When Should You Use an Advisor?

September 30, 2011

Dan Solin’s excellent new book, The Smartest Portfolio You’ll Ever Own (see my review here), devotes several chapters to whether passive investors should work with an advisor. It’s a question I’ve considered before, and I think Solin has a lot of interesting insights to share.

The suggestion that most investors should use an advisor is a tough sell in the financial blogging community. Most Canadians with significant assets work with advisors, but the proportion of DIY investors is surely much higher among regular visitors to websites like this one. Indeed, many Couch Potatoes embraced the strategy after a negative experience with an advisor, and that aftertaste will take a long time to fade.

As a DIY investor myself, I’m happy to support people who manage their own portfolio. At the same time, I believe that most investors are likely to do better over the long run if they work with an advisor—as long as it is the right kind of advisor. Unfortunately, there are huge problems with the advice industry in Canada, which is dominated commissioned salespeople who charge hidden fees embedded in financial products, and who believe that an advisor’s role is to select winning fund managers or pick stocks. Excellent fee-only advisors are out there, but many have minimum account sizes of $200,000 or more, which rules out the overwhelming majority of Canadians.

The situation is somewhat different in the US, where investors have more options, but Dan Solin’s take on the DIY-or-advisor question holds up pretty much anywhere. Here are his major arguments:

  • If your assets are under $100,000, you may find it hard to find an advisor who will take you on for a reasonable fee. For this reason, as long as you have the ability to build a simple index fund portfolio and leave it alone, you would be better off on your own.
  • If an advisor says he or she can help you beat the market, that’s a dealbreaker. “It’s one thing to decide you need assistance,” Solin writes. “It’s another to use a broker who transfers your wealth into his or her pocket.”
  • Only go the DIY route if you are sure you have the necessary discipline. It’s easy to stick to the plan in a bull market, but an awful lot of investors panicked in 2008–09, and plenty more are doing so now. Solin points out that well-advised investors had appropriate asset allocations that allowed them to endure the volatility.
  • Consider using an advisor “if you want continuity with your investments for your spouse and family when you die.” If you’re the only one managing the money and you get hit by a bus, is your partner going to be left to the sharks?
  • An advisor can be extremely helpful in managing a portfolio for maximum tax efficiency. In Canada , this is especially true for retirees who are dealing with forced withdrawals from RRIFs and trying to avoid Old Age Security clawbacks and other benefits for seniors.
  • If you’re a strong believer in the Fama-French principles, you may want to use Dimensional funds, which are only available through a select group of advisors (yes, Solin is one of them). Although you can capture some of these premiums using ETFs, Dimensional funds have a long track record of outperforming traditional small-cap and value index funds.

I tend to agree that passive investors who want to work with an advisor should look for one who uses Dimensional funds. It’s not just that these are excellent, low-cost funds. The real benefit is that the advisors who sell them get it. Solin quotes a Morningstar study that found “advisors who use DFA encourage very smart behavior among their clients.” ETFs can also be excellent tools, but many advisors use them for tactical asset allocation, sector plays and a lot of other nonsense that has nothing to do with passive investing.

As Solin reminds us, investing is about process, not products.

{ 15 comments… read them below or add one }

J from Ottawa September 30, 2011 at 9:50 am

I started saving money by making monthly contributions my Banks Mutual Funds, for 10+ years they had a generally positive return, I would add some lump sums at tax time and I didn’t really think much about them.

When the balance got big enough I decided I should get better organized with a proper advisor and I gathered some references, selected one and in early 2008 transferred everything to an advisor. About 4 months later the markets fell but I didn’t panic in fact I felt better that at least I was now in the hands of someone who would understand how this worked and I would have a solid strategy.

However as the markets recovered I found I was lagging the recovery, I finally looked up the funds I was in on the Globe and Mail listing and found that all but one of the six funds we had invested in were returning below average returns for their category of funds, and they had been doing so for at least 5 years. I wasn’t comparing them to some optimal strategy just the average return for the same class of mutual funds. I felt foolish for not checking this in advance but when you hire an “expert” you have to put some trust in them.

When I raised this with the advisor the response was very frustrating I just got the standard sales pitch over and over. I now understand that I was in heavy DSC funds and there was no way they would ever be competitive. I found that the advisor was really no different than the bank, just selling a product that was paying him a commison.

I am now convinced that if you have taken the time to save anything significant you have no option but to fully educate yourself. Even if you use an advisor that you feel is trustworthy you need to be on top of what they recommend as you cannot take any advice blindly.

To that end I find this blog and others a wonderful resource; your articles provide short, clear, and well researched information that truly empower a novice DIY investor. The comment format allows topics to be debated and there are eneough blogs out there that you can see and understand different opinions on various strategies which gives me even more confidence.

I have now watched the current market tumble without losing any sleep as I am confident I am well allocated and I understand that I will not be retiring any time soon and I am just buying in at cheaper price. One day the markets will rise and at that time I simply need to make sure I am well allocated for my age and situation.

Thanks for the great advice.

Julian September 30, 2011 at 4:17 pm

Dan, thank you for your excellent website and articles. They’re an invaluable resource for someone like me who is contemplating making the switch to passive investing.

I’m debating the question of whether to use an advisor, and you list a number of good reasons above. But on the question of fees alone — by the time you pay an advisor 1.0% or 1.5%, on top of the aggregate MER of a typical index portfolio, it seems to me that you’re getting pretty close to the level of the ridiculous mutual fund MER’s, which are precisely what indexers are trying to avoid.

I’m curious to hear other people’s thoughts on this.

Canadian Couch Potato September 30, 2011 at 4:38 pm

@J from Ottawa: Great to hear that you’ve found a strategy that you’re comfortable with. I think you’re right—whether you’re a DIY investor or you work with an advisor, you need to put some effort into understanding how markets work and how our own behavioural biases get us into trouble.

@Julian: You ask a great question. The key idea here is whether the fees you pay are worth it. Many Canadians pay over 2% to 3% in fees to “advisors” who do little more than sell products. Paying someone to pick mutual funds doesn’t add value, and the commission structure puts these advisors in a conflict of interest. I have met many investors who were using wholly inappropriate products that were chosen for one reason: the advisor got a nice fat commission on them. Segregated funds are a prime example.

If you work with a fee-only advisor who advocates a passive strategy, your all-in costs should be no more than about 1.75%, often less, including fund MERs and the advice. So it’s cheaper right off the top. But more important, the fees you pay to the advisor are for things that have genuine value: financial planning, tax planning, risk management and other services that are just as important as choosing specific investments. The advisor has no incentive to sell you inappropriate products, since he or she is paid directly by you. A good advisor can easily pay for himself or herself by saving you from financial or behavioral mistakes that would cost you more than 1% to 1.5% per year.

Yes, you can get your costs below 0.5% as a do-it-yourselfer, but the question is, do you have the experience and discipline to pull it off without making costly mistakes? Many people can do it, and I encourage them, but it’s not as easy as many people think.

Chris September 30, 2011 at 5:14 pm

Just curious, how much do DFA advisors in Canada typically charge? From a quick Google search, it looks like DFA advisors in the US average tend to charge around 1.6%/year for a $100k portfolio, including their annual rebalancing charge and aggregate annual transaction fees. (I remember a previous poster said he charged 1.0%, but I’m guessing that probably doesn’t include the rebalancing fee and average transaction fees.) Is this roughly what they charge in Canada?

Also, what do the MERs look like for their Canadian funds? Are their Canadian funds the same as their US funds, or are they hedged or tax-advantaged in any way?

Canadian Couch Potato September 30, 2011 at 5:35 pm

@Chris: The advisors typically charge between 1% and 1.5%. and of course, the percentage goes down as the account size goes up. Most of the advisors in my directory use DFA, and they’re all in that range. That certainly includes rebalancing, and there are no transaction fees if they’re using DFA funds.

As for the fund fees, they’re listed on my index funds page. They range from 0.38% to about 0.72%. DFA Canada has created some funds that are unique to this market, but the US and international funds would have the same holdings in both countries. DFA doesn’t use hedging in its equity funds, only in its fixed-income funds.

More info here: http://www.dfaca.com

Be'en October 2, 2011 at 3:26 am

Dan, you have a very thorough knowledge of investing and financial planning. Despite this, would you ever consider using a certified financial planner/adviser to manage your portfolio once it reaches a certain size? If yes, what would be the threshold for the portfolio size, and would you use a DFA adviser or someone else?

Canadian Couch Potato October 2, 2011 at 8:49 am

@Be’en: I don’t feel I need to pay anyone to come up with an appropriate asset allocation for me, nor to help me design a portfolio. I think the Complete Couch Potato is a better portfolio than those used by 90% of advisors out there (and about one-tenth the cost). Behaviourally, I’m holding up, too: I managed to endure 2008–09 and the last five months without deviating from the plan (I even rebalanced in February 2009 and again this summer), so I don’t think I need my hand held.

However, I think would use an advisor to help me manage a large portfolio in a tax-efficient way, especially in retirement. For example, it’s difficult to manage withdrawals if you have both non-registered accounts and RRSPs (which funds do you draw first?) and a good adviser can really help here. I would also value an advisor’s help if I was concerned that my family would be cast adrift if I were to die. Yes, I’m sure I would use a DFA advisor, but not just because of the funds. As I mention in the post, it’s more about an advisor who has the right idea about where they can add value.

Be'en October 3, 2011 at 12:35 am

Thanks Dan. I am planning not to use any adviser and instead rely on people who are contributing through their blogs, and hence wanted to see if I was on the right track as far as this aspect was concerned. I do see value in having an adviser in the event that I should die, because my wife is totally illiterate when it comes to financial management. Sooner than later I am going to get my two kids involved and educated on personal financial management which should help in this matter.

I have so far dealt with two “financial advisers” and they haven’t been straight forward, to put it mildly.

Steve October 4, 2011 at 11:46 am

To me, listening to the suggestion that an advisor can assist in optimizing ones portfolio, as long as you pick a good advisor is like being told investing in the stock market is a good idea, as long as you pick good stocks. Both are correct, but the trick is how do you pick the right stock, and how do you find a good advisor.

The good professional fund managers are in the same water as the sharks, and investors who choose to go for a swim do so at their own peril . The idea of handing the money I spent my life accumulating to some kind-faced fund manager expecting they will make decisions in my interest, to me, borders on idiotic.
The high rollers have friends and experience to weed the good from the bad. The regular folk are left to random luck. What, are we supposed to interview them and ask for their qualifications? Select them based on their office furniture? Their diplomas and salesman-of-the-year trophies? These guys are professional spin-doctors, an art they practice all day long. So we are now going to have a chat with them and see if they sound smart and honest?
Dan, you have strayed from your core beliefs. The advice you have been giving on passive investing is one of the rare shining lights of truth in this corruption filled industry. Stick to your core belief, a lot of people are depending on you.

Canadian Couch Potato October 4, 2011 at 12:54 pm

@Steve: You’re hitting on the major problem with this debate. People see “active or passive” and “advisor or DIY” as the same question. But they’re two different issues. My core belief is that active management (fund picking, stock picking, market forecasts) usually has no value. However, I also believe that people should pay for professional financial advice if they need it. There is no contradiction there.

Passive investors can find an advisor who uses low-cost passively managed funds. These advisors see their role as providing advice: risk management, financial planning, tax and estate planning, managing emotions, etc. However, the client must be willing to pay for this advice directly, since these advisers do not collect trailing commissions. This is not much different from hiring an accountant or a lawyer.

The problem is that perhaps 5% of advisers fall into this category, and many of these have high minimum account sizes. That’s why I think investors with less than $100,000 are usually much better off on their own. Those with bigger portfolios, however, will have an easier time finding a fee-only professional and not a salesman.

Jenn T October 4, 2011 at 8:59 pm

My natural inclination would be the opposite. I think investors with $100,000 or less could be better off with advisors. Those with larger accounts might be better off solo…with good accountants. I have roughly a $2 million account. Paying a 1% fee would cost me $20,000 a year to the advisor. I would rather “couch potato” my money, and hire a great accountant. Would an advisor add $20,000 of value each year to me? Or over 10 years, based on my account size, would they add $209K of value over 10 years…considering a 1% advisor payout? Some people have large account because they have been frugal. If you fall into money, and you don’t have a clue, then perhaps the advisor is a good option. And if you’re starting out, maybe an advisor could help too. But if you built the money yourself, why would you suddenly start wanting an advisor who could cost you more than 200K over 10 years just because you built a large account. I love my accountant. He knows what I do, and he’s way way way cheaper.

Canadian Couch Potato October 4, 2011 at 9:23 pm

@Jenn T: Fair enough. Whether an adviser can add 1% in value depends on you as an investor. If you have a well designed, low-cost portfolio and the discipline to follow your plan, probably not. But again, people who can do this are a minority. I can assure you that many high net-worth people are not good investors and would definitely get value from a professional. Being frugal, or being a good businessperson, does not necessarily mean you’ll be a good investor. Wealthy investors also have much more to lose if they screw up!

I agree completely that a good accountant is worth his or her fee many times over. Note that professional wealth management houses will usually include tax management as part of their suite of services.

Those with small portfolios often have little choice but to work with a commission-based adviser who will just put them in mutual funds. The 2% fee may not be a lot in dollar terms, but there’s no value there. If the investor is capable of setting up a preauthorized contribution to a low-cost balanced fund, they will almost certainly do better on their own. At this stage of life, saving and developing good money habits are more important that designing a perfect portfolio, and the average mutual fund salesman can’t help with that.

Jas April 28, 2012 at 9:39 am

@Jenn T : If you have a $2 million account, an advisor using ETF and DFA funds could cost you less then 1%. Many advisors reduce their fees for accounts over 1 million. Also, wealthy client often have money in non-registered taxable accounts, where the portfolio management fees are tax deductible. At a maximal marginal tax rate of 46%, a 1% fee is equivalent to 0.54%. Finally, using an advisor allows you to have truly canadian domiciled index funds so you don’t have to worry about the US estate tax (http://canadiancouchpotato.com/2011/12/08/ask-the-spud-am-i-vulnerable-to-us-estate-taxes/) and have better tax efficiency for international equities (http://www.financialwebring.org/forum/download/file.php?id=1759 ).
As mentioned by CCP, DFA funds makes it easier to include a small cap and value tilt to your portfolio.

Jon March 24, 2014 at 5:46 pm

Hi Dan,

I noticed that you changed the find an advisor section to all PWL advisors. Any suggestions for those of us living in Vancouver or Edmonton (I have family in both who are interested).

Thanks,
Jon

Canadian Couch Potato March 24, 2014 at 7:28 pm

@Jon: I should note that PWL works with clients in both BC and Alberta. If your family members want to work with someone in their home city, please email me and I can make some suggestions.

Leave a Comment

{ 1 trackback }

Previous post:

Next post: