How important is professional money management to the financial health of your investment portfolio? Can you “go it alone”? Let’s consider: It is now thought quite normal behavior for investors to seek out professional financial guidance in setting up an initial or evolving investment portfolio, and even to defer most buy and sell decisions for the portfolio on a continuing basis to such professionals. The main reason, of course, is that the “professional” is believed to have more or less greater knowledge and competance in the area of stock and bond investment than the average investor. Many investors perceive this personal financial responsibility to be so important to the future security of themselves and their families, that it simply must be handled by a professional money manager, or financial adviser.
Is this perception of professional financial competance generally correct? And is it wise to “farm out” such an important part of an investor’s life to some individual, in many cases not even known personally, simply because he or she holds him or herself out to be a ‘professional’? Let’s put aside for now the question of differences in competance between so-called professional financial advisors or money managers. So again, as a general proposition, is it unwise for the individual investor to even attempt to handle his own investments?
Most investors are intimidated, at least to some extent, by the financial (especially stock) markets. Even if followed on a regular basis, to most investors, the stock market represents the frightful possibility of loss, as well as the potential for gain. There is almost no educational input even through the college level, unless this subject is majored in, within a financial or economics curriculum. Even within those academic categories, almost no information or experience is received or given concerning how the stock market really works. As a practical matter, on the job training in some closely related field, or many years of individual study and investment experience are the only ways most investors learn to become successful.
I’ve talked to a surprising number of business and finance graduates who, unless they are, or have worked on Wall Street, or in some investment capacity, still don’t really have a clue or any significant level of confidence as to how to consistently make money (or not lose it) in stocks. While majoring in these categories in college and post-graduate school certainly helps build a base of knowledge to draw on, there is always a ‘learning curve’ required, unfortunately, many times at the expense of brokers’ clients. This learning curve risk for investors does not even include the risk or potential for investment manager fraud, although infrequent. Both of these risks are minimized within an index fund.
So the answer to the question, “Can the average beginning or prospective investor learn how to confidently handle his own investments”, I believe is YES! It used to be true, before the existence of index funds, that an investor not only had to accurately value a prospective stock purchase, but also needed to understand and accept the normal volatility and cycles of the stock market, many times based on market “psychology”. This psychological component, to many investors, was the most difficult part of successful investing.
Index funds have made things much easier. Individual stocks need not be researched to decide whether or not to invest. A basket of individual stocks combined, sold together and maintained in an index fund, at a very low cost, has changed the game significantly. More investors are now aware of the greater ease of maintaining an asset allocation, and rebalancing periodically. While not sufficiently profitable, in my opinion, this strategy can put the portfolio on an automatic pilot basis, and even eliminate the need for a financial advisor beyond, perhaps an initial ‘run by’.
Index funds have been shown to outperform managed mutual funds on a consistent basis. Over 95% of mutual fund managed by a ‘professional’ money manager lag the returns of index funds on a longer term basis, such as ten years or more. These index funds need no consistent oversight since there is very little turnover. For this reason, costs are significantly less than managed mutual funds.
If individual stocks, on the other hand, make up a significant portion of an investor’s portfolio, and they are routinely chosen or recommended by a financial advisor or manager working on his own or for a full service brokerage firm, the investor will usually end up “paying through the nose”. This is one of the main reasons investors should strongly consider becoming an ‘indexer’. The other big reason, aside from low cost, is lower risk, as mentioned above.
If index funds are used as the only investment vehicle, for both stocks and bonds, as in the Strategic Stock Accumulation Strategy laid out in my book, professional money managers are usually not necessary, except possibly for an initial consultation, to discuss the advisability of such a strategy (take the advice with a large grain of salt though, if adoption of this strategy by the investor threatens the advisor’s monetary self-interest).
If, on the other hand, the investor is simply not interested in learning the ‘basics’ of stock market investing, or being involved to any significant degree in the management of his or her portfolio, then ok, hire an investment manager to handle all activity within the portfolio. Just be aware of the risks involved with going down this road. I would be very wary of hiring an individual, working on his own, to manage a portfolio. How can you really be sure of the manager’s competance, even after an apparently successful financial management history of a number of years.
Many sophisticated investors were totally convinced Bernie Madoff was the greatest thing since sliced bread. Most of his investors were too impressed or intimidated by him to ask questions and demand answers until it was too late. Many lost their life savings as a result of his decades long Ponzi scheme.
If you do hire an individual financial manager because you don’t want to personally get involved with the management of your portfolio, then you MUST get involved with the management of your manager. If you aren’t willing to do this, then Good Luck! There’s a very good chance you’ll need it. There is just too much temptation for many brokers to over trade (churn) the account. You must demand accurate monthly statements and have a trusted accountant examine EACH of them closely, if you choose to disengage from the buy/sell activity within your portfolio.
It is so much less risky for such a disinterested investor to simply invest in one of the so-called “Target Index Funds”, based upon his or her age. They are structured so that the portfolio has more stock index fund dollars and fewer bond index fund and cash dollars invested for a younger individual. The stock component decreases and the bond-cash component increases as the investor ages. The portfolio is regularly rebalanced. This is all on automatic pilot, and does serve to reduce risk.
These Target Funds are a no brainer, and probably represent an investment vehicle as low risk as possible and yet still allows the investor to have exposure to the stock market. Many discount brokerage firms offer these target funds based on age. This strategy, however, doesn’t have a long track record, but the long term profitability potential, is probably still much better than a bond/cash only portfolio, and the best for someone not willing to get involved at all.
The Strategic Stock Accumulation Strategy is very profitable over a lifetime, as shown with the research I personally conducted and described in my book, “How to Make a Fortune during Future Stock Market Crashes with Strategic Stock Accumulation”. The strategy does require time involvement of the investor, although it is limited in most cases to end of the year buying and selling. A summary of the SSA strategy is offered in a previous post on this blog.
As I point out in my book describing the Strategic Stock Accumulation Strategy (SSA), it is very dangerous to be financially illiterate, especially if an investor willingly turns his life savings over to an individual he barely knows. I don’t care what he says his performance record is. It is much safer for such an investor to “invest it and forget it” in target index funds within a large discount brokerage firm.