Your Complete Guide to Index Investing with Dan Bortolotti

Why You Don’t Need a Financial Realtor

2018-06-17T20:59:00+00:00May 11th, 2011|Categories: Behavioral Finance|Tags: |7 Comments

On Monday, I asked readers to consider whether even index investors would benefit from the services of a financial advisor. Most of those who left a comment seemed to agree that the right advisor could add value, although committed DIY investors expressed their doubts.

The most interesting response I received came from a financial advisor with a major financial institution. While he has to remain anonymous—compliance departments don’t like their advisors spouting off on blogs—he gave me permission to publish his thoughts.

This advisor advocates using passively managed funds, but feels that his role is about much more than building portfolios:

Dear Dan,

I thought I would poke my head up and enter into this emotionally charged debate about whether an advisor’s fee is worth it. As with all the big questions in finance, there is no black or white answer: it comes down to what colour of grey you can stomach.

Let’s start with the facts, since they pack less of an emotional charge. At first glance, the data do not look good for advisors. In their paper What is the Impact of Financial Advisors on Retirement Portfolio Choices and Outcomes?, John Chalmers and Jonathan Reuter looked at participants in the Oregon University System’s Optional Retirement Plan. Some of the investors in this plan used full-service brokers, while others used the default investment options and received no advice. Chalmers and Reuter found that the broker clients underperformed the non-advised investors by approximately 2% per year on a risk-adjusted basis. They also found that the advised clients were just as likely to chase returns when allocating their initial contributions.

So is the debate settled? Maybe not. I would argue that the broker clients in this study were receiving investment guidance, not advice. This may seem like semantics, but I think it’s where most of the confusion and disappointment comes from.

Guidance is not advice

To understand what I mean by investment guidance—and why I agree it’s usually not worth paying for—I’ll quote Brad Steiman, who heads up Dimensional Fund Advisors in Canada: “The vast majority of advisors I encounter tend to act as financial realtors by driving their clients around the capital market neighbourhood and showing them different portfolios. While touring the neighbourhood they may bring up considerations such as cost, tax efficiency, diversification, or concentration, and when all is said and done, their client chooses the portfolio he can live with, often as a matter of personal preference. In the extreme case, the tour is foregone entirely, and the client, or more specifically the ‘customer,’ simply says which portfolio he wants to buy and asks to have the paperwork drawn up.”

Most of your readers seem to be running from this kind investment guidance, and I would side with them. If all your readers need is a properly designed portfolio, they can use one of your Couch Potato models. For the non-advised investors in the Chalmers and Reuter study, the default choice was a similarly well designed mean-variance portfolio that was automatically rebalanced. There is evidence that investors who use these default investment choices in employer retirement plans tend to have enormous inertia, which in this case worked in their favour.

Unfortunately, most people do not invest like that. A study by Werner De Bondt informs us that individual investors display excessive optimism, are overconfident, downplay the importance of diversification, and reject the trade-off between risk and return. All of these traits show up in the dividend debate that was waged on your site and in those who raised their hands at your investment seminar when you asked them if they beat the market.

Bernstein’s DIY checklist

In an earlier post, you mentioned William Bernstein’s conclusion that “only a tiny minority will ever succeed in managing their money even tolerably well.” Bernstein writes that successful investors need at least four qualities: a genuine interest in investing, the horsepower to do the math, a working knowledge of financial theory and history, and “the emotional discipline to execute faithfully, come hell, high water, or Bob Prechter.”

Your readers should ask themselves if they possess all four of these qualities. If not, then paying for financial advice—as opposed to financial guidance from someone who will just drive them around the neighbourhood—may be the wisest choice they ever make.

I believe there will be a peaceful resolution to the debate between the advisory community and individual investors. As your readers are finding out, passive funds and mean-variance portfolios are tools that allow us to defeat a lot of our behavioural biases. If you combine an advisor who knows how to use these tools with a client who understands how powerful they are—well, it’s not perfect, but it’s the best shot any of us has.


The Optimist


  1. Rob Gerber May 11, 2011 at 7:48 am

    Nice letter. Thanks for posting. Really like “Financial Realtor” image. The reach of semantics goes even deeper.A 2009 Ipsos Reid study stated that less then half the people working with Financial Planners actually had a wrtitten Plan. People working with Brokers, Advisors, their father, all say they have a Financial Planner. If there is no Plan to work from or too, is their a plan? I know a very good Hedge Fund Manager. He knows he is not a very good Financial Planner.
    The 2010 Unretirement Survey, posted recently by Sunlife, finished with the note that 79% of Canadians do not have a Financial Plan.
    To me the interesting questions are, of the 79% stated by Sunlife, how many of them would be good DYI Inestors and who is planning for the majority of that number that are less then High Net Worth? Most Advisors, Planners (Institutional or Individual) etc, are focused on the High Net Worth leaving the average Middle Class family unsupported.
    And Dan, isn’t it time that these larger firms started embracing Social media?

  2. Chris May 11, 2011 at 9:40 am

    If one goes through the Chalmers and Reuter paper that “The Optimist” referred to, it turns out that the *raw* underperformance of the two groups is “approximately one percentage point lower per year, which is what we might expect given the additional fees that HIGH investors must pay to their financial advisors” (page 3). i.e. There is almost a perfect correlation between the amount of underperformance and the advisor’s fees. I strongly doubt that a nebulous distinction between “guidance” and “advice” will erase the underperformance due to the extra fees.

  3. Dave May 11, 2011 at 12:14 pm

    Great Topic

    To me the bigger issue is not whether an advisor can add value but whether the service is worth the price charged. Many advisors can and do add value in terms of time and effort as well as expertise, but many sadly fall into the “Realtor example”.

    Another issue is that like the real estate, the financial services industry competes on everything but price which keeps the floor price too high. The result is too many participants and wide variation in service which hurts the good advisors.

    As no two investors are the same, my dream is to be able to acquire advisory services “Unbundled” and “A la carte” based on my needs.

  4. The Passive Income Earner May 11, 2011 at 12:52 pm

    Very nice. I made the same comment elsewhere by comparing a Financial Advisor to a Real-Estate Agent …

    I have to say that I really like the end points in the letter about asking if you have the qualities to do it yourself. I think that’s really important. A co-worker recently inherited and he was talking to me about it and as we discussed, it was obvious his interest and knowledge was very limited. All I offered was to seek financial advice and to take his time looking for the right person.

  5. My Own Advisor May 11, 2011 at 10:22 pm

    The reason I don’t use a “financial realtor” is, rightly or wrongly, 1) I believe I can go it alone because 2) my experience is the net value gained by using a financial advisor is not worth the price I would pay for services rendered.

  6. Ryan May 12, 2011 at 4:47 pm

    1. Could you pull the trigger if you had to or would you rather someone else did it?
    – Gutcheck says most people contemplate what to eat for dinner
    2. Can you only make logical choices or are you emotionally charged?
    – I’m doing this to buy a house that I can have a long life and a family in, I couldn’t dare make a mistake by investing in technology look what happened in the tech boom (An APPL a day says techs are here for a while)
    3. Is you goal extra pocket change and a savings account or would you like the change to get a bang once in a while?
    – its a lot easier when you have 30 yrs to go and you don’t think about losing the house.
    4. Are you biased?
    – No, The Blue Jays are the best team in baseball.
    5. Are you looking for a guilt free scapegoat?
    – It wasn’t me… my mom loves that one
    6. If you were in a war defending your territory would you be a one man army or would you like to have a couple infantry, sargeants, and lieutenants on your side (you are the general you call the shots on your investments)?
    – A good defence is team defence, defence wins championships
    7. Have you ever made a mistake?
    – Well I told you before… it wasn’t me
    8. Do all Porsche’s drive the same? Different mechanics, different tires, different climates…
    – If I had a Porsche I’d have the cash to put the best tires on it… Big Mudders cause I live in Alberta and we have lots of snow. Fastest Rig on the road… its still classy cause its a Porsche
    9. Did you know that supplements/health aids/medication only requires them to be effective in 5% of the population to get to the shelf…
    – What do you mean not every cancer treatment will work for every person. If I could just get an extra 5 years of life expectancy, oh boy the money I would make.

    Moral of the story every little bit helps. DIY’s can’t always be perfect and every little bit helps… some people would kill for an annualized return of 5% help or no help. Noone complains when it works.

  7. Michael May 17, 2011 at 4:12 pm

    As a committed indexer, I don’t think it’s necessary to have investment advice per se. That being said, when you consider more complicated issues, like estate planning, tax issues related to different kinds of investment accounts (non-registered vs. RRSP vs. TFSA), tax issues related to having a corporation, etc., then the need for advice becomes greater. I plan (of course) to hire an advisor who charges by the hour to provide the specific advice required.

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