On the Benefits of Financial Counsel

Despite the many ways that investing has become easier and cheaper over time, it is still an area filled with complexity. As Lusardi and Mitchell write, “A larger array of available financial instruments does offer new opportunities for more tailored financial plans than available in the past, but these can also make poor decision-making more costly to the ill-informed investors.”

The great thing is that your financial needs are likely not all that unique.

We have talked about some of the parts of a financial plan, including asset allocation, portfolio management, and investing in general. Any comprehensive personal financial plan would include not only

 investing, but also retirement planning, income taxes, insurance, and estate planning. No one is an expert in all these fields, and every one of them comes with its own costs and benefits. Unfortunately we are largely left to our own devices to navigate these fields.

Most people recognize that a do-it-yourself approach in all these areas is not realistic. Therefore, hiring qualified professionals to put together an estate plan or to counsel you in regard to insurance coverage seems like a prudent thing to do. The only thing worse is not undertaking those activities that serve to protect you and your family.

It is controversial to be against something as seemingly valuable as financial literacy, but this education does come with a cost. A paradoxical effect of financial literacy education is that it can create worse outcomes. Willis writes: “In reality, this education may do no more than increase overoptimism and the illusion of being able to control financial risks. Participants consistently self-assess as having learned a great deal and having gained confidence, but their poor performance on literacy exams indicates that their confidence is misplaced.”

 In short, participants do not really know what they think they know.

A worse sin that we all face is that we do not know what we do not know. We are all at risk of making decisions based not on faulty information but on a lack of knowledge of the issues at hand. For example, a majority of workers eligible for defined pension plans don't have much knowledge about what benefits they are eligible for.

 We should all recognize the specialized areas in which we likely do not have enough knowledge or education to make decisions. In talking about investment education, it may seem an anathema to say that in many cases individuals would be better off with investment counsel than they would be doing it on their own.

The challenge comes not necessarily in education, although as we have seen, that could a problem. The investor's challenge comes down more to the issues of behavior. We know that one of the behaviors that can be detrimental to an investor is overtrading. While the explicit costs of trading these days are low, the implicit costs remain high. These costs are high because overtrading usually involves trades that occur emotionally rather than as a result of a rational calculation. In short, we buy high and sell low on a consistent basis.

One could think of all sorts of ways of preventing this type of behavior, but in the age of the online brokerage account, a potential trade is only a few mouse clicks away. One way of removing the temptation to click is to interject another party between you and your portfolio. This usually takes the form of some sort of financial advisor or investment manager.

No one who has looked at the evidence should expect to get consistently market-beating results by hiring an investment manager. Maymin and Fisher note that, given this middling performance, individuals who hire managers may be looking to them to serve some other function. They write, “Perhaps investors retain advisors to prevent themselves from making bad trading decisions — to help them navigate near-term emotions like fear, regret, and greed and make healthier, more-objective choices that keep them on track to meet their long-term goals.”

By tracking the “touches” an advisory firm had with its clients, Maymin and Fisher are able to demonstrate that individuals act consistently with this sort of approach. Clients eventually become more relaxed in their contacts with the firm. Not surprisingly, they become anxious in times of market volatility and seek out their advisor more often. So the value added in these client-advisor relationships comes not through the underlying performance of the portfolio but through the support of an advisor who acts as an emotional buffer. Maymin and Fisher write, “Therefore, we conclude that the advisor's role in helping investors stay disciplined and on plan in the face of market volatility, including dissuading them from excessive trading, is one that is highly valued by the individual investor.”

One of the challenges for investors is to find an investment advisor who can act in this capacity. The sexy part of the investment management business is in some of the areas we have already discussed — selecting securities, allocating assets, and managing portfolios. This is the ongoing challenge of “beating the market.” These things have tangible outcomes that can be measured and monitored.

Yet this may be a misplaced effort. Charles D. Ellis, author of the investment classic The Winner's Curse, notes how clients would be better served by a focus on investment counsel as opposed to even more intensive investment management. He writes, “Our profession's clients and practitioners would all benefit if we devoted less energy to

 attempting to 'win' the loser's game of beating the market and more skill, knowledge, and time to helping clients recognize market realities, understand themselves as investors, and clarify their realistic objectives and then stay the course that is best for each of them.”

Ellis notes that this is easier said than done, in part because this requires a different skill set and mindset than that required for investment management. The point is a good one though. Putting together a globally diversified portfolio of index funds is now cheaper and easier than ever before. It should not be surprising that we are seeing new online services that want to manage your portfolio for a fee far less than what is commonly available from investment advisors. The difficulty does not lie in constructing the portfolio but rather in managing our inevitable reactions to its ups and downs.

Going further, financial advisors are in a prime position to help individuals make more informed choices about their financial future that have little or nothing to do with portfolio management. In commenting on the financial services industry, Dan Ariely writes, “It's still centered on the rather facile service of balancing portfolios, probably because that's a lot easier to do than to help someone understand what's worthwhile and how to use their money to maximize their current and long-term happiness.”

 These types of decisions are tougher and ultimately more important than the nuances of today's portfolio allocation. Unfortunately the vast majority of people in the financial services industry are not set up to provide this type of service.

Nothing in this discussion means you should, or should not, hire someone to manage your portfolio. Research shows that even when presented with an opportunity to receive free, unbiased investment advice, the vast majority of investors decline the offer. And those that do accept the offer don't follow through on the advice.

 So we should not be complacent that availability of financial counsel is some sort of magic bullet. Some investors are competent in handling their finances. Others will never get comfortable handing the reins over to someone else. No matter the circumstances, we all need some strategy or structure to help buffer our portfolios from our worst instincts.

For some, that means hiring an advisor. For others, it may mean having some other trusted individual, perhaps a spouse or colleague,

 with whom they can discuss these matters. And still for others, it may involve using simple coping strategies that prevent them from making rash decisions in regard to their portfolio. It seems strange to talk about not going it alone in a book on becoming a more informed investor. The fact is that none of us have all the answers. We all need help in trying to make sense of an increasingly complex and noisy financial world.

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