How to Lower Your Investment Returns: Use a Broker

Ha! I know I'll get comments from the title of this post alone. ;-)

But, you know, the same story keeps coming up over and over again: "financial advisors" (or brokers in this case) are really, really good at one thing -- taking your money and making it their money. Want some examples? See these past posts from Free Money Finance:

• Many Taxpayers Get Burned by Inept or Crooked Preparers

• Bad Advice from a "Financial Planner"

• The Richest Man in Babylon: Get Advice from Someone Who Knows What He's Talking About

• Make Sure Your Financial Advisor is Not a Loser

Well, here's another piece of fuel to throw on the fire. This one comes from Money magazine and notes that brokers are no better at selecting investments than average investors. The details:

Left to their own devices, investors are prone to engage in all kinds of bad behavior, like chasing whatever fund is hot at the moment. A good adviser will head all that off and keep you on your long-term plan.

And indeed, if your adviser lives up to that ideal, he deserves a good payday. Unfortunately, according to a recent study of cash flows into and out of mutual funds, the pros are just as susceptible to classic errors as the rest of us.

Oh yeah. Is this really a shock to anyone?

The article goes on to list three trick questions you should ask your broker to see if you should keep him or dump him.

The piece also features a sidebar that contains facts on brokers including:

• 1.38 percentage points - Average amount by which broker-sold bond funds trailed funds that investors chose each year.

• $8.8 billion- Estimated annual amount by which funds that people bought on their own out-performed broker-sold funds.

• $15.2 billion- Amount that investors shelled out in 2002 on loads and other fees.

I'm not a big fan of paying more and getting less for a service, and hence, I make my own investments. Primarily, I'm invested in index funds. Their low expenses make them great investments -- so much so that Wall Street analysts, investment pros, and people who manage billions of dollars like them.

Comments

[Duane Gran]

The article cites a paper (http://papers.ssrn.com/sol3/papers.cfm?abstract_id=616981) which analyzes the performance of brokers who sell mutual funds. Mutual funds are popular, but I wouldn't extrapolate too much about brokers over this isolated data point.

That said, if you build the same portfolio and transact it the same as you broker would, you will have more money. Personally, as I sit across the table from my broker I know that he and his team are smarter than me, so I have about zero odds of producing the same portfolio. The value proposition works and I know enough to confirm this.

How about a hybrid approach? There is nothing preventing someone from doing business with a broker while directing another investment account.

[Brad]

I have to agree regarding using a 'broker' alone. The entire financial plan is undermined utilizing a 'broker' alone. An advisor should be one that at least advises, but hopefully plans all aspects - even if the planner does not execute everything, it should be planned out and appropriate professionals (estate planning lawyers, CPAs, securities 'broker', insurance providers, etc.) need to be involved in the implementaion of a complete financial plan, if your advisor isn't licensed, or expert enough to do any or all the above.

I am all for people taking it upon themselves to do their own fianacial planning. However, many do not, or procrastinate at the very least - if they ever do anything -- EVER!

Many that do their own investing never consider further education and consequently understand about as much as they already did when they start. Often, they then make poor decisions (i.e. buying high and selling low) due to lack of discipline and knowledge.

Those that do their own work also need to develop the mental fortitude to learn about investing, know themselves, then develop the plan, and stick with that plan, rather than be led by any 'what's hot now' trend.

Poor performance in a relatively similar poor market is OK as long as what has been understood as goals and risk tolerance and then planned for is being done. Better performance will follow with better market performance. People must always keep in mind their journey and where they are along the way. If the end (i.e. retirement) is years away, stick with the plan that has been discussed and agreed upon. If the end is near (i.e. college funding) an appropriate investment plan will have taken that into account. The losses (and gains) will be less dramatic.

In the end, the individual is responsible. If they select a poor advisor, it is up to them to find another advisor that will get the job done. People have to be willing to dedicate more time to selecting an appropriate financial advisor than they do picking a sandwich for lunch at a restaurant, if they have neither the desire nor the willingness to proactively do it themselves, or are unable to mentally deal with day to day market noise - they wind up hurting themselves financially (by making reactionary poor decisions and suffer permanant financial damage).

Thank you for posting. I am a new reader to this blog and I appreciate what you have here.