How To Be Smarter Than Your Financial Advisor

By Stephen D. Simpson, CFA | September 26, 2011 AAA
How To Be Smarter Than Your Financial Advisor



Any way you slice it, there is big money in running money - there are trillions of dollars out there in pension funds, mutual funds and individual investor accounts. The financial services industry is a multi-billion dollar enterprise predicated on helping people do what they cannot (or do not wish to) do for themselves.

The question is how much of this is really necessary. Are you better off paying a professional to run or advise you how to run your money, or can you go it alone? Said more bluntly, are you smarter than your financial advisor. If not, can you learn to be?

TUTORIAL: Estate Planning: Introduction

The Case for Professional Management
To start with, it is important to note that there are a lot of diligent professionals out there; people who not only work hard to deliver the best results and service possible, but also work to improve their education and knowledge bases. It is also important to realize that good tools can be just as important as innate (or acquired) genius. Many financial services firms give their brokers and advisors access to powerful databases and financial planning tools that can help predict future needs and recommend optimal savings and investment strategies for given risk tolerances. (Learn how to weed out those who are just out to make a quick buck. For more, see Find The Right Financial Advisor.)

The Problem
That said, the biggest problem with the financial services industry is that financial advisors are salesmen first and foremost and they are paid accordingly. Though some firms may require a college degree in business or economics, many do not. Likewise, some firms encourage continuing education and the pursuit of certifications like Certified Financial Planner, but again many do not. (For related reading, see CPA, CFA Or CFP- Pick Your Abbreviation Carefully.)

In many cases, firms hire potential brokers and advisors literally off the street, give them a little training (including help in passing the securities licensing exams), and then set them loose in a probationary period. Those that prove that they can gather assets and/or generate commissions get to stay and those that do not are often shown the door. So long as these advisors do not blow up clients (or cause assets to walk out the door), nobody pays all that much attention to portfolio performance, nor does anyone really care if a top producer cuts out a little early for golf instead of staying at the desk to read a 10-K.

It's also important to understand that in many cases you are not paying for especially individual advice nor the advisor's individual talents. Many financial services firms actively discourage advisors from thinking like portfolio managers and instead provide approved lists and recommended strategies to apply to customer accounts. Likewise, critical decisions like asset allocation often come about as the result of entering data into a computer and allowing someone else's algorithm to tell the broker/advisor what to do.

What Can You Do?
If you want to surpass your advisor in knowledge and ability, the most important thing to do is read, read more and then read more after that. There is no end in the learning process for an investor, and likewise no end to what can be learned. Those who are new to investing can go with trusted standbys by the likes of Peter Lynch, while more advanced investors can always find a previously unread book with new information on accounting, emerging markets or business strategy. (For more on emerging markets, see What Is An Emerging Market Economy?)

Likewise, there is no shortage of reading material when it comes to learning about markets, companies and industries. An investor can learn a lot about a company simply from freely-available 10-Ks and annual reports, and most public libraries subscribe to major daily, weekly and monthly business publications, as well as providers of detailed investment information.

Remember, the majority of advisors were, or are, just like you - they didn't graduate from Ivy League schools, they don't live to read balance sheets and they don't dream of complicated differential equations. In many cases, they've just had a little more training - often, just the study materials provided when they were hired and maybe some follow-up continuing education material. They are regular people, and if individual investors hit the books while they hit the golf course or squash court, it doesn't take long to catch up.

Going a step further, some may wish to try to imitate some of the training of Wall Street professionals. Although people outside of the financial services industry cannot become a Chartered Financial Analyst (due to the industry experience requirement), there is plenty to be learned from the study materials and sample tests that are available here at Investopedia. (For related reading, see An Introduction To The CFA Designation.)

Practice is also an under-appreciated part of building up investment knowledge. There's plenty of scorn out there for mock portfolios and trading simulations, but the reality is that even many very successful investors will test new methodologies before committing real funds to them. Set up a mock portfolio, try a new strategy and you may learn a little more about what does (or does not) work in the market.

Prospective do-it-yourself investors should also realize that experience plays an invaluable role. There is no book or model portfolio that prepares you for your first bad stock pick, nor your first broad-based market crash. With experience comes a little perspective and an ability to tamp down the fear that naturally arises when the markets go haywire. Unfortunately, there's no easy "how to" here - experience comes from actively trying.

TUTORIAL: Financial Careers

The Bottom Line
Many people find investing to be a mystery, a chore or a fright house (or some combination of the three), and simply do not want to take on the responsibility of managing their money. There's nothing wrong with that. If people want to take a more passive role with their money, that is their right. By the same token, though, many people are not only able to match the abilities of their advisors and take more responsibility for their money, they should do so. Here too there is a middle case - even for those investors who do not want to put forth all of the effort to become their own financial advisor, a little incremental education and knowledge-building could help find better advisors, get more out of them and make the most of their investment portfolio. (For related reading, see Do You Need A Financial Advisor?)

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