Are the costs of professional financial advice outweighed by the benefits you receive in trying to build your retirement nest egg? Should you avoid this cost by undertaking investing and money management on your own, or is this a penny-wise and pound-foolish approach? If you are asking these questions then you might already have saved yourself more then you know. The value added by a financial advisor, referred to as “advisor alpha,” varies depending on the knowledge, skill and effort of the individual investor to whom the advisor is giving advice. If someone does a terrible job looking after their own investments, advisor alpha will be high. If an individual does a good job on their own, then it might be substantially less.
Asking questions about your finances and investments is smart and prudent, whether you work with a professional or go it alone. It makes sense to educate yourself while researching your options, even if you ultimately plan to work with an advisor for part or all of your planning and investment needs. Financial planners do more than manage your money; they can help you quantify your needs, articulate your goals, manage your time, keep your emotions in check, and deal with your family. Some observers have likened the job of a financial planner to that of a therapist or a counselor, providing support and guidance as much as money management services.
If you have the time and interest to become educated about finance and investments, regularly monitor the market, and critically evaluate your investment options, then you may want to handle your investments on your own. If you do not have the time, are not particularly interested in the topic, and/or have difficulty managing your emotions when making investment decisions, then a financial advisor can save you time, money, and aggravation. Finally, financial planning is not one product or service. Some individuals find that they need help putting together a plan, or that they would like a second pair of eyes overlooking a plan they have developed on their own. While not all advisors offer these types of ad hoc services, many do. Flat fee or hourly-based engagements can be a good way to bolster your own efforts and supplement your own knowledge of specialized topics, such as investment location and tax.
What about paying a financial advisor an asset-based fee for money management? Vanguard produced a piece on Advisor’s Alpha in 2013 that explains why professional advice can make sense for even the most fee-conscious investor: “For some clients, paying fees regardless of whether transactions occur may seem like ‘money for nothing.’ This is viewing the advisor’s value proposition through only one portion of the cost benefit lens. The benefit and wisdom of not allowing near-term market actions to result in the abandonment of a well-thought-out investment strategy can be underappreciated in the moment.” The piece continues: “…an advisor’s alpha (that is, added value) is more aptly demonstrated by the ability to effectively act as a wealth manager, financial planner, and behavioral coach—providing discipline and reason to clients who are often undisciplined and emotional—than by efforts to beat the market.” In short, the goal is not to outperform the market, but rather to outperform an investor working on his / her own, without professional advice.
Another study by Terrance K. Martin Jr., Ph.D. and Michael Finke, Ph.D., CFP® compared profiles of planning and advice over the span of 14 years. The four categories were Comprehensive Planning, Planner Only, Self-Directed, and No Plan. Martin and Fink noted that few academic studies had attempted to quantify the value provided by a comprehensive financial planner, so this one was one of the first to draw any such conclusions. As they wrote in the Journal of Financial Planning: “Those who had calculated retirement needs and used a financial planner (which likely captures those who used a comprehensive planner who follows a more thorough planning process that includes retirement needs assessment) generated more than 50 percent greater savings than those who estimated retirement needs on their own without the help of a planner.”
Their report continues: “When average retirement wealth was examined by survey year (1994–2008), households with a comprehensive strategy to retirement planning consistently recorded higher mean values of accumulated retirement wealth.
In conclusion, professional financial advice is not right for all investors, but understanding the value of a good advisor will help lead you to a successful outcome, whether you work alone, receive ad hoc advice from a professional, or hire a comprehensive, professional wealth manager. Ultimately you must make the decision that feels right for you.