have failed miserably. When it comes to your money remember the old saying “a penny wise a pound foolish.”

[1] John Ruskin (1819-1900) English critic, essayist, artist and poet in the Victorian and Edwardian Eras