On Investment Advisers
So let’s say you managed to wrestle down your high-interest debt to nothingness (Chapter 6), and you’ve conquered the problem of acquiring savings on a monthly basis (Chapter 7). Hopefully you’ve made some decisions around starting a retirement account (Chapter 9) and around buying a home (Chapter 12). You’ve begun your investment journey (Chapters 13 and 14), managing to scrape together somewhere between $25,000 and $25 million. Likely closer to the former number admittedly, but hey, I’m an optimist.
Around this time, you will confront that age-old question of the bourgeoisie: Do I need an investment adviser?
The quick answer, modestly speaking, is that 95% of us do.
The longer answer, which takes up the remainder of this chapter, is why you probably need one, what an investment adviser should do, how to find one, when you should fire one, and how you would know if you’re in the 5% category that doesn’t need one.
So Why Do You Need an Investment Adviser?
Let’s start with the wrong answers.
Your adviser beats the market. Your adviser has unusual insight into market values, trends, and patterns. Your adviser has special access to deal flow that other people do not have. Your adviser has computer software that can give him, her, or you, an edge. Your adviser is a friend of your uncle, and you should go to him. Your adviser is a great golfer, and you do love golfing.
All of these reasons are just plain wrong. About the first few claims—to special insight, technology, or access—I can only urge you to put on your most skeptical goggles and resist the temptation to believe this bunch of lies. The last few reasons—having to do with relationships and nonfinancial expertise—are less wrong, but might lead you to settle for less than the best investment adviser for you.
We are also, incidentally, beginning to answer the question of how to find an investment adviser. An adviser who talks about the great return he or she can get on your money is not the right one for you. I know that sounds a bit contrarian, but just stick with me for a bit here. An adviser who spends the bulk of the “getting to know you phase” focused on golf outings and NBA tickets probably will not serve you best in the long run.
Now pay attention closely to this next part, as it’s the key point of the chapter.
A good investment adviser has two, and only two, functions: the “plan” and the “hand.”
First Function: The Plan
First, your investment adviser should get to know your specific financial situation well enough to design a simple, foolproof, automated, all-weather plan for you. This plan design may take a few hours of discussion, but it should not take a professional much more time than that.
A good plan primarily consists of setting up a sensible asset allocation to fit your longest-term wealth goals. It will include provisions to periodically rebalance your allocations.
If you are still in the wealth-accumulation phase of your life, that good plan will also include automatic contributions from your paycheck or savings account into your investment accounts, without you having to make the decision to automatically contribute. This automation, as discussed in Chapter 7, is absolutely the key to a good plan.
A sign of a good plan is not how it performs when the investment adviser and you are “right” about the markets. Rather, a good plan is one that performs to expectations even when you are totally “wrong” about the markets, or the markets “misbehave.”
So Which Asset Allocation Should the Plan Have?
Careful readers of Chapters 13 and 14 will already know what I consider the correct asset allocation for a person still in the wealth-accumulation phase of life. I am realistic enough to know, however, that your investment adviser will instead design a plan consisting of roughly 60% stocks and 40% bonds. Because they all do. That’s fine.
Here’s my cynical view of why the 60/40 split is where advisers all end up. It’s so that when the market goes down by 35% next year, they can point to the solidity of the 40% allocation to bonds and show how prudent they were all along. That way, you won’t fire them in the midst of the downturn. It’s a client-retention strategy. Even though, as you know from the previous two chapters, it’s holding back your wealth accumulation pretty significantly.
So, I don’t agree, but I understand. That’s between you and your investment adviser. At this point the key is that you make a plan and that you decide with your investment adviser to stick with whatever you decided together. Especially for the next function of the investment adviser: the hand.
Second Function: The Hand
When the financial markets next crash by 35%, the role of your investment adviser is to hold your hand, patting it occasionally, for comfort. This has the effect, hopefully, of calming your nerves. In addition, the good adviser is also firmly holding your hand in place to prevent you from doing anything rash.
Do not sell. Do not trade. Don’t press that button. Don’t call up your broker. Don’t stop automatic contributions. Do not change your asset allocation targets in the middle of a crash. This is not the time go into safe assets. Stop! The adviser’s grip on your hand needs to be quite firm indeed.
Your investment adviser, a good investment adviser, is there to grab your hand and prevent you from doing the wealth-destroying thing, which would be to deviate from your initial plan in the midst of the market crash. Your investment plan only works if you continue to contribute the same amount, despite the 35% crash, and despite the fact that it looks like the world is ending. By the way, the world is not ending.
Incidentally, your investment adviser needs to be optimistic about the long-term power of investing. Optimism is the key to easy, long-term, wealth accumulation.
Here again, we are partly answering the question of how to find the best investment adviser.
When interviewing an adviser, you should ask what they would do to avoid a 35% loss on your equities investment.
Note: This is a trick question. The correct answer is that the 35% drop in the market is not avoidable. He or she can’t time it right, avoiding the crash ahead of time. If your adviser claims to be able to time it right, to be “nimble” and ready to “trade around” in the face of a declining stock market, you are talking to a liar or a confused person. He or she is ignoring (or worse, hiding) all the research that’s ever been done on “timing” the market.
You should also ask what he or she intends to do with your equities portfolio after the market drops 35% (which I’m telling you right now, and they should have told you from the beginning, they were unable to avoid). This is also a trick question. The correct answer is: nothing. Do nothing. The adviser’s role is to pat your hand reassuringly, and then to grip your hand to prevent you from selling.
A good investment adviser knows that a 35% drop doesn’t mean the stock market is broken. Stock markets drop by 35% every decade or so. It’s just what risky markets do. The good investment adviser knows that regular automatic contributions to your portfolio—especially after the 35% drop in prices!—are the absolute key to accumulating long-term wealth. This is known as dollar-cost averaging. Remain optimistic after the crash. This is how you will gain wealth in the long run.
So how do you know if you’re in the 95% category of people who need an investment adviser?
You should ask yourself two questions.
First, do you know how to set up a simple, automated, all-weather asset allocation investment plan at a reasonable price that will work even if you’re completely wrong about what will happen in the future? Be modest here. It’s OK to need help. If you’re not sure of the answer, you need an investment adviser.
Second, do you know with 100% certainty that you will stick with that original all-weather plan when all the world falls apart? Again, be modest and skeptical about your stick-with-it-ness. The Financial Infotainment Industrial Complex (remember Chapter 2!) will try to convince you that “this time is different” and that you need to break with your plan. If you’re not sure if you will be tempted by those voices of madness, then you need an investment adviser to hold your hand. If you have managed to survive a major downturn already in your life without changing course, then perhaps you do not any longer need an investment adviser.
Firing Your Adviser
I hope you can read between the lines about what kind of investment adviser should be fired. Anyone who claims unusual expertise or an amazing track record should be viewed with deep skepticism. I’ve met a tremendous number of smart finance and investment people in my life, but I’ve never personally met someone who I would trust if they told me they could consistently “beat the market” by managing my money. I’m not saying it’s impossible. I’m just urging profound skepticism.
Remember, your investment adviser’s role is not to “beat the market,” but rather to set up a reasonable plan and then to hold your hand.
While 95% of people with $25,000 or more in investible assets probably do need an adviser, over time some smaller number of people need that adviser for the rest of their life. What I mean by that is that more than 5% of people can do it themselves, after some years of having an investment adviser. Optimistically I think that after 5 or 10 years of paying an investment adviser, lots of people could take on managing their own money. After 20 years, you’ll probably have been through a significant market blow-up, and you’ll know how it feels. Did you panic? Did you sell? Did you change your asset allocation when the Financial Infotainment Industrial Complex told you “this time is different”?
If you stuck to your plan after the stock market fell 35% percent, then you might be ready to graduate to managing your money without an investment adviser. If you are not absolutely sure of how you’ll react, however, you will be better off continuing to pay a good investment adviser, even though all they are doing is telling you to “stick to the plan” when you’re totally panicked.
Fees
Finally, let’s talk fees. A reasonable investment adviser charges 1% of the value of your assets per year. So to be concrete, you should happily pay $1,000 per year on your $100,000 portfolio. If you have a large investment portfolio, you will pay a lot more money than that to your investment adviser, since 1% of a larger portfolio can get pretty large. If you and your investment adviser designed the foolproof plan, and he or she prevents you from being a fool when the market crashes, the 1% per year will be well worth every single penny.
If you do some compound interest math on the effect of that 1% fee over a lifetime of investing, you will be shocked to discover that your investment adviser might capture 20% to 50% of your investment gains. Fees well above 1% per year, for 40 years, will start to approach closer to 50% of your investment gains, whereas a lower fee for fewer decades will capture your gains at the bottom end of the range. For even a normal-sized investment portfolio, you should expect to pay tens of thousands to hundreds of thousands of dollars to your investment adviser.
These numbers, added up over the long run, are in fact stunning. That’s why I’d urge you to evaluate after 5 or 10 years whether you are ready to graduate to running your own money, by reviewing those initial questions above. But be brutally honest with yourself. If you don’t know for sure, you need to keep your investment adviser. Panicking mid-crash, or failing to automate, or generally stressing about the ups and downs of investing, can and will cost you more than 20% to 50% of your investment gains.