The information systems that have become fully integrated in our lives have changed the nature of business.
The ability that people have to do their own research about the best product for their needs, how to implement it, and where to find it at the lowest cost has created a new type of business; the idea of cost-cutting discount stores has taken off. These establishments cut their operating costs to a bare minimum so that they are able to pass the savings on to the customer. This idea works well for commodities, and companies like Walmart have been able to position themselves in such a way that they actually add value by making consumers feel satisfied that they have made their purchase at the lowest possible price. The cost cutting business model does, however, come with an indirect price; stores like Walmart and Costco are not full of eager employees waiting to help you. The lack of service isn't a huge issue when it is commodities being purchased, but what if the goods become more specialized? I know that the last time I went to buy a TV it took me thirty minutes to find an associate to help me, and when I had someone to help me they did not have the information that I needed to make an informed decision. This lack of service and expertise is not the fault of poor management, it's the fault of the consumer. The price elasticity of demand forces brick and mortar retailers to reduce their fixed costs to try and compete on price with online stores. This combined with the wide availability of information tends to make people think that they can become experts and do not need to seek out the recommendation of a professional.
The same phenomena can be observed in the financial services industry. There is a vast quantity of information available to people about the financial markets, financial planning, and the different financial products that are available to consumers, and with the development of discount brokerages, it is possible for someone to spend the necessary time doing research to put themselves in a position to successfully plan for their financial future while minimizing costs. So if the information is available, and people are able to make their own investment decisions, why do financial advisors and financial planners exist? They wouldn't exist if they weren't able to provide a service that people see as valuable, but where is the value?
*An important note before I discuss the value that these professionals provide is that not all of them do in fact provide value. It is the nature of compensation in the business that makes this possible. In my previous posting I discussed the difference between an advisor and a salesman. With the impending fee disclosure that will be implemented in the next few years, the clients of salesmen will start to wonder what exactly they are paying for when they see the fees on their statements; these clients will start migrating away from salesmen and toward advisors.
Whether an advisor is fee based or commission (trailer fee) based, they will usually charge between .5 and 1% of assets as a management fee, so what should you be expecting in return?
- A Plan - The single most valuable service that a financial advisor can provide to their client is the development of a financial plan. The clarity that can be gained from understanding how much needs to be saved in order to retire with a certain level of income is unparalleled. A comprehensive financial plan will also address the insurance needs necessary to maintain the integrity of the plan in unexpected circumstances, and government benefits that the clients expects to receive as they age. If the plan was something that could be put in place and forgotten about it would make a lot more sense to pay an upfront fee, but this is not the case. Market returns and changing life circumstances can have an impact on the way that the plan is carried out.
- Systematic Review - Administering a financial plan is something that requires knowledge, experience, and confidence. When the financial markets had a downturn in 2008 the decision to stay invested was a difficult one, and how to proceed in the market in the coming years was equally difficult. It is the responsibility of the advisor to restructure the plan to show what needs to happen to stay the course, and to provide the confident advice that will allow the client to have peace of mind. A minimum annual review should be expected, and more frequent reviews should be available if life circumstances change.
- Expertise and Knowledge - When you are making the decision not to take your finances into your own hands, but to pay someone to advise you, it is an obvious expectation that the person you are paying should be educated in the field of finance. The intricacies of financial planning should be fully understood by the advisor to ensure that your trust is being put in the right place. Finding the right advisor with the right skill-set and knowledge base is a challenge in itself, but I will address my thoughts on that in another post.
When people ask me why they need a financial advisor, my answer is that they don't. Having a financial advisor is a choice. It is a choice to hire a professional to manage your finances and spend the time to plan your financial future with you. This is a service that you should expect to pay for. I would never tell someone that they need to have a dentist either, but it makes more sense to me to have my annual cleaning and maintain the health of my teeth than to wait until an emergency arises to seek out help.
When it comes to managing your money, if you can do it on your own that's great. If you have your own life, career, and family to deal with, working with a professional can be the best option.