Do You Need A Financial Advisor or Can You Do It Alone?

Examining where you are financially and putting together a Financial Preparedness plan requires a bit of time and effort. Inevitably, the question pops up as to whether to do this on your own or to work with a financial advisor.

The short answer is yes, either way. The long answer is if you choose to go it alone, make sure you have reliable sources of information.           

I’ve had the luxury of being an advisor and an individual investor.  What I’ve learned over the years is that there are pros and cons to working with an advisor or doing it on your own.  As I’ve said, every person needs to do what provides them with the most comfort.

The intent of this section is to provide you some insights to help you make the decision of how to proceed on pursuing your plan.  The reality is that most of the work will need to be done on your own anyway.  Gathering information, retrieving statements and thinking about your situation are all things that you will do.  You’ll also need to review your situation on a yearly basis.  These things shouldn’t be delegated to someone else.             

So let’s look at what you need to consider when deciding to choose or not to choose an outside resource to help you formulate a plan for your finances.

Some of the pros of working with a Financial Advisor are:

• A good one is priceless, and the cost will be easily made up in advice and convenience. They will spend the time to understand you and your financial needs and work toward your goals. A good advisor will be interested in you for the long term, not for short-term gain.  Remember that an advisor is running a business and a good one will understand that a long-term successful relationship with you will be mutually beneficial. 
• They’re on top of the latest trends and products. In light of the latest mortgage backed securities disaster, this can be a pro or a con but I’ll list it as a pro here.  It’s important that you understand that an advisor provides advice; you make the decisions. Therefore, choosing an advisor doesn’t mean that you neglect your need to stay educated about investing and the current markets.  Your knowledge of investments and finances should grow as you work with your advisor.  Believe me, the good advisors value an educated discussion with a client!
• They can save you time and worry. Retirement planning should be a major part of their job and a good advisor knows how to do it. For some of us, they save us the worry of whether or not we have the right information and are using it correctly. For many people this is a great source of comfort. Talking to a professional informs us and gives us the choices we need to make the right decisions.

Some of the cons of working with a Financial Advisor (FA) are:

• Cost. While not always true, when you consider the fees and expenses of investments and investment accounts, the cost of working with a financial advisor can be higher than going it alone. Always be sure to understand what all the fees and expenses are and how your advisor gets compensated. 
• Bad advice. Really, this can happen as easily online or on the golf course as with a professional. A good rule of thumb is always to step back and understand the risks and alternatives when someone makes recommendations or provides advice about what you should do with your finances.  That goes for family as well as advisors.  Always remember that you are in control.  It’s your money.  In the end, they’re your decisions.  Not someone else’s.
• Incentives. Financial advisors make their money by investing yours. Their incentive is to get your money working so they get paid. You should consider the type of investor that you are, but I believe that should be wary of commission only brokers. Instead consider flat fee or those that get paid on a small percentage basis. The thinking here is that they either have no incentive to “churn and burn” or have a direct incentive to make you more money because they get a small percentage of it.
• Selling you what you don’t need. See above. If the advisor has not talked to you about risk and clarified the type of investors you are before they make an investment recommendation, you need to walk away from that conversation.  Also, watch out for big insurance or package deals that you have trouble understanding. Chances are the Financial Advisor doesn’t understand them either but gets a big chunk for selling them, possibly up to 7%. Ask them how they get compensated for an investment.  They’ll even respect you more for asking.
• Good financial advisors retire too. Be sure that you’ve discussed your advisor’s “career plans” and any “succession plans” they may have for their business or when they decide to retire, you’ll be stuck with the task of finding another ace FA again.  

           The fact is you can do it either way. Some people feel better having someone help make their retirement plan for them, and others want to stay firmly in control. The rest of us lay somewhere in between and need to weigh the pros and cons of whether to hire someone to help us out or not.


How to pick a Financial Advisor?
If you choose to work with someone rather than going it alone, it leads to the question of how to pick a financial advisor, Certified Financial Planner™, or other financial professional. Like finding the right doctor or dentist, making the wrong choice could be damaging to your (financial) health. It’s best to proceed cautiously and ask a lot of questions before signing on with anyone.

• Referrals. This is often the best way to find any professional, whether it be your mechanic, your brain surgeon, or even your hair stylist. Ask your friends and family but don’t stop there. They may “like” the person just fine, but always do more due diligence on your own. This is your financial health, after all.  It’s YOUR advisor, not your friend’s!
• Interview several. Give yourself choices. Get second, third, and fourth opinions.  Let them know that you’re interviewing several other advisors to find the most appropriate one for you.
• Google them. One of the advantages of the internet is you can find out about people. Do it. You might be amazed at what you dig up. Check out their standing with the National Association of Securities Dealers (NASD). This is the regulatory body for stockbrokers and financial advisors.   
• Ask them how they get paid. The reputable advisors will be happy to answer this question and as I said, they’ll respect you as a client for doing so.  If they don’t answer you or you don’t like or understand their answer, move on to the next advisor interview. 
• How are they licensed? Can they sell mutual funds, stocks, bonds, insurance? Are they limited in any way?  It’s wise to work with an advisor who can provide you the most options as investments selected should be based on the needs of the client, not limited by what the advisor can or can’t offer.
• Consider the firm they work for. Big names like Merrill Lynch and Morgan Stanley can be high quality but they can be expensive. If the financial advisor you’re considering is working as an independent they still have a trading and product platform they work within. Ask them who the company is and then research it.  Google the firm and ensure that they are not only legitimate but don’t have any pending judgments against them.
• Ask them what their service level commitments and communication policies are. How often will they contact you? Do they conduct annual reviews? Quarterly reviews?  What happens when problems occur?  Who can you call and how quickly will they respond to your concerns?
• Do they have specific designations? Many FAs have letters after their names. Unfortunately, these “qualifications” often mean only that the firm they work for had set up an easy class so they could get these letters and impress clients. Major firms are especially notorious for this. Many reputable advisors have gained the Certified Financial Planner™ (CFP©) designation. The training to get this designation is intense and thorough. It indicates that the advisor has been through training that is focused on all aspects of financial planning including estate and retirement planning. A growing designation in the industry is that of the CFA (Chartered Financial Advisor).  This indicates that the advisor is extremely knowledgeable about investment selection and understanding the micro and macro factors impacting the markets.  Either of these designations should be view as a plus when considering advisors.

COMING SOON : SAFE 4 RETIREMENT : THE 4 KEYS TO A SAFE RETIREMENT

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What is 'The Four Percent Solution'?

In the book, 'A Safe Retirement : The 4 Keys to a Safe Retirement'  I discuss ways in which you can determine how much money you will need on an annual basis during retirement. However, it is also fundamental to look at this important question from the opposing end. How much money are you allowed to spend without running out before you reach the pearly gates?

Of equal interest is how much are you allowed to spend and not build up an enormous surplus that you’re not able to enjoy yourselves?

Much thought has gone into these questions and into finding the exact sweet spot of allowing the highest possible income with microscopic risk of outliving your money.

            Here I’ll cover one such formula that has become a recent topic of debate and interest among people looking for that “magic” rate of withdrawal.  In my research with retirees, over and over I hear how people are animate about not touching the principal that generates their retirement income.  Certainly, this should be a goal and is critical to you staying on track with your plan as we’ll soon discuss.

            But is there a way in which people can take income and still ensure that their principal will remain constant?  Certainly we can buy CDs or original issue bonds (and hold until maturity) for this to occur.  However, the reality is that this approach not only yields low rates on CDs and it’s very difficult to gain a bond at the exact value that you’ll be able to redeem it at without fluctuations in price over this time.  Plus for most of us, our investment portfolio will be the major source of retirement income and that portfolio should be made of various holdings and asset classes (stocks, bonds, mutual funds, etc.) 

            So the question becomes ‘how much should I withdraw from my portfolio to gain an income while ensuring protection of my principal?’: 7%?  5%?  This is an interesting question when you’re seeking a percentage rather than an amount.  Even with a large portfolio, if you look at percentages rather than amounts for your yearly income, a single percentage change can impact your ability to maintain your principal.

            So, what is the right number?

            Fortunately we have professors, analysts and economists who are much smarter than me who study this stuff.  I'll discuss one approach that is gaining interest and attention: the 4% solution.  This is an approach that says that withdrawing 4% from your investments will provide lifetime income and you’ll never outlive your assets. 

           

     The Trinity Study -

            In 1998 a group of finance professors at Trinity University in San Antonio, Texas published a paper studying the optimal percentage annual withdrawal from a retirement portfolio. They based their study on various portfolio asset allocation compositions between stocks and bonds. (I discuss asset allocation more in the following chapter, How to Maintain Your Retirement.) They considered the following portfolios where stocks are the S&P 500 and bonds are high-grade and from the United States:

•  100% stocks
•  100% bonds
• 25% stocks, 75% bonds
• 50% each of stocks and bonds
• 75% stocks, 25% bonds

The interesting part of the study was that in any of the asset mixes, a withdrawal rate of 4% protected 100% of your principal.  What is also interesting is that a conservative mix of 25% stick and 75% bonds would allow for protection of principal and the ability to withdraw 6% of your portfolio.

            Below is a link to a chart from the study showing the decline in the portfolios over thirty years.

(http://www.bogleheads.org/wiki/Safe_Withdrawal_Rates)

           

            However, to fully recognize the viability of this study in an individual’s portfolio as a driver of income, it’s necessary to consider and include inflation into the mix.  The more appropriate chart is provided below which takes into consideration yearly inflation and when this is included the 4% figure becomes even more pronounced.

Source: Sustainable Withdrawal Rates From Your Retirement Portfolio Philip L. Cooley,Carl M. Hubbard2 and Daniel T. Walz


    The numbers in the main body of the chart refer to the percentage likelihood of reaching the goal of not running out of retirement funds. When inflation is included (and it must be to be valid), we see that the greatest likelihood of not having to tap into principal occurs with a portfolio of 75% stocks and 25% bonds.
    Taken in the wrong light, this graph can be unsettling for the conservative retiree. Should you have your entire portfolio in stocks through good times and bad or you’ll end up in the street? No, but if you’re looking at a 30 time horizon and are not interested in tapping into your principal, you’ll need more stocks than perhaps would be recommended for the retired investor. And by stocks I don’t mean those selling for two cents a share and promising 1000% return in just a few short days. I mean a highly diversified portfolio of blue chip companies.
    The following are the conclusions from the study as pointed out from the online wiki on the study:
“The study produced a number of conclusions, including:

• Withdrawal periods longer than 15 years dramatically reduced the probability of success at withdrawal rates exceeding five percent. 
• Bonds increase the success rate for lower to mid level withdrawal rates, but most retirees would benefit with at least a 50 percent allocation to stocks. 
• Retirees who desire inflation-adjusted withdrawals must anticipate a substantially reduced withdrawal rate from the initial portfolio. 
• Stock-dominated portfolios using a 3 to 4 percent withdrawal rate may create rich heirs at the expense of the retiree's current standard of living. 
• For a payout of 15 years or less, a withdrawal rate of 8 to 9 percent from a stock-dominated portfolio appears sustainable.”

    The Trinity Study actually found that a heavily stock laden portfolio of $100,000—tapped at 4% over thirty years, and assuming the rate was not adjusted for inflation—created a $700,000 portfolio at the end of the time frame. Wow. But based on historic market returns this is absolutely feasible.
    I think for most retirees and those considering retirement there is value in evaluating the 4% solution.  When the study “backtracked” with historic data, the numbers in the chart bare out the following comment:

“One scenario backtested in the Trinity study suggests that a retiree with a suitably allocated $1 million portfolio could withdraw $40,000 the first year, give herself a cost-of-living adjustment every year afterwards, and have a 98% chance of the portfolio lasting at least 30 years.” 

Sharpe’s Point - 

            Now before you run out and decide that the 4% solution is what you’re going to do, understand that it isn’t without debate. Nobel Prize winner William Sharpe (creator of the ‘Sharpe Ratio’) disagreed somewhat with the findings of the Trinity Study. He felt it was too rigid and risked building up an unspent surplus. If the goal is to leave a significant inheritance that’s one thing, but if, instead, maximizing the potential of a retirement portfolio is what’s wanted then 4% might not be the best avenue.

            He also cautioned that the solution would encourage fixed spending habits that can prove problematic in down markets.

            “’If a retiree adopts a 4% rule, he will waste money by purchasing surpluses, will overpay for his spending distribution, and may be saddled with an inferior spending plan,’ wrote Sharpe and colleagues Jason Scott, managing director of the Retiree Research Center at Financial Engines, and John Watson, a fellow at Financial Engines.”

            Sharpe’s idea then was that the real solution was regular monitoring and tailoring of the portfolio to find the optimal amount.

I couldn’t agree more, and it’s important to evaluate all of the information on this approach (we include web links to the content mentioned here and other resources for your research in the Resources Area).  If you work with an advisor ask them about this approach.  When looking at the research, it seems that 4% is a great place to start but this doesn’t mean that we can neglect the ongoing and important questions that only you, as the investor, must answer.

What’s the anticipated time horizon of the portfolio? The longer the anticipated lifespan, the lower the percentage withdrawal. It’s common sense. If you’re looking at thirty years or more, 3% might be a better figure.

In contrast, if you’re retiring older, and perhaps not in good health, a shorter lifespan can be factored in and therefore a larger percentage of the funds can be spent each year. Although, again, not written in stone, with an anticipated payout period of fifteen years or less, 8% or so could be tested as a permissible withdrawal rate.

Prudence and the Annual Review -

            It would appear the best course of action, as is so often the case, is to take these studies for what they are; guidelines. Considering a 4% annual withdrawal rate is an excellent starting point.

            Review the math yourself, or with your Financial Advisor if that’s your case, and see if it works for your situation.

Be prudent.

If timing the synchronicity of the end of the lifespans of both yourself and your portfolio isn’t exactly possible (is it ever?) then which is the worse evil; running out of money or leaving a bit extra for your loved ones? I know my answer.

The authors of the Trinity Study wrote:

“The word planning is emphasized because of the great uncertainties in the stock and bond markets. Mid-course corrections likely will be required, with the actual dollar amounts withdrawn adjusted downward or upward relative to the plan. The investor needs to keep in mind that selection of a withdrawal rate is not a matter of contract but rather a matter of planning.”

            Planning and regular reassessments are indeed the additional aspects to rounding out the 4% solution.

            I cover the importance of the annual review in more depth in my book, 'A Safe Retirement ; The 4 Keys to a Safe Retirement', but understand that regular reviews of your portfolio and overall retirement lifestyle needs are a key aspect to maintaining your Safe Retirement. Approach your annual budget from the aspect of how much can you spend. Start with 4% and see where it takes you; many financial planners report using this number with success. And then reassess each year at your designated annual review to make sure this number is still working for you.            

            Prudence is a lovely lady, make sure she’s part of your Safe Retirement and you’ll be living your dream for the rest of your lives.