Being Your Own Advisor
Warren Buffett has said that risk is what happens when you don’t know what you are doing. That applies to anything you might do; from investing, to trimming the hedge, to driving a personal watercraft. Strangely everyone nods knowingly, but few say, “What do I not know that I should?”
There is a lengthy list of risks. Many advisors carry out the minimizing steps subliminally. That is one of the reasons that many people think that advisors are worth less than they are paid.
Here is an incomplete list of potential problems.
- All your wealth will be consumed, given to others, or lost. Some losses are avoidable, but only those that you know exist.
- Efficient purchases are not possible without understanding the inventory of methods and products.
- Time is a dominant factor in planning. Many years ago, I dealt with people whose native language had only a rudimentary future tense. The meaning of net present value (NPV) of future cash flows eluded them. If I were to ask prospective clients to explain NPV as a condition of joining the client list, I would get few new clients. NPV is a fundamental decision tool. Learn how it works.
- Investment risk in the classic sense, is a function of two things. Variability and time. Highly variable securities are said to be risky because they are unpredictable at a particular future time. If there is no particular point in time you care about, the rules are different. Similarly, does it matter how much your home is worth on any day you intend to stay there?
- The intrinsic value of a security and the amount it will sell for on a given day are not closely related. The market price is the consensus opinion of the people buying and selling that day. That price reflects need, boredom, and emotions like fear and greed. Objectivity, day-to-day does not exist.
- Diversity might reduce your volatility but it does not necessarily make you more money. Learn to judge how market volatility affects you specifically.
- Most people misjudge existential risk like death or disability. Over a career, they are much more probable than most people realize. Our mind tends to overlook high probabilities unless they are near certain. Learn how intuitive thinking can harm you.
- Most people are unaware of the diversity, complexity and size of the market for products. How many different life insurance products could you buy? Thousands. Which of them would meet your needs well enough that paying the premium is an acceptable move?
- Portfolio design is a difficult subject or it is easy. Using ETFs is easy and cheap but you are really just choosing a particular management format. Is it the right one for you? Then there is rebalancing and it’s tax effects.
- Taxes matter. If you cannot do your own tax return or do not know how to manage what appears there, you have little hope of finding a tax-efficient portfolio.
- You are human and that makes you into your own worst enemy. Objectivity is elusive when you are doing it yourself. Memory and emotion are undesirable factors.
Financial planning has three parts.
- The client typically must supply the vision.
- The advisor must check the vision for completeness and discover conflicts. When the vision is agreed upon and priorities established, the advisor supplies methods to achieve it.
- The client and the advisor decide which to implement, when, and why as described by some strategic priority list. From there, an ongoing review and revise process because things change.
There will soon be many new do-it-yourselfers because regulations in nearly every jurisdiction will make it so advisors are fussier about who they deal with. Up until now, advisors have shielded many clients from obvious risks. Once those people follow the media message and decide that investing and planning are idiot-proof, they may come to believe that they can carry out the program cheaper and without assistance. Some, but not all, will be able to do so.
If you want to do it yourself, be sure you know the entire contents of both the client and the advisor task lists. You must do both. Knowing that is a key part of financial literacy.
Remember, usually cheap turns out expensive.
Don Shaughnessy is a retired partner in an international public accounting firm and is now with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.