January 31, 2018

This post might end up being a tad longer than some in the past and I regret that some of you have already closed this window after reading that, but if you have then you probably weren’t ready to hear the information anyway. I wanted to lay out specifically what I think constitutes good advice and end the discussion talking about the different ways you can pay for such advice, the pros and cons, and ultimately how much that’s all worth to you. This is my life, so obviously I think it’s important – hopefully after reading it you at least think of your relationship with your advisor differently than you may have in the past.

First things first – what is good advice? I’m not talking about investment strategies, many of which are debatable from advisor to advisor and client to client, I’m asking how you decide what advice is good and what is bad in the beginning and why I believe many clients get it backwards. To me, all good advice shares some common characteristics – the specifics may change – but these commonalities shouldn’t. First, the advice should come from a competent person (what are their credentials and experience?) who is well informed about your situation. Second, the advice should be specific to you and your situation and shouldn’t require a small set of very specific outcomes in order to be correct – it should be robust. Third, regardless of the complexity of the advice, the client should have a base level of understanding of the purpose of the advice. Finally, the advice should give the client more confidence about their own situation (this isn’t saying that good advice never calls for sacrifice, just that adhering to it shouldn’t require you to suspend all emotions to abide by it – emotional pain can be a significant cause of plan failure). The one thread that ties all of the above together is that each requires an advisor to make decisions only after going through a process and that none of the above immediately discusses an outcome.

Some examples of types of advice that violate the above principles: A prospective client goes to an advisor with a specific amount of money to invest and without knowing the clients goals, the timeframe, their ability (both emotionally and financially) to take on risk, the advisor recommends an investment product. Any advice that starts with a market prognostication – I think the market will go up or down a lot and if that happens, XYZ investment will do well (not robust). Any advice that starts and ends with the advisor asking the client to ‘just trust me’ (not understanding the advice you’re being given won’t mitigate the consequences if things go wrong). Any advice that requires you to endure an undue amount of emotional discomfort because ‘it’s good for you.’ Just because investing in stocks over very long periods of time has tended to result in higher returns doesn’t mean it will always do so or that it’s right for you – if you can’t sleep at night because you lost 1% today, take a different route.

There are many reasons that clients go wrong in their pursuit of good advice. Some of that involves the knowledge gap that exists between advisors and clients, allowing clients to be taken advantage of. Some of it comes from investors’ willingness to believe that silver bullets exist and that they can meet their personal goals with very little risk while simultaneously sacrificing nothing to achieve said goals – those situations don’t generally exist in reality, so if you find yourself staring down that gun barrel, move. Some of it is because investors can assume that a good outcome automatically justifies the decision-making process.

The difference between process driven decision-making and outcome driven in the world of financial planning, which often involves investing, is one of the things that makes our job unique. Imagine you or someone you know challenging Lebron James to a game of one on one. There is just north of a zero percent chance, unless you happen to know a professional basketball All-Star, that that person can beat him in basketball. Now imagine that same scenario in the investing world – imagine Warren Buffett and you in a stock picking contest – you each get to pick one stock and hold it for one year. Guess what? You have about a coins flip chance of winning that contest. Guess what else? If you win, it wouldn’t be because you know more than Warren Buffett about investing. The ability, especially during long market upswings, of uninformed investors to make money is one of the things that separates investing from so many other disciplines. I’ll give you an example, in Enron’s 2000 annual report, they showed their company’s stock returns for the previous one, five and ten years.[1] Over those timeframes, they outperformed the S&P 500 by 98%, 221%, and 1032%, respectively. Someone who ignored a financial advisor’s advice to invest in a diversified portfolio, some of which possibly mirrored the S&P 500 over that time period, could have been forgiven for thinking that they were a genius and their advisor was an idiot – until they weren’t. On December 2, 2001, Enron was no more.[2] You see, the end result in investing doesn’t always confirm the process and good outcomes don’t imply that better ones don’t exist. Taking on more risk and ending with a portfolio that has a larger number at year end implies that you took on more risk more than it confirms portfolio construction ability. A good advisor can tell you the difference.

I’ll give you another example outside of just investing. For the last several years, some significant complexities have been introduced into the world of health care via the Affordable Care Act (ACA – nicknamed Obamacare). One of those complexities is that, for families that don’t have access to healthcare via their employer, they can get access via ‘the Marketplace’ and also, if they have income below certain thresholds, they can qualify for federal subsidies to help pay premiums. The top income level to qualify for a subsidy each year is 400% of the Federal poverty level (based on family size). Using Nebraska as an example, let’s take a retired couple, each 64, so prior to Medicare eligibility and look at two very different scenarios. In the first scenario, the couple decides to do some internet research and runs a retirement calculator that says that they can safely withdraw $70,000 a year from their IRAs. In the second scenario, the couple goes to an advisor who confirms a similar amount, but says, ‘hey, if you take $70,000 from your IRAs and have no other income or deductions from that, your Modified Adjusted Gross Income (MAGI), will exceed the 400% FPL put in place by the ACA, and you will qualify for $0 in premium subsidies. If, on the other hand, you withdraw $64,960, you will qualify for $2706 PER MONTH in premium subsidies’.[3] That type of mistake is the difference between having health insurance that costs somewhere between $27,360 and $38,724 a year and insurance that costs $0-$6252. It’s one of the odd quirks of the law that going just one dollar above that threshold costs you the ENTIRE subsidy and it can also be the cost of trying to save by not paying for advice.[4][5]

The point of all of this is simple – in the world of financial advice, the outcome does not necessarily justify the process and not paying for advice doesn’t necessarily save you money. It’s one of my pet peeves in looking at commonly cited statistics that say, if you pay an advisor ‘X’ it will cost you ‘X’ over the course of your investing lifetime. This would be true only if you assume that you know exactly as much as your advisor and that, without their help, you would have done the exact same things that you did with their help – at best a silly assumption and for those of you capable of that, you probably shouldn’t be paying for advice. For the rest of you, consider that paying for financial advice could improve your financial outcomes and in a lot of cases, could end up being a net positive over the course of your lifetime.

Lastly, how can you pay for advice? There are myriad ways, including commissions (which we’ll exclude for this argument since commissions are often associated with product sales more than advice), hourly fees, retainers, one-time planning fees (flat), and advisory fees charged as a percentage of assets. In my opinion, each of the above could be considered a legitimate way to charge for advice depending on the circumstances, I would just ask that you do a quick thought experiment to consider which makes the most sense for you. If you pay one-time or hourly fees, what is the likelihood that you will continually seek out advice prior to coming across a difficult financial situation? If the answer is ‘high’ then I think that seems perfectly fine. If it’s not, think about engaging with your advisor in such a way that you have an ongoing relationship with them, even if only to help ensure that you remain on track to pursue your goals. Doing so can help prevent the types of mistakes we outlined above.

Good luck in your pursuit of good advice.

This information is provided for educational purposes only, is believed to be accurate, is not intended to provide specific legal, tax or other professional advice and should not be applied or relied upon in any particular situation without the advice of your tax, legal and/or financial services professional. The concepts presented may not be suitable for every situation. Standard & Poor's 500® Index (S&P 500®) is comprised of 500 stocks representing major U.S. industrial sector. It is an unmanaged index and cannot be directly invested into. Past performance is no guarantee of future results.

[1] http://picker.uchicago.edu/Enron/EnronAnnualReport2000.pdf

[2] http://www.economist.com/node/895651

[3] https://www.healthsherpa.com/find-plans/eligibility?zip_code=68510&fip_code=31109&people=[64ma,64mb]&size=2&income=64960&year=2018&cs=premium&page=1

[4] https://thefinancebuff.com/federal-poverty-levels-for-obamacare.html

[5] https://www.valuepenguin.com/understanding-aca-subsidies