Should I Use an Investment Professional?

Question

A recent article I read cited:

People who work with an investment professional are nearly twice as likely to those who DIY to feel confident that they will have enough money to retire.

and

44% of people who use an investment professional have $100K or more saved for retirement as opposed to 9% of DIYers

Does this make the case for using an investment professional for the broader population as opposed to doing it yourself (DIY)?

I have my own opinions on the matter, but would like to hear from others.

Answer 1

People ... are nearly twice as likely to ... feel confident

Great, confidence is amazing. That and $5 will buy you a cup of coffee.

44% [who hired a pro] have $100K or more [vs.] 9% of DIYers

There's no way to examine these numbers without a link to the source, but it stands to reason that if you have a plan that you're sticking to you'll save more money than if you are just investing haphazardly. It's too bad that we can't see what the returns are for those using a pro vs. DIYers. That would be much more valuable than an arbitrary dollar level. Unfortunately $100K isn't really that much money if you live in the US, so it's an irrelevant talking point.

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The real question is whether investment knowledge is readily available to the masses or if having a person who specializes in finance is required to make good decisions about investment. I think the fact that the conventional wisdom prefers index funds to actively managed funds demonstrates that investment professionals are less useful than they might have been even a decade or two ago.

If money should be spent on professional advice, it's probably better spent on CPAs or other tax professionals who can help optimize your investments for tax efficiency, though even that is now available as more common knowledge.

Answer 2

Let me start with something you might dismiss as trite - Correlation does not mean Causation.

A money manager charging say, 1%, isn't likely to take on clients below a minimum level.

On the other hand, there's a long debate regarding how, on average, managed funds don't beat the averages.

I think that you should look at it this way. People that have money tend to be focused on other things. A brain surgeon making $500K/yr may not have the time, nor the inclination to want to manage her own money.

I was always a numbers person. I marveled at the difference between raising 1.1 to the 40th power, getting 45.3 (i.e. Getting 45.3 times your investment after 40 years at 10%) vs 31.4 at 9%. That 1% difference feels like nothing, but after a lifetime, 1/3 of your money has been skimmed off the top. the data show that one can do better by simply putting their money into a mix of S&P index and cash, and beat the average money manager over time, regardless of convoluted 12 asset class allocations.

Similarly - There are people who use a 'tax guy.' In quotes because I mean this as an individual whom they go to, year after year, not a storefront. My inlaws used to go to one, and I was curious what they got for their money. Each year he sent them a form. 3 pages they needed to fill in. Every cell made its way into the guy's tax program. The last year, I went with them to pick up the tax return. I asked him if he noticed that they might benefit from small Roth conversions each year, or by making some of their IRA RMD directly to charity. He kindly told me "That's not what we do here" and whisked us away. I planned both questions in advance. The Roth conversion was a strategy that one could agree made sense or dismiss as convoluted for some clients. But. The RMD issue was very different. They didn't have enough Schedule A deductions to itemize. Therefore the $3000 they donated each year wasn't impacting their return. By donating directly from their IRAs, this money would avoid tax. It would have saved them more than the cost of the tax guy, who charged a hefty fee, in my opinion. It seemed to me, this particular strategy should be obvious to one whose business is preparing returns.

Answer 3

Ask yourself the same question for furniture making. Would you feel more comfortable sitting in a chair that you made yourself versus one that you bought from a furniture store? How about one that you bought from IKEA and assembled? For an experienced, competent furniture maker, you might be able to make an equivalent chair for less money and be highly confident. For a "DIY" builder, you might be less confident but be willing to take more of a risk with the possibility of making a good chair for less money (and gain experience on what not to do next time).

The same applies to investing - if you are highly confident in your own abilities, DIY investing may work better for you. For the "general population", however, relying on experts to do the hard work (and paying a little more for their services) is probably a better option and gives you more confidence.

As for the second quote, I'm note sure there's a causality there. If anything, I think it's the other way around - people who have more money saved for retirement are more likely to use investment advisors.

Answer 4

I am sure there would be many views on the above topic, my take is that DIY takes the following:

1. Interest factor in financial instruments
2. Knowledge about financial instruments
3. Ability to conduct independent research on the instruments
4. Discipline to stick to your decision and to recognize a bad one
5. Enough spare time to expend on the entire exercise and to monitor the returns

Now, for many, one or more of the other factors are missing. In this case, it is probably best to go for a financial adviser.

There are others who have some of the above in place and are interested but probably cannot spend enough time. For them a middle ground of Mutual Funds probably is a good choice. Here they get to choose the fund they invest in and the fund manager manages the fund.

For the people who have the above more or less in place and also are willing to take risk and learn, they probably can do a DIY for a while and find out the actual result.

Just my views and opinion.

Answer 5

Even if we accept these claims as being true, neither the fact that their clients are more confident, nor the fact that people who use an investment professional have a higher net worth tells you anything about the value of the service that such professionals provide.

Judging a service provider is a complex matter where you take into account multiple variables but the main ones are the cost and quality of the service, the cost and quality of doing it yourself and the value you assign to your time and effort. I think it's highly likely that professional gardeners will on average maintain larger gardens than those who do their own garden work. And any professional will have more experience at his profession than an average member of the public. But to determine if hiring a professional is objectively "better" requires defining what that word means.

Finance is a bit weird in that respect since we actually do have objective ways of measuring results by looking at performance over time. But since the quotes you give here don't address that at all, we can simply conclude that they do not make the case for anything related to financial performance.

Answer 6

Agree with the above poster regarding causation vs. correlation. Unless you can separate out the variables questions like this are somewhat impossible to answer.

Additionally, one of the fundamental issues is the Agency Problem. Depending on the fee structure the advisor might be more interested in their own self benefit then yours.

Answer 7

Yes.

The investment world is extremely fast-paced and competitive. There are loads of professional traders with supercomputers working day in and day out to make smarter, faster trade decisions than you. If you try to compete with them, there’s a better than fair chance you’ll lose precious time and money, which kind of defeats the purpose.

A good wealth manager:

• stays with you for years. They listen to you, understand your goals and fears, help you target specific goals, and make a plan for accomplishing them.
• invests your money methodically according to your plan.
• gives you access to a wide variety of beta and alpha strategies.
• offers solid, structural risk management.
• gives you access to best of means of trade execution so you take advantage of all market opportunities, and avoid losing money needlessly to taxes.

In short, they can save you time and money and help you take the most advantage of your current savings.

Or, you can think about it in terms of cost. Most wealth managers charge an annual fee (as a % of the amount invested) for their services. This fee can range anywhere from close to zero, to 0.75% depending upon how sophisticated the strategy is that the money will be invested in, and what kind of additional services they have to offer. Investing in the S&P500 on the behalf of the investor shouldn’t need a fee, but investing in a smart beta or an alpha strategy, that generates returns independent of the market’s movement and certainly commands a fee. But how does one figure if that fee is justified?

It is really simple. What is the risk-adjusted performance of the strategy? What is the Sharpe ratio? Large successful funds like Renaissance Technologies and Citadel can charge 3% in addition to 30% of profits because even after that their returns are much better than the market.

I have this rule of thumb for money-management fees that I am willing to pay:

• For simple portfolios that don’t trade a lot like simple Betterment type portfolios, the fee should be less than 0.15 %.
• For sophisticated portfolios with an expected Sharpe ratio of under 1, the fees should be atmost 0..50%.
• I think for an expected Sharpe ratio of 2 or higher, the fee should be close to 1%.