Avoiding Problems with Financial AdvisorsI see a lot of financial advisors with solid strategies to help their clients reach their financial goals. And I see advisors with many of the problems below, most of which are just inherent in managing billions of dollars from an institutional perspective. There are potential problems in every decision. Being aware of them in your decision making process helps you feel more in control and objective when such problems arise. As investors, it’s important to be realistic about what financial advisors can accomplish. And we must accept the responsibility of understanding investing well enough to hire and evaluate the best financial advisor to get the results we want, which is funds for life. Having done this, you’ll be more likely to avoid having problems with the financial advisor you choose. Click Here to read my tutorial post How to Understand Your Investments if you are new to investing and asset allocation.
Reasons Investors Are Unhappy with Financial AdvisorsThe Qualtrics chart below shows the top reasons investors have have been disappointed with their financial advisors. The top reason is “Good Investment Track Record”. This equates to disappointing returns, and it indicates investors are on top of their game; they are checking performance. I think, however, that investment performance may also be expressed as the next few reasons for being disappointed: (no longer) Trusted and (lack of) Personalized Service, or Poor Customer Service. I am guessing that this is because investors were expecting a more personalized portfolio that would weather all stock market conditions better. Hence, the real problem was problems performance, but to their clients, it felt like the servicing of their account. Expectations around investment returns are exactly what this post addresses. Now that you’ve seen the biggest problems investors report as being problems with financial advisors, let’s address them.
Fees During Bear MarketsHigh fees were cited as a big problem with financial advisors. I do find, however, that high fees are less of a reported problem when investment returns are great. Like many other professionals, financial advisors don’t get paid based on how much money they make for you. They will, however, make more money when your account grows, if their fee is a percentage of the money they manage for you, as it commonly is. One problem with using a financial advisor is that you are going to pay wealth management fees even when the investments they make on your behalf lose money. You probably realize this already, but it can be particularly painful when your accounts loose value, such as during inevitable bear markets. Most financial advisor’s clients lose less money in their overall portfolio than the overall stock market since almost all advisors use a diversified asset allocation that includes bonds. Nevertheless, it can feel wrong to pay for something when the value of your investments drops 30% to 40% or more, speaking from personal experience. At the time, my expectation was that my financial advisors would have anticipated the financial crisis and my portfolio would have been better positioned for it by having higher levels of cash beforehand. In hindsight, this common performance problem arises for several reasons, mostly during bear markets since it’s easy for anyone invested to grow account values during bull markets. First, financial advisors are under huge pressure by their firms and clients to get good results. If they have too much money in cash vs stocks, their clients complain when they miss a bull market and returns suffer. This makes it hard for financial advisors to be tactical, as explained more below. Plus, who wants to pay a financial advisor to have your money in cash? We can all choose a money market for our investments fairly easily and forego the advisor fees. It’s also important to be aware that the marketing information used to solicit clients is presented revealing the best possible past return data. It’s seems natural to expect the same good returns moving forward. Not only this, but your investments will go through periods of losing account value, sometimes significantly, during bear markets which is addressed more ahead. Click Here to read my article with a chart comparing the cost of hiring a financial advisor vs investing yourself.
Tactical Financial AdvisorsFinancial advisors who move their clients into higher levels of cash during overvalued markets, and seek out undervalued investments based on broader economic and global trends are known as tactical. Sometimes such advisors are said to have a “value” approach to investing. I think of tactical as more trend focused than value investors, however, but the two can overlap. Like many investors, when I worked with financial advisors, I thought they were, as a whole, more tactical than most of them actually are. There are a few potential problems for tactical advisors, however, making them harder to find. For one thing, your investment performance can suffer when they are wrong. This sheds a bad light on the advisor’s track record, and the wealth management firm loses clients. The other problem is that it is difficult for an advisory or wealth management firm managing $100 billion to ease in and out of client investments. This is addressed more below. Click Here to read my post, Pros and Cons of Using a Financial Advisors.
Every Investor Makes MistakesRepeat: Every investor makes mistakes. Sometimes investors think that financial advisors are immune from mistakes. We enter into the advisory relationship thinking that this financial professional knows a lot more than us. Our thinking is that, therefore, he won’t make a mistake and loose account value by choosing losing securities or funds or be over invested in a bear market. But every investor makes mistakes, including those managing billions of dollars. (These are almost always team managed, as opposed to having one manager.) To avoid this problem in hiring a financial advisor, look at annual returns (every year) instead of the annual numbers averaged together, which usually obscure the mistake years. One good thing is that we all learn from our mistakes. This means that the more experience a financial advisor has managing wealth through bear markets, the more she will know about getting through the next one with her client’s money intact. And since most financial advisors use a long term buy and hold strategy, experiencing bear markets are simply part of that strategy. This circles back to investors clearly understanding the financial advisor’s investing method before hiring her and having realistic expectations within its’ context to avoid surprise problems later. If you are invested in a buy and hold strategy with stocks, the value of your stock account will drop significantly, periodically. This is going to happen if you manage your own investments, or if you hire a financial advisor. It is inherent in buy and hold (passive) investing. This is not a financial advisor problem; the problem is not understanding the method the financial advisor is using when you’re caught off guard with big stock account declines when using a buy and hold strategy advisor.
Higher Cost for the Same ProductNowadays most financial advisors and wealth managers buy funds instead of individual securities for their clients. This is where some of the problems stem, although low cost index funds such as ETF’s can avoid many of the problems addressed here. You can click here to read my post in this financial advisor series Should You Manage Your Own Money with more information about advisors and ETF’s. Many financial advisors invest their client’s money in higher priced funds that replicate cheaper funds. In other words, this is basically the same investment wrapped in fancier paper, and it cost more. Note that unknowingly, many investors make this same mistake. Here is how it happens. Often, financial firms offering the funds create more than one fund with the same investment strategy, same fund managers and almost identical securities. The fees, however, vary, often due to marketing costs or other admin fees. You can avoid this problem by asking any financial advisor you are considering hiring if he could use a cheaper investment product to get the same results. Often, a low cost ETF (Exchange Traded Fund) can get the almost the same results, or even better results after fees are considered. This is explained more below.
Over Diversification by Wealth Managers and FundsWhen a fund or wealth manager over diversifies into hundreds of stocks (instead of index funds), the investments usually end up performing about the same as the cheaper index based ETF’s. I’ll explain why this happens. Remember that index funds (like the S&P 500) hold securities that represent the overall market, or a section of the market, such as small company stocks. When the stock market moves up or down, most stocks move with the market as a whole. This makes it hard to beat the performance of the index, but some funds and wealth managers do outperform the market (index). They can be worth their weight in gold, and their fees. This is what you’re seeking when investing or hiring wealth management. ♦ Wealth Building Tip – [bctt tweet=”Wealth Tip – Beating the index is referred to as alpha in investing lingo. #investor #retire #financial” username=”retirecertain1″] Back to over diversification. This index under performance can be a problem with financial advisors when they put your money into enormous funds (or too many individual stock positions) that have to over diversify because they are so huge. To avoid this problem when hiring a financial advisor, you can check to see how the products the advisor recommends compares to the index that most closely compares to that recommended product. It’s also helpful to see the number of holdings suggested funds have to see if a fund is over diversified and is likely to replicate an index.
Most Active Investment Funds Under Perform IndexesRemember when you hire a financial advisor, depending on their method, they may put your money into funds of some type, or into individual stocks, usually with someone else (not the financial advisor you hire) actually picking the securities. Surprisingly, most fund managers who pick securities (individual stocks or bonds) do not perform better than the index. This means you can just buy index funds (with ETF’s or index mutual funds) which have lower investment fees and there is a higher probability that your investment returns will be higher. This only becomes a problem when a financial advisor puts your money into actively managed funds that don’t perform better than the index. This is something you can check when you are interview financial advisors, as I’ll explain below. Different funds have different focus areas, such as small company (cap) stocks, or large company stocks. And indexes exist for all these different focus areas. This makes it easy to see if a fund manager performed better than the cheaper index fund. ♦ Wealth Building Tip – When fund managers actively pick stocks vs buying an index fund, they are called “active” fund managers, as opposed to passive. Passive investing, on the other hand, refers to simply buying index funds of some type. In 2018, for example, only 68.83% of active (stock picking as opposed to index) fund managers performed better than their related index according the S&P Dow Jones Indices LLC and assembled at SPIVA. The chart below shows this data over multi years for all different areas of the market. Active bond picking managers performed worse than stock picking fund managers as shown in the SPIVA chart below. Just as I was, you may be wondering if active fund managers outperformed with global and international funds. Refer to the SPIVA table below that I found to show that active stock picking under performed index funds in most years. While the performance reflected in these charts most likely represents mutual funds (as opposed to wealth managers that purchase individual securities for high net worth clients), it fairly demonstrates that stock picking rarely beats the market (index). Not only this, but many firms have funds that are available as both mutual funds for individual investors (often called “retail”), and almost identical funds that financial advisors use (often called “institutional”). This indicates that this same active manager vs index performance data can be roughly applied to all actively managed funds. To be fair, this under performance is not always due to the skill of the fund manager since mutual fund managers have challenges with having to meet fund redemption’s at inopportune times. In other words, when the market starts to crash, fund holders start selling their mutual fund shares, often frantically, forcing the fund manager to sell stocks near the market lows so they can provide the exiting fund holders with their cash. Regardless of the reason, this can be a problem with hiring financial advisors that invest your money in active funds since this can lead to higher fees and under performance. Again, you can avoid this problem when hiring a financial advisor by checking the performance of the funds or wealth managers that the advisor recommends for your account. (Note that this redemption problem is one that that mutual fund investing has which wealth managers investing in individual securities for their high net worth clients don’t experience.)
It’s Easier for Individual Investors to Buy and Sell SecuritiesAnother problem that occurs with financial advisors (and institutional wealth management) is that the money under management becomes too large, making implementation difficult. The actual implementation of buying and selling securities is easier for individuals than it is for wealth managers. Imagine an individual investor selling a hundred shares of a security compared to big institutional fund managers who attempt to ease many millions of dollars in and out of stock positions without affecting the stock prices. Just picture an enormous cruise ship trying to turn around quickly without making any waves. Most fund managers are also under pressure to not reveal their transactions since others may copy their transactions, or their selling (or buying) may influence the market, affecting the price of the securities even more. In fact, some investors simply mimic the transactions of successful fund managers and investors (the “smart money”) making the need for discrepancy even greater. Programs even exist that help implement the best fund manager’s strategies! And it’s a given that if an investment strategy or fund manager is successful, they become huge as word gets out of their success. What a challenge this must be for fund managers. This is certainly an advantage that individual investors who choose to spend the time researching and buying individual stocks have over enormous funds. You can avoid this potential problem with hiring a financial advisor problem by comparing the performance of the recommended funds and products to the closest index. You may even decide to invest in index funds yourself or hire a financial advisor with a primary focus on low cost index funds or ETF’s.
Assuming Your Financial Goals Will Be MetIn working with financial coaching clients, I’ve noticed that many assume if they begin saving more money, and investing it in stocks and bonds, they will have enough money to live comfortably in retirement. Yet, studies show that most people are not reaching this point from saving money and using a long term buy and hold investing method. This is because many people don’t understand the importance of saving early enough, encounter unfortunate costly situations, high lifestyle (or worse) expenses or the investment returns simply aren’t there for the time frame they are investing in stocks and bonds. The problem, then, occurs when investors assume that if they hire a financial advisor their financial goals will be met. Since they’re paying 1% or more for a financial advisor every year, it’s logical to expect you’ll gain funds to live comfortably for life. But often investing in stocks and bonds won’t get you to your financial goals whether or not you hire a financial advisor, especially when the method is based on a simple and age appropriate asset allocation model when the time to save is simply not there before retirement. This problem is not with the financial advisor. The problem doesn’t exist when you’re realistic about the highly probable investing results. You can also do one of several things that can get you to financial independence, such as prioritizing your lifestyle spending, and creating extra income streams from alternative investments, online business, consulting, or real estate rentals.
Reasons for Performance ExpectationsWhen you look at the well-designed marketing material that shows averaged past performance of investment products in their best possible light, this naturally and logically becomes your expectation. This not guaranteed expectation catches investors off guard years later when the anticipated 6% to 8% (based on past performance) from a diversified portfolio doesn’t occur. It may happen and it may not. It mostly depends on your time frame, the economy and market valuations. Plus, when you’re thinking of hiring a financial advisor, how many are going to say to you that they don’t think you can reach your financial goals even if they work with you? My suggestion is to find the financial advisor who will tell you that you may not reach your financial goals if the stock market behaves as it has in the past following periods of high valuations. We all want to hear that things will go our way, but we’re better off hearing that things probably won’t go our way so we can remedy the situation while there is time. You can remedy this problem by finding the advisor who will roll up her sleeves and say “Let’s figure out how to get you where you want to be based on your specific situation and needs if the stock market doesn’t perform best case scenario.”
Alternative Financial AdvisorsAlso, realize that there are very few financial advisors who suggest alternative income streams as mentioned above simply because it is not what they do. But when you have a realistic picture of your current trajectory by not expecting that stocks and bonds will provide funds for life if they may not, you can create your own income streams beforehand if that is what is needed. If you can easily generate enough income from your investment accounts to cover your lifestyle expenses after inflation, then you’re all set. If not, you can make changes by getting creative with your lifestyle and your expenses. You can make it happen, but only when you know the reality about your probable investment returns. You can plan for the worse and hope for the best. So, the problem is that investors think that hiring a financial advisor will help them have enough money to live comfortably in retirement. Again, this could happen, but it may not. You can overcome this problem if you choose to hire a financial advisor by not assuming that stock and bond investing done by the will deliver funds for life since future investment returns are based on estimates and you may not have enough money saved. Second, this problem can be avoided by remembering that investing is only one part of not running out of money. There is also the important lifestyle spending part of the equation. Then there is the income part of the equation, which a financial advisor may be able to help with in the form of dividends or interest, but there is likely much more untapped income potential under your control.
Most Financial Advisors Are Only Experts in Traditional InvestingMost financial advisors don’t address alternative investments and income streams. For proactive investors who have chosen to add alternative assets and income outside of the money being managed by a financial advisor, it can be tricky managing the big picture. You can remedy this problem when hiring a financial advisor by letting her know of your other assets, as they may affect your best asset allocation. Fortunately, I see a few financial advisors who specialize in entrepreneurs in the online and event networking I do as a financial publisher. The trend in alternative investing and entrepreneurship is here to stay given the internet opportunities and spread of information. It’s good to see some financial advisors incorporating alternative wealth building from small business ownership and even real estate rentals it into their methodology. Click here to read my post Should You Manage Your Own Money with more information about alternative investments and advisors.
Financial Advisor Problems SummaryTo avoid unforeseen problems after hiring a financial advisor you can do the following:
- Understand investing basics including the index concept
- Hire a financial advisor based on clear and accurate performance evaluation and future potential returns
- Have realistic expectations
The information on this website is for education only and is not to be construed as personal financial advice.