6 Times an Investment Advisor Isn’t a Waste of Money

Last week I talked about how easy it is to invest in a way that’s likely to outperform just about everyone else, including the professionals.

The tools available to you these days are so good, no matter how much money you have to invest, that it doesn’t make sense to pay a professional for help if all they’re going to do is watch your portfolio and rebalance it every now and then. You can get that exact same service from a computer for a fraction of the cost.

But that doesn’t mean you have to do it completely on your own. There are good reasons to pay for investment advice, and even some potential reasons to have someone manage your investments for you.

The key is understanding what’s worth paying for and what isn’t.

What ISN’T worth paying for

The numbers don’t lie: no matter how convincing their argument is, the odds of any investment professional outperforming the market over any extended period of time are almost non-existent.

It’s counterintuitive, but it’s true. Unless you’re investing with Warren Buffett, you just aren’t going to find someone who can produce better investment returns than you’d get from using simple, low-cost index funds.

So thing #1 you shouldn’t pay for is an investment professional who claims that he or she will beat the market. You’ll almost certainly get worse returns and pay a hefty price for the privilege.

Thing #2 you shouldn’t pay for is a professional who simply buys index funds, holds onto them, and rebalances for you every once in a while.

That’s not to say that someone who does that can’t be valuable (they absolutely can). It’s just that they need to do more than that in order to be truly valuable, because there are plenty of ways for you to do that on your own with minimal effort.

So, what is worth paying for?

Here are 6 good reasons to pay for professional investment advice

1. Creating the initial plan

While it’s easier than ever to access top-notch investment portfolios, creating your overall investment plan can still be overwhelming. There are so many different options available that it can be hard to even know what questions to ask, let alone where to start.

And that’s the first place a good investment advisor can be really helpful.

A good advisor will listen to your goals, learn about your current financial situation, and help you create a plan that lays out exactly:

1. How much to save
2. Which accounts to use
3. Which investments to choose in each account

That’s the foundation of a good investment plan, and with that in hand you can use some of the tools we talked about last week to put it in place.

This kind of relationship is great because you can pay a one-time fee for the advice and reap the benefits for years to come.

It’s a limited cost for a lifetime of value.

2. Behavioral coaching

A few years ago Vanguard released a report that quantified the value-add of a good advisor in terms of increased annual investment return. You can read the report here.

According to them, by far the most valuable service an investment advisor can provide is behavioral coaching. As they write:

Because investing evokes emotion, advisors need to help their clients maintain a long-term perspective and a disciplined approach…. Most investors are aware of these time-tested principles, but the hard part of investing is sticking to them in the best and worst of times…. Abandoning a planned investment strategy can be costly, and research has shown that some of the most significant derailers are behavioral: the allure of market-timing and the temptation to chase performance.

In other words, the best investors are the ones who stick to their plan through the highs and the lows. They avoid getting over-aggressive when the market is high, and they avoid selling out when the market is low.

And even when we have the best intentions, we’re not always good at maintaining a long-term view when everyone around us is freaking out. But a good investment advisor can lay the groundwork for consistency at the beginning of your relationship AND coach you through the turbulent times to help you stick to your plan.

According to Vanguard, that kind of coaching can increase your investment returns by up to 1.5% annually, which means it may be worth paying for all on it’s own.

3. Tax optimization

If all of your money is in tax-advantaged accounts like 401(k)s, IRAs, and health savings accounts, then this one isn’t relevant to you.

But if you have a significant amount of money in taxable investment accounts, there’s potentially a lot to gain from putting the right investments in the right accounts in order to minimize your tax cost and therefore maximize your gains.

For example, stocks are generally tax-efficient because for the most part you don’t recognize gains until you sell, and even then they’re usually taxed at a lower rate. Which means that you can defer gains for years at a time, even in a taxable account. (They do pay dividends each year, which are taxed, but even those are generally subject to lower tax rates.)

On the other hand, bonds pay out most of their gains as interest each year that’s taxed as ordinary income, which in general makes them tax-inefficient.

So as a general rule of thumb, you would prefer to fill up your taxable investment account with stocks and leave your bonds for your tax-advantaged accounts.

Now, that’s an oversimplified way of looking at it, but a good investment advisor will understand which accounts are available to you, what your tax situation is, and how to place the right investments in the right accounts in order to minimize your tax bill.

According to Vanguard, that expertise can add as much as 0.75% annually to your investment returns, but again that depends a lot on the specifics of your situation.

4. Special interest investing

Some people like to invest for more than money. For example, there’s a big trend towards socially responsible investing, which essentially means that you incorporate your personal values into your investment plan.

As an example, if you’re a proponent of sustainable energy, you may choose to exclusively invest in companies that you believe are pushing sustainable energy forward. Or you may simply decide NOT to invest in oil and gas companies.

Whatever it is, if you want to take something other than a market-based approach to investing, you may benefit from working with a professional who has similar values and can devote all of his or her time to finding the best investment opportunities in your chosen space.

On the flip side, this is also an area that’s ripe for deception. It’s very easy for someone to say that they specialize in a certain type of investing without really having any relevant experience or expertise.

So if you want to go this route, ask a lot of questions and make sure any professional you work with is both truly an expert and has your best interests in mind.

5. Withdrawal strategies in retirement

One of the trickiest parts of investing is knowing how to spend all the money you’ve accumulated once you retire.

This isn’t something I specialize in, so I actually have a lot to learn here myself. But basically this has to do with taking the right amount of money out of the right accounts at the right times, based on both your personal needs and market conditions.

The more accounts you have, and especially if you have multiple accounts that tax withdrawals differently, the trickier this gets. According to Vanguard, good advice on this front can increase your returns by up to 0.70% annually.

6. You know you won’t do it on your own

The surest path to investment success is simply making sure that you do it.

For the first 10 years or so, it’s your savings rate that matters more than anything else. As long as you’re saving the right amount of money, the actual investment strategy doesn’t matter all that much.

Then, once you’ve accumulated a decent amount of savings, the strategy itself becomes much more important. Because at that point the returns you earn, good or bad, will add up to a significant amount and you want to make sure you’re doing it right.

Both of those things can be done on your own. You can certainly save on your own, and as we learned last week you can also manage your investments with ease.

BUT being able to do it and actually doing it are two very different things.

If you know that you won’t stay on top of this stuff on your own, it may be worth paying someone to do it for you. It will cost more than the DIY route, but it will be a lot more effective than not doing it at all.

Know what you’re paying for

The main point here is that you shouldn’t assume that it’s worth paying an investment professional. There are many cases where the cost will outweigh the benefits, especially when compared to the fantastic investment tools you have access to these days.

But there are situations in which getting professional advice is worthwhile, IF you know exactly what you’re paying for and what you’re getting.

Oh, and as for finding an investment advisor who both has the expertise and has your best interests in mind, I would start here: How to Find the Right Financial Planner for YOU.

So what about you? Have you worked with an advisor or are you going the DIY route? What’s your reasoning?