Investment Management vs. Financial Planning (Part 2)

I wanted to discuss one other financial planning function that relates to investment management: acting as a “circuit breaker.”

I recently spoke with a financial adviser about how I might enter the investment management business. He invited me in for a free consultation. After explaining that I was a self-directed investor, he suggested I could still benefit from a financial adviser as someone to monitor my performance and act as a “circuit breaker.” I wasn’t completely clear what he meant.

This comment in response to Dr. Mark Perry’s July 2014 blog post explains:

     > I am not a financial advisor but I do investment research for
     > a company that services financial advisors.
     >
     > …full service advisors offer one value that Vanguard does
     > not. They provide a voice of reason to keep their client from
     > making foolish investment decisions… individual investors
     > that manage their own blended portfolio tend to do much
     > worse than any static blend of equities and bonds. The reason
     > for this disparity is because individual investors make emotion-
     > based investment decisions that destroys performance.
     >
     > During recessions, Vanguard will not contact clients to
     > alleviate their fears to stop panic selling, which prevents
     > investors from participating in the market recovery. Vanguard
     > won’t actively advise clients to stay away from the hot tech
     > mutual fund that rose 1000% from 1997 to 2000.

This review suggests that Vanguard advisers can serve this function (especially for clients with $500,000 or more). I would certainly think it to be in Vanguard’s best interest to keep clients invested since that is how they get paid.

     > During market extremes, the full service advisor can be the
     > voice of reason that keeps their investors invested in a
     > static mix of equities and bonds. Will this strategy beat the
     > S&P 500 or a blended index similar to the static mix? Most
     > likely not because of fees.
     >
     > However, as long as advisors keep their investors invested
     > in a strategic equity and bond mix, the advisors will likely
     > generate performance above what individual investors can do
     > on their own. It’s not hard especially since the hurdle is low.

I’m guessing many of the self-directed fall into the “buy-and-hold” category. These comments are quite apropos for them.

Ideally though, I think that even long-term, self-directed investors should have a trading plan. They should know when they will get into positions and when they will get out. “Prepare for war in a time of peace” is the saying that comes to mind.

For shorter-term investors who are trading for a living, I don’t think the “circuit breaker” function makes as much sense. I’d be skeptical about whether a financial adviser (planner) could help me unless s/he knew the details of my system and/or had studied it in detail. Also, anyone approaching trading as a business should understand how detrimental rash decisions based on fear and greed can be to performance. I think a stoic outlook is essential for survival.

     > I don’t believe advisors can truly help clients beat the market.
     > However, advisors can help investors beat themselves. From
     > that perspective, the fees are worth it.

Advisers are acting as coaches in the “circuit breaker” role. If they can’t help clients beat the market, though, then the clients’ best interests might be served by leaving investing out of the financial planning domain altogether.