Ideas

Do I Need a Financial Advisor?

Imagine for a moment that you are in need of medical assistance (Get well soon!) and are interviewing two doctors that are candidates to perform the procedure. One you find to be highly skilled; complete with an office stacked floor to ceiling with awards and certificates of achievement. However, you don’t really “click” and find her personality to be somewhat abrasive. The second doctor seems competent as well, but doesn’t have quite the same flash or pedigree. Her bedside manner, on the other hand, is exceptional. She is empathetic, patiently answers your questions and is someone you can imagine being friends with under different circumstances.

Which doctor would you choose?

We will return to our two doctors, but first let’s turn our attention to the benefits of expertise and empathy in the world of financial services. A 2014 study by two Swedish researchers in the Journal of Financial Intermediation, set out to answer the question, “Do financial experts make better investment decisions?”Their answer? A resounding, “No.” To quote them directly, We find no evidence that financial experts make better investment decisions than peers: they do not outperform, do not diversify their risks better, and do not exhibit lower behavioral biases.” It would seem that financial professionals then, are not practicing what they preach. A finding that adds another damning chapter to the volumes of research on the poor track record of financial “experts” in forecasting future market moves. So, if expertise in the world of high finance is so ethereal – why bother working with a professional at all?

The answer lies in our flawed psychology and our ability to help others even when we cannot help ourselves. A study conducted by Aon Hewitt compared the investment performance of those who received financial advice (“Help” group) versus those who took a do-it-yourself approach (“Non-Help” group). The advice was delivered online, and was tailored to the specific needs of their portfolio, (although it remains unclear to me whether the advice was automated or delivered by a professional). However, one finding was unambiguous – across all ages, income levels and market conditions, those who received advice outperformed those who did not, to the tune of 1.86% per year net of fees.

Of equal significance was the finding that the positive impact of financial help was most profound during periods of great market volatility, rising to 2.92% per year (net of fees) outperformance during the time we now know as “The Great Recession.” It takes just a bit of middle school math to demonstrate that the power of 2% per year benefit, compounded over an investment lifetime, can easily be the difference between whether or not someone has adequate resources with which to retire.

When choosing a plumber, you ought to largely ignore likability and pick the greatest pipe-fixer-upper you can find. A similar thing could probably be said of a surgeon. But the selection of a financial professional is a much more nuanced proposition inasmuch as the greatest value they provide is not in stock selection or market timing, but in preventing you from making a handful of bad decisions that will make or break your financial future.

The study shows that help was of most assistance in helping investors choose appropriate levels of risk, keep themselves from timing the market, managing risk over a lifetime and receiving advice in times of uncertainty. Some people find this help by using an automated advisor, while others need a person to sit across the table and guide them. As I recently said to my friend Daniel Egan, "some people can use a FitBit to get in shape, but I'll always need a mean looking trainer yelling at me to do one more rep." Wherever you choose to get your advice, please seek professional advice of some kind. 

In emphasizing the importance of coaching and behavioral management, please do not understand me to say that content knowledge is unimportant in the provision of financial advice. There is a robust body of research on “what works” on which your advisor should be schooled and prudent tax and investment advice can make a world of difference. Indeed, appropriate risk-taking over a lifetime was one of the biggest drivers of return found in the study. 

But competence of this sort is just the ticket to the dance. Your selection of a dance partner should have at least as much to do with whether you’ll listen to and follow their advice when you least want to. Maybe we as a human race aren’t very well suited to help ourselves and listen to our own best advice. But we do seem equipped to help each other when times get tough – and that’s worth a whole lot.

So...do you need a financial advisor? Yes, but probably not for the reason you thought. 

To learn more about the behavioral case for getting good financial advice, please check out THE LAWS OF WEALTH by Dr. Daniel Crosby.