I want to emphasize that “some” investors using an advisor could probably be DIY investors, not all.
What Are You Paying For?
Many investors in Canada use mutual funds for the bulk of their portfolios. For the most part, mutual funds have three main components of cost which are collectively known as the Management Expense Ratio, or MER. There are actually some additional cost considerations over and above the MER (such as trading costs inside the mutual fund itself), but that is a discussion for another time. Right now we will look at the MER which is made up of:
- The investment management fee
- The advisor service fee
- Administrative expenses
The Investment Management Fee
The investment management fee is what the mutual fund company charges for its service of managing the investments of a particular portfolio or fund. A passive investment style would command a lower management fee than an active investment style. Perhaps an average investment management fee would be in the 1.00% range for an actively managed fund.
The Advisor Service Fee
The advisor service fee covers the compensation of the financial advisor through which you purchase your mutual funds. This fee is charged regardless of the actual service you receive. One advisor might provide a written Investment Policy Statement and full financial plan with quarterly phone calls and annual meetings and another may only call once a year to make sure you are still alive. The average advisor service fee might be about 1.00%.
Administrative expenses cover the fund’s accounting bills, legal bills, GST/HST etc. These are usually in the 0.25% to 0.30% range as an average.
Adding It All Up
So from the above three areas, a run of the mill mutual fund might have an MER of 2.25%: 1.00% for the fund management, 1.00% for the financial advisor and 0.25% for the administrative expenses of running a mutual fund.
When It Might Make Sense For An Investor To Do It Themselves
Some people spend more time researching markets and strategies than some advisors. They may have a real interest in following the business news or reading investing books. This represents a minority of investors, but for this group they may be better off handling their own investments and bypassing the 1.00% advisor service fee, especially if they are receiving little to no service. They could implement a Couch Potato Portfolio (which is low maintenance and very low cost) or they may employ more sophisticated strategies. For investors who are interested but are receiving good service, this is a different story – other factors need to be weighed. A competent financial advisor might identify risks in your financial situation that you aren’t aware you are exposed to. They may also serve to keep you sticking to your original investment strategy – whereas some DIY investors can change strategies (and usually at the wrong times).
Often times, the arguments come down to fees. But it is obvious that an investor using an advisor with total costs of 2.25% per year *could* end up further ahead, and more protected, than someone who chooses to do it themselves with an average cost of 0.35%. Not all DIY investors stay the course (neither do all financial advisors, it should be said). Not all DIY investors adequately protect themselves and their families. And not all investors would even care to handle their own finances.
So, as is often the case, we need to determine the value received for the costs incurred. A confounding variable is the tendency to think one knows more than they actually do, or to be over-confident.
What Does It Take To Be A Successful DIY Investor
There’s no way around it – you have to dedicate some time on a regular basis to keep on top of what is happening. A couch potato portfolio may only need a few minutes per year after acquiring enough knowledge to start their portfolio, but the initial knowledge needed takes far more than a few minutes. If you’re convinced that a couch potato portfolio is for you after reading about it for the first time for 15 minutes – you probably aren’t as ready as you think. It’s a compelling story, but if it only took you 15 minutes to convince you – it might only take 30 minutes, 5 years later, for another strategy to sound equally compelling. The magic of a couch potato portfolio is only yielded after decades – are you certain you can stick to it? Many people found out that they couldn’t in 2008, as an example.
If you choose to manager your own portfolio actively, then this obviously takes a bit more ongoing time. Chances are you enjoy it, but again – do you have the discipline? If you’ve ever been suckered into an investing workshop which sells software to help you trade the markets and advertises with testimonials of people who quit their jobs to make big money in only a few weeks, I can pretty much guarantee you shouldn’t be doing it yourself. You just don’t have the common sense required. (Who would sell the secret to making big money? If everyone could just buy this information, eventually everyone would be employing the information and that would eventually negate its value. Prices would adjust to reflect this information.)
In both cases (DIY investing passively or actively), a lot of people are overconfident in estimating their vigilance. Vigilance is partly knowledge (which can be learned) and partly psychology (which is often the culprit in financial underperformance – both rate-of-return wise and from a general financial planning perspective.)
How good are you at assessing yourself? THAT is a fundamental question.