When Should You Use an Advisor?

Dan Solin’s excellent new book, The Smartest Portfolio You’ll Ever Own (see my review here) devotes several chapters to whether passive investors should work with an advisor. It’s a question I’ve considered before, and I think Solin has a lot of interesting insights to share.

The suggestion that most investors should use an advisor is a tough sell in the financial blogging community. Most Canadians with significant assets work with advisors, but the proportion of DIY investors is surely much higher among regular visitors to websites like this one. Indeed, many Couch Potatoes embraced the strategy after a negative experience with an advisor, and that aftertaste will take a long time to fade.

As a DIY investor myself, I’m happy to support people who manage their own portfolio. At the same time, I believe that most investors are likely to do better over the long run if they work with an advisor—as long as it is the right kind of advisor. Unfortunately, there are huge problems with the advice industry in Canada, which is dominated commissioned salespeople who charge hidden fees embedded in financial products, and who believe that an advisor’s role is to select winning fund managers or pick stocks. Excellent fee-only advisors are out there, but many have minimum account sizes of $200,000 or more, which rules out the overwhelming majority of Canadians.

The situation is somewhat different in the US, where investors have more options, but Dan Solin’s take on the DIY-or-advisor question holds up pretty much anywhere. Here are his major arguments:

• If your assets are under $100,000, you may find it hard to find an advisor who will take you on for a reasonable fee. For this reason, as long as you have the ability to build a simple index fund portfolio and leave it alone, you would be better off on your own.

• If an advisor says he or she can help you beat the market, that’s a dealbreaker. “It’s one thing to decide you need assistance,” Solin writes. “It’s another to use a broker who transfers your wealth into his or her pocket.”

• Only go the DIY route if you are sure you have the necessary discipline. It’s easy to stick to the plan in a bull market, but an awful lot of investors panicked in 2008–09, and plenty more are doing so now. Solin points out that well-advised investors had appropriate asset allocations that allowed them to endure the volatility.

• Consider using an advisor “if you want continuity with your investments for your spouse and family when you die.” If you’re the only one managing the money and you get hit by a bus, is your partner going to be left to the sharks?

• An advisor can be extremely helpful in managing a portfolio for maximum tax efficiency. In Canada , this is especially true for retirees who are dealing with forced withdrawals from RRIFs and trying to avoid Old Age Security clawbacks and other benefits for seniors.

• If you’re a strong believer in the Fama-French principles, you may want to use Dimensional funds, which are only available through a select group of advisors (yes, Solin is one of them). Although you can capture some of these premiums using ETFs, Dimensional funds have a long track record of outperforming traditional small-cap and value index funds.

I tend to agree that passive investors who want to work with an advisor should look for one who uses Dimensional funds. It’s not just that these are excellent, low-cost funds. The real benefit is that the advisors who sell them get it. Solin quotes a Morningstar study that found “advisors who use DFA encourage very smart behavior among their clients.” ETFs can also be excellent tools, but many advisors use them for tactical asset allocation, sector plays and a lot of other nonsense that has nothing to do with passive investing.

As Solin reminds us, investing is about process, not products.