You can learn to invest and plan your life’s finances all on your own. On my weekly MoneyTrack TV series, I showed viewers how they can use digital tools to help manage, save and invest their savings. We also shared stories of others who taught themselves how to wisely invest and take control of their retirement planning.
Yet, I also heard from people across all income and age groups–including do-it-yourself investors who admitted that they need more input to build and maintain a truly solid financial plan and execute on a sound investment strategy, one they could stick with over time.
Being an excellent steward for your own money takes work, patience and, sometimes, nerves of steel, especially during volatile markets. Even the most even-tempered DIY investors sometimes want a second pair of eyes to avoid “buying high and selling low.”
People hire financial advisors for many reasons, and not just to improve returns. One of the main reasons is that they realize they need help curbing their impulsive behavior. In fact, even when you feel confident in your own abilities, over time you may recognize you’ve developed “tunnel vision” with your portfolio. When this happens, being open to new perspectives can add clarity to your decision making process. And the closer you get to retirement, these insights about your own behavior begin to bring real value to your results.
When you’re younger, investing on your own might seem more like a game that has no real long-term impact. But once you’re in your 50s and 60s, and wondering whether you’ve truly built enough of a nest egg to retire the way you want to, the consequences of making one bad investment decision suddenly becomes very real.
At some point, it makes sense to collaborate with someone who knows more about the markets, more about rebalancing your portfolio, tax planning, Roth IRA conversions, more about required minimum distributions (RMDs), than you do. This is when you may want to review what you’re doing with someone who can react faster and make calmer, objective decisions.
By now, most people have learned that advice coming from an independent fiduciary fee-only advisor is best for serious planning and investing. Why? Because fee-only advisors are not investment sales reps, like brokers. And unlike brokers, they’re legally required to always put your best interests first.
The whole point of working with a highly qualified (vetted) advisor is to provide you with peace of mind. The question is: How do you want to work with an advisor—and pay them for their advice? And how do you know you’re getting your money’s worth? These questions may seem insignificant, but, in reality, your answers will determine the nature of this relationship.
Test driving your relationship
Once you’ve narrowed down the choice of advisor (more on that later), it’s smart to test-drive the relationship by initially hiring them on an hourly basis or simply pay a fixed price for a specific project, like creating a financial plan or reviewing your portfolio .
But where do you go from there? If you’ve established a good rapport with this advisor, and have a clear vision on strategy, you might want to take the relationship to the next step—hiring them on an ongoing basis to manage your investments.
In these arrangements, most advisors won’t work hourly, or on a fixed-price fee arrangement because the planning is dynamic. More than likely, they’ll charge an annual retainer fee that’s either negotiated based on complexity, or that’s based on a percentage of the assets they manage for you, otherwise known as assets under management (AUM) fees. An AUM fee is a form of retainer fee.
Generally, AUM fees can be as high as 1% for portfolios under $1,000,000 and decrease as the account size goes up. You pay these fees directly to the advisor, usually from a separate cash account.
At first glance, this might seem like a lot. You might be asking, “Why would I pay an advisor $10,000 a year to manage my $1,000,000 account?”
At first glance a one percent a year fee may seem expensive. But not when you can see how that fee often pays for itself. When you think about how much is at stake if you make the wrong investment decisions, the costs may seem very reasonable.
Here are just some of the many things you should expect a fee-only advisor can do for you year-over-year:
- Figure out how much you really should be saving and investing for retirement, college and other major financial goals so you can course correct as you go. (And helping your children set themselves up for success).
- Develop a sound liquidity management plan that enables you to have the cash flow you need when you need it, so you can avoid having to sell during a down market to generate cash.
- Recommend the right mix of stock, bond and cash investments based on your financial objectives, timeframe and risk tolerance which improves your performance and better protects you from sudden market shocks.
- Audit all of your investments for management fees and/or hidden marketing costs you may not realize you’ve been paying that add up to thousands of dollars a year.
- Monitor and periodically rebalance your portfolio to its original mix of stock, bond and cash investments in a manner designed to minimize investment taxes.
- Use tax-loss harvesting to reduce capital gains taxes by selling certain investments at a loss to offset profits from the sale of appreciated investments.
- Handle account-related transactions such as deposits, checkwriting, and withdrawals.
- Meet with you quarterly or as-needed to review and collaborate with you for your children, family to discuss how recent or upcoming life changes are impacting your overall financial or estate planning.
- Help you identify and resolve risk areas that could lead to costly mistakes, such as having too much cash sitting idle, not having an updated estate plan, or potentially increasing your tax liabilities
Of course, an advisor will benefit financially if the value of your portfolio rises under their stewardship. That’s one motivation for them to deliver good returns and help minimize losses.
So, you might ask, what keeps an advisor from making high-risk moves that might result in higher returns—and higher fees? The answer is the fiduciary standard and that the advisor’s business model is aligned with your best interests. When an advisor is compensated only and directly for you, their loyalty is 100% to you, the client. Not to some third-party broker or insurance company. One sign of an excellent fiduciary advisor is that they will have a client retention rate above 98%.
Hands-on or hands-off?
Once you’re okay with the idea of hiring an advisor on an AUM-fee basis, your next major decision is determining whether you’ll trust them to manage your portfolio without your direct input or whether you want to keep them on a tight rein.
If you feel a need to drive the car, then it may make sense to hire the advisor in a non-discretionary capacity. In this arrangement, everything the advisor recommends—from your initial investment mix to buying or selling stocks, bonds or mutual funds–must first be approved by you, and carried out by you.
However, the tradeoff of this relationship is that it means you need to be available to execute when the situation calls for action. Is that realistic? For example, if you and your advisor have developed an investment strategy but then your advisor has to wait for you to approve each purchase or sale of a stock, you may end up losing more—or profiting less—than if the advisor had been able to act on their own.
This can especially hurt you during market downturns, when the advisor may want you to quickly offload shares of certain positions to limit losses while also buying other securities that are temporarily bargain priced. You can’t do this as easily if you’re on vacation or just can’t be reached.
Once you’ve gotten to know an advisor and have a sense of trust established, it’s a natural step to ask him to work in a discretionary capacity. This gives the advisor the ability to implement investment transactions on your behalf without having to get your approval first, as long as their actions align with your specific investment objectives and risk tolerance. Remember, you’re in a collaborative relationship so you can communicate as often as you want.
Fees that pay for themselves
Of course, AUM fees are only worth paying if the advisor can help you achieve your financial objectives more effectively than you could on your own.
While this is not easy to qualify, there is a growing body of research that claims that, when certain processes are followed, a fee-only advisor significantly improves investment results.
For example, according to a Vanguard study, an advisor who does all of the above can potentially add around 3% in returns every year. Another study by Morningstar claims that financial planners who use advanced retirement planning and investment strategies can generate, on average, as much as 22% more income for their clients during their retirement years.
Choose like a consumer
Of course, if you’re going to spend $10,000 a year to have an advisor manage your $1 million dollar portfolio, the due diligence process you use for choosing them should be as thorough as what you’d use if you were hiring a lawyer, accountant or contractor.
Most people rely on advisor recommendations that come from friends or family members. Few people realize they can get more facts about an advisor’s background from regulators at the Investment Adviser Public Disclosure website.
When you meet with the advisor for their first time, ask about all fees. How much will you have to pay account maintenance or custodian fees? Transaction fees for check writing or wire transfers? By law, any advisor is required to provide you with a standalone document listing their fees. Even so, you’ll want to know exactly what you’ll be getting and what you’re paying for before you hire them.
YOUR ADVISOR IS STANDING BY
Consider getting extra help toward financially thriving post-pandemic. With so many changes to your taxes and your finances, this may be the year to get extra help from a financial planner. A fee-only fiduciary financial advisor can offer expert tax planning as well as help you set your financial goals and priorities – so you can take advantage of all of the tax breaks you deserve and make the most of your financial-planning opportunities.
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