Even Skilled Investors Can Use a Financial Advisor
In the past decade years, more investors have been turning to professionals for help with their portfolios. One measure of the industry—assets under management at registered advisors—swelled from $22 trillion in 2002 to nearly $50 trillion in 2012.
What's behind that surge? More people need help as employer-sponsored pensions give way to self-guided retirement plans such as 401(k)s and they realize that investing in a globally linked market is complicated.
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Yet, a growing number of investors and experts are embracing financial advisors for a more surprising reason: to help them avoid the most costly error investors can make, which is listening to their emotions.
People tend to buy when markets are on the way up and sell on the way down. That costs the average mutual fund investor nearly 4 percent a year, based on data from research firm Dalbar Inc. If you invested $100,000, losing nearly 4 percent a year would mean you'd end up with about $130,000 instead of $280,000, assuming a 6 percent annual return.
Dalbar found that "psychological factors" account for 45 percent to 55 percent of the persistent gap in investment returns. In short, investors can't resist running with the herd.
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Case in point is the Great Recession. In March 2009, when the markets hit a trough, household net worth had fallen from a high of $64.4 trillion in second-quarter 2007 to $50.4 trillion in first-quarter 2009. Americans' stock holdings plunged 5.8 percent to $5.2 trillion, and mutual funds holdings slid 4.1 percent to $3.3 trillion, as investors pulled $300 million out of their equity funds at the bottom of the market, according to data from the Investment Company Institute.
"I do think there is a very strong case to be made for a sensible advisor to help you make the right decisions," said Charles Ellis, founder of consulting firm Greenwich Associates and former chair of the investment committee for Yale University's endowment, as well as a longtime proponent of buying inexpensive index mutual funds directly.
An advisor may also be able to help you establish a plan you feel comfortable sticking with.
Dalbar President Louis Harvey argues that the seeds of bad buying and selling decisions are planted well before ill-timed transactions. An investment strategy must meet needs as well as risk tolerance, he said.
"We found that when there is a mismatch; you have reactions that lose people money," Harvey said.
While not a sure-fire solution, a financial advisor can provide a counterpoint and a reminder that staying invested through downturns yields the best returns over time.
"I don't think there's any dispute that a lot of people out there could do a good job of investing their own money," said Michael Branham, president of the Financial Planning Association. But, he added, "there's so much volatility in the market that it's easy to get emotionally charged either way."
The surging stock market is most likely emboldening investors again. Current low bond yields can make it tempting to jump at higher-risk fixed-income investments. It's tempting to pour in more money, right? But then you'd run the risk of buying high—falling into an emotionally driven move, such as investors who sold during the March 2009 low.
An outside voice of reason can be a major advantage for many investors, said Mark McNabb, clinical professor of finance at the University of Texas at Dallas. "You need someone to act as your filter sometimes," he said.
Dean Harman, president of Harman Wealth Management, recalled meeting with a client who told him that, on one hand, she didn't want to lose money. "On the other hand, she was saying, 'Should I get aggressive so I can make more money?' "
Dean reminded her of the long-term goal they had agreed on—funding her retirement to the tune of $56,000 a year.
"I brought her back to what her goal is," Harman said. "As long as we can deliver the income she needs, and a modest amount of growth, she doesn't need more than that."
He said he views an aggressive stance on behalf of this client, who has $1.5 million with Harman Wealth, this way: If it were successful and increased her assets under management to $3 million, her life wouldn't change that much. But if the posture were to backfire and the portfolio fell to $700,000, "then she's in real jeopardy of not being able to generate the income she needs to meet her goals," he said.
"Manage to your goal, not to what the markets are doing," Harman advised.