The Three Misconceptions About Working with an Advisor
Misconception #1: "My Advisor has the answer."
If there were a magic solution that works 100% of the time, I would love to know it. By knowing this magic solution, I can reduce my workload tremendously and assure that all my clients reach their goals 100% of the time.
Run for the hills when you come across someone that states they have the answer. If that person has the answer, demand to see how that strategy worked 100% of the time in all circumstances. Financial services' marketing is notorious for this type of message.
I don't agree with this message. However, I do understand its use. I think that most people want to believe that there is a solution that always works. Therefore, apply the solution, be happy and don't worry, and focus on the other issues in your life. I really wish it were that easy.
I have watched more people get drawn into the illusion that there is one strategy that is the perfect answer. I attended a luncheon where a financial advisor sitting next to me stated that he had the answer. It all came down to using two different types of index funds and this strategy that he developed. It always works and everything else is risky. (He claimed)
A local newspaper columnist has the coach potato method of investing. His conclusion is that it comes down to a simple strategy with a little readjusting each year. What happens when both stocks and bonds are both a bad place to have investments? Is it possible that both stocks and bonds might not work? Then what is the answer?
There is the recent Wall Street Journal story of the financial advisor who fills the marketing pages with excitement about his ability to manage money. He markets his tremendous track record. He talks about how he made the right calls and his timing has been perfect. However, the real story is that he has made some very bad calls as well. Of course, that is not advertised in his marketing. The stock market always has a way of humbling those who think that they have it figured out.
There are three characteristics of an effective strategy. First, it works best on an average. It is never perfect. However, it is consistent enough of the time on average. Second, it is adaptable. Times change and a strategy that might work well in one investment climate probably does not work as well in another climate. Third, it works as well on paper as it does in real life. I have analyzed many strategies that look great on paper. In reality, the moon and the stars would have to align for it to work in real life.
Most magic bullet solutions come in the form of a guarantee. I think that the next great class action lawsuit will be against insurance companies and their guaranteed investment programs. These are commonly referred to as indexed annuity programs. They are programs that promise you can always participate in stock market returns and never fall below a guaranteed rate of return. (Usually in the range of 6 to 7%)
In order to not receive a ton of e-mails, let me give my disclaimer:
I am sure that there are ethical advisors that promote these products and educate on all of the pros and cons. Further, I am not stating that these products are the wrong solution for everyone. This is just my opinion.
The majority of these programs are marketed as if you get the best of all worlds. They are marketed as you get great return and never risk loosing money. In my opinion, they are a numbers scheme. On paper, the guarantees are true. In reality, they are not telling you the entire story. If clients truly understood how they worked and looked past the emotional marketing strategy, they would think twice before investing their money in these programs.
If someone is guaranteeing you something, you are giving something up in return. That is not always bad. I have analyzed one program that makes sense. (not an indexed annuity) No insurance company is going to take all of the risk just so a client can get all of the reward. Keep in mind that insurance companies are in the business of making money.
Misconception #2:"My Advisor is Managing my Money."
What is money management? I would break money management down to 6 main areas:
What is buy and hold investing? I would break this process down into 4 main areas:
These two very different processes are confused in today's environment. It is easy to see how that has happened. The investment landscape in the 80's and 90's was a much easier time than today. For 18 years, the market went up. Sure there was a pause here and there. For the most part, markets would recover and continue their journey upwards. An active style of management was not as critical.
During the 80's and the 90's, today's investor was born. The first 401 K Plan dates back to 1980. The mutual fund industry went from two or three hundred mutual funds to over 15,000. The majority of your advisor/client relationships were formed during that time period.
The buy and hold model worked well during that timeframe. To a degree, that model could almost be called money management. The whole idea behind money management is to create long-term growth. For the most part, the stock market created an ideal environment for advisors to flourish in that role.
Times change. A fierce bear market eliminates large percentages of paper wealth. Clients think that advisors are managing money. There is no active money management in a buy and hold format. For the most part, advisors are still employing techniques that worked in the 90's. Unfortunately, these techniques are not effective in this particular environment.
I would suggest that this particular investment environment requires a much different approach. A money management approach is needed. If you assume that your advisor is working under that model and you are wrong, additional losses could be the result.
Most advisors work in a commission based situation. In my opinion, that type of set-up cannot work going forward. A true money management scenario works best in a fee (and not commission) based system.
Let's look at the buy and hold model that most of the advisement community uses. A prospective client meets with an advisor. The advisor goes through the process of determining goals and needs. An investment portfolio is put together. The client accepts the recommendation and then the portfolio is implemented and the advisor is paid a commission. This is where the process starts to break down. Until this point, there has been an equitable exchange of value. The advisor has performed an invaluable service of analyzing risk, explaining risks, and then putting a plan together.
The next year would require a follow up visit to make sure that everything is working. Does the advisor and the client arrange for another meeting the next year?
In most cases, the advisor will continue to meet with the client and make recommendations. Although the advisor is not getting compensated, there is always the compensation that results in additional investments or even referrals. What if there is not any additional business or referrals? What if the advisor gets real busy? The advisor might have all of the best intentions in the world to keep reviewing on an annual basis. However, his or her practice has just become unmanageable. Regardless of the reason and or good intentions, the client has an expectation and it is not being met.
I think that most people feel that they pay a commission for an advisor to go through the process of setting up a portfolio and establishing financial goals as well as the management of those assets and goals forever. With the best of intentions, many advisors leave that impression.
I truly believe that the financial services industry is working under a model that sets up Financial Advisors to be less effective.
In reality, setting up a plan and managing that plan are two different tasks. Unfortunately, the advisor never explains this difference and the client assumes that both are being carried out. The fact of the matter is, that many advisors don't know to differentiate between the two.
Think about it for a moment. If an advisor makes his or her living off of commissions, how could they afford to meet with a client year after year and receive no compensation for that time? There comes a point where an advisor acquires too many clients and just runs out of time.
Now I realize that I am walking a fine line in bringing up these issues. This is not a slam against advisors. I am simply bringing up the fact that there are many assumptions being made and expectations not being met. I fault the industry. The industry is coaching advisors based on an outdated model based entirely on commissions. After nearly 12 years in the financial advising business and making many of these mistakes, I feel a proper explanation is to be made so that people understand.
Money Management can be performed in a commission setting. In order to have true money management, the advisor must have a specific set-up that allows for cost effective management as well as flexibility. After researching and analyzing every possible way to effectively manage money, I truly feel the fee based system works best for the client.
Why is this so important today? You need to know and understand that someone is working for you. These are complicated times we are facing today. This is not like the 80's and the 90's where you could pick a mutual fund with a blindfold, invest, and leave it alone. Ironically, it was coach potato approach of the 80's and the 90's that have made this decade and beyond more challenging.
How could this be dangerous for your retirement goals? It comes down to time. Time is the most precious commodity that we have when it comes to investments. Time is not something anyone can afford to waste.
Misconception #3: "My Advisor is Qualified to Handle My Needs."
There are many ways to determine the aptitude of someone advising you on financial matters. Unfortunately, only time will tell whether someone was truly qualified to handle your needs. So, you can only go on observation and experience before allowing someone to help you with your finances.
You could consider years in the business. Years and experience produce some level of wisdom. I would give anything to have today's knowledge yesterday.
Another qualification would be designations. The designation of Certified Financial Planner meets many of the tests of qualification. That is a tough process that one goes through to gain certification. Of course, there are many other certifications that an advisor could receive as well.
Qualification could be merited based upon the team around the advisor. An advisor can have a qualified team in place that helps in the process.
A qualified advisor can look at all available options and make an unbiased recommendation. It has been revealed that many investment companies were making biased recommendations using propriety products in the 90's. These products paid higher commissions and qualified the advisor for additional benefits. In order to be effective, that bias has to be removed.
A qualified advisor has a specialty. No one person can be everything. The financial services business offers one the ability to work in all areas and recommend solutions for many needs. All it takes are a few licenses. That does not mean that they are qualified in each of those products. Figure out the specialty of the advisor. Take advantage of that specialty. Consider leaving the other areas to other advisors who live and breathe that area daily.
For instance, you would want someone well versed in handling investments to manage money for you. You certainly wouldn't want someone that does it as one of his or her many other duties. You would want to be careful having someone, who specializes in investments, implement an estate plan for you. You would want to be careful having someone, who is an expert in the area of insurance, handling investments for you.
Once again, I am walking a fine line. Many advisors would not appreciate this article nor agree with it. There are advisors (some that I know personally and our dear friends) that could handle almost every area of financial services with perfect accuracy for a client. You just have to realize that they are the minority and not the majority.
Scott Burns, a writer for The Dallas Morning News Finance section, writes as if all financial advisors are commission hungry predators. I appreciate that his writings point out the dangers of unethical people. All industries have them. However, there are outstanding advisors that will do a great job for you.
Be careful to not assume that a person is qualified to handle something on your behalf. Understand that product salespeople outnumber those who are true advisors with specialties. It comes down to time. What you might not understand can rob you of the precious commodity of time. Once lost, its only value is experience.