The Value of Expertise: Why Many Investors Overlook Financial Advisors

By Gary Dyer, CFA – Vice President & Portfolio Manager

In October 2019, CNBC and Survey Monkey conducted a survey, in which over 2,700 people responded to the question, “Who is the person most responsible for managing your money?”. Not surprisingly, either the person taking the survey or their significant other managed their assets 92% of the time. However, the noteworthy result of the survey is that only 1% had hired a financial advisor.

So why aren’t most investors, even those with a material amount of assets, not interested in hiring a financial advisor? There is a myriad of reasons, but some of the more common may include:

• Paying a fee for something they can do themselves
• Enjoying the process of investing their portfolio on their own
• No true value provided unless returns are outperforming the benchmarks

Why Should I Pay for an Advisor When I Can Invest Myself?

Hiring an experienced financial advisor can more than pay “dividends.”  While individual investors typically spend most of their time looking for the best investment securities, an adept financial advisor will gather a host of data about the investor before recommending any specific investment. This data includes age, risk tolerance, return goals, liquidity needs, income stream(s), tax situation, investable assets, illiquid assets (such as real estate), and more.

Multiple studies have shown the biggest decision impacting long-term returns is not the security selection, but rather the asset allocation (i.e., mix of stocks, bonds, alternatives, etc.). A financial advisor will work with the investor to determine the appropriate asset allocation long before recommending the first individual security. It’s important to decide on the ‘right’ allocation for each investor’s unique situation to maximize return with the least amount of risk. This can more than pay for the advisor’s fee if the individual investor has not positioned their portfolio properly to take advantage of their circumstances.

I Diversify My Assets. Do I Still Need an Advisor?

Let’s take it a step further. If the investor has put considerable thought into many, if not all, of the aforementioned factors that go into determining the appropriate asset allocation and they enjoy researching the individual securities to put in their portfolio, why pay a firm to manage their assets?

First, individual investors have more investment options to select from than ever before. In fact, even if you exclude the thousands of individual stocks and bonds available to purchase, there are more than 10,000 mutual and exchange-traded fund investment options (not including multiple share classes that many funds offer). With these options, it can be overwhelming for an individual investor to perform due diligence and select the appropriate securities to populate their portfolio. On the other hand, many financial advisory firms, like Central Trust Company, have expended considerable resources on research products, services, and personnel to assist in screening, selecting, and monitoring securities that populate portfolios.

Fact: Individual Investors Often Underperform

Unfortunately, one fact cannot be denied – the average individual investor consistently underperforms the stock market over the long term. A Boston-based research firm called Dalbar did a 30-year study (Quantitative Analysis of Investor Behavior) ending on 12/31/21 in which the S&P 500 Index and the average equity mutual fund investor generated annualized returns of 10.65% and 7.13%, respectively.

At first, this may not appear to be a large discrepancy, but when the difference is annualized over 30 years, the investor winds up with less than half the amount at the end assuming the same amount was invested at the beginning of the period.

Some items that may lead to the difference in individual investor returns include:

• Attempts to time the market (such as periodically moving in and out of stocks and cash)
• Emotional investing (such as a lack of willingness to purchase stocks amid a significant correction)
• Practicing a short-term investment strategy rather than focusing on achieving long-term financial goals

Interestingly, “making a mistake with their wealth” is a common reason individual investors hire a financial advisor. For the investor that enjoys the process of self-managing their assets but is like the average investor for one or more of the reasons above, a happy medium may be to have the advisor manage at least a portion of their assets.

The Importance of Active Portfolio Management

There is also a compelling argument that a financial advisor is worth their weight in gold even if they fall short of those infamous benchmark comparisons. A financial advisor will fully diversify a portfolio across various asset classes, so the investor’s returns have a stronger chance at avoiding the extreme volatility of owning just one or two classes. Furthermore, a financial advisor will closely monitor an investor’s portfolio instead of taking a “set it and forget it” approach that some individual investors abide by.

During a 2-3 period of strong stock market returns, a portfolio with an original asset allocation of 60% equity can drift to a 70-80% allocation. A diligent advisor would be in contact with the investor and verify if the 60% allocation is still appropriate, and if so, trim back the equity allocation to 60% to preserve some of those gains. In the case of the “set it and forget it” individual investor, the portfolio is vulnerable to lose the gains if a downturn occurs since the portfolio was never rebalanced.

In summary, all the aforementioned factors speak to the value of hiring a financial advisor. A third party that has experience in analyzing the financial situation of people encountering all types of life circumstances can be invaluable in meeting an investor’s long-term financial goals. A highly knowledgeable advisor at a trustworthy firm is a great place to start.