THIS POST MAY CONTAIN AFFILIATE LINKS. PLEASE READ MY DISCLOSURE FOR MORE INFO.
Recently, I’ve wondered why more financial advisors don’t benchmark.
I’ve talked to a few advisors, and some have confessed that they are reticent to create a benchmark for their clients. It’s just easier for them not to. It doesn’t help that most clients are unsure of what their money manager should be benchmarking against.
I was talking to a friend at work this past week. He was telling me about his deep affection for his financial advisor. My friend had gone through many bad advisors over his lifetime. He was overjoyed to finally have a good one.
I asked my friend how he concluded that his financial advisor was doing a good job. He said that his advisor was a straight shooter and told him that he would achieve average returns. My friend was ecstatic to have had his portfolio return 10% last year, when the historical average is 8%.
Sadly, I had to burst his bubble. I shared with him that the stock market returned 20% last year. He looked shocked. If market performance is “average”, it seemed clear that my friend was actually receiving below average returns.
Since his returns were much lower than the market’s, I was curious to know what his advisor considered “average”. Unfortunately, his advisor had never defined “average” for him. Instead, my friend simply trusted that “average” would be just fine.
I always say, nobody cares more about your money than you, except maybe the IRS. It’s imperative that you understand all of the money moves that your financial advisor makes. Unfortunately, advisors do not always have the best of intentions in terms of growing your money.
Expectations
The best way to avoid a sticky situation is by setting clear expectations ahead of time. “Average” returns is just too vague. Your advisor surely isn’t vague about his or her fee schedule.
Additionally, simply telling your financial advisor to maximize the amount of money that they can return for you is also not a wise goal. You also need someone who will guide you in the areas of estate planning, taxes, and even the psychological side of money. If the market drops by 50%, it’s important to have someone who will stop you from making a rash decision and assure you that the market will eventually get back up. It’s amazing how valuable level-headedness can be.
Quantify
You should be able to quantify your financial advisor’s performance each year.
For instance, if your financial advisor tells you that the S&P 500 will be the benchmark, you should expect that your return should match the S&P 500, including the financial advisors fees.
If they aren’t consistently matching whatever benchmark you set, should you really keep them around? On top of that, are they really earning their fee? Often times, that fee is 1% of the value of your portfolio.
With a $500,000 portfolio, the fee might be around $5,000 per year. You have to ask yourself, are you really receiving that much value? Even better, you’d hope that you are receiving more value than that.
No Benchmark
I find it truly comical when a financial advisor says that they don’t have a benchmark. Imagine if you could say that about your professional life as well. To me, this is really code for “don’t hold me accountable for my results, and if you’re content being oblivious, I’m happy taking a fee each quarter from you.”
At work, this would translate to, “Hey Boss, trust me that I’m doing a good job and just give me a paycheck. Don’t bother setting objectives on what I should achieve for the year because I’m doing just fine.”
This is laughable.
Understanding Your Portfolio
Hopefully by now, I have convinced you that a proper benchmark is key. Once you set a benchmark, it’s important to look into your portfolio to understand what exactly your advisor is doing.
Your portfolio may be a 60/40 split between stock and bonds. It may even be 100% in bonds. Either way, you need to know where and why your money is being invested. I’ll never forget meeting with an advisor to talk about a friend’s portfolio. I asked him why he had so many different holdings in gold, and he wasn’t able to give me a straight answer. When I broke down the information to my friend, he was baffled and pretty upset about the way his money had been invested. My friend had been clueless because he hadn’t taken the time to really dig in and figure out all of his holdings.
Stocks to Bonds Ratio
One of the easiest ways to see if your advisor is doing well is to figure out the ratio of your stocks to bonds. Then, utilize Vanguard Total Stock Market Index Fund and the Vanguard Total Bond Market Index Fund as your benchmarks. By using these two funds with the allocation splits that your financial advisor has set up, you should have a pretty good idea if they are earning their keep when it comes to investing.
If they’re not, while I can’t recommend specific funds, it may make sense to do some additional digging. You can even consider a robo advisor such as Wealthfront or Betterment. Either may be able to handle your money in a better manner than your financial advisor.
“Nobody cares more about your money than you, except maybe the IRS.”
Haha how true! Thanks for the laugh. We don’t benchmark the average ourselves but it’s around 14% to 30% depending on which brokerage I think.
Lily | The Frugal Gene recently posted…11 Surprising Downsides of Being a YouTube Vlogger
Wow 30% returns is excellent. I wouldn’t mind handing you over some of my money if you can consistently do that 🙂
Recently, I wanted to do some research to try and improve my investment portfolio risk management and have two questions answered for me. I want to know that at my current pace of saving, how much money do I need to retire and when I could retire.
After meeting with the advisor twice, the advisor spent minimum efforts trying to answer my questions. On the other hand, the advisor was trying to convince me to move my money out of my brokerage and invest with that brokerage.
I was a bit disappointed that they were trying harder to get me to move my money rather than trying to answer my questions.
Leo T. Ly @ isaved5k.com recently posted…Is A Cruise Vacation Really That Great?
I’m sorry to hear that Leo. That’s always disappointing when you take time to meet with folks and they’re unable to answer the questions that you have. I’ve dealt with some of those issues in the past and it’s frustrating that simple questions can’t be answered.
I don’t use an adviser, but agree that they should have a performance target. Being my own adviser, I find it ironic that I don’t benchmark my own total return performance. I do however watch my asset allocation and the cash my investments throw off in terms of dividends very closely. Tom
Tom @ Dividends Diversify recently posted…The New Millionaires | Introduction | Part 2
Hahhaa…that’s one of the things that I am ardent about. A couple of years ago, before I saw the light, I tried to invest on my own. I would benchmark myself and once I saw that I was failing, decided that it was better to let the S&P 500 do my investing 🙂
My Robo advisor account has been doing well for the last two years I’ve invested in it.
But then again, everything has done well in terms of the stock market.
The real test will be when we are in a bear market. It will be very interesting to see how my Robo account handles that period of time.
I’ll really curious as well. I opened up a wealthfront and betterment account. I’m planning on sharing my results over the past year. It’s been fun to see how they work so far 🙂
I haven’t benchmarked my portfolio because I’m sitting in the overall market funds… so the benchmark exercise would be pointless 🙂
Erik @ The Mastermind Within recently posted…$165k Net Worth at Age 25
Hahahah…that’s awesome to hear Erik, although I have to admit from time to time I like to see how the lines look on Personal Capital 🙂
I don’t use a financial advisor because I think they add the most value with complex portfolios. It seems you are referring to a rather vanilla stock/bond portfolio that does not involve a lot of moving parts. So I agree with you that we should look at what value an advisor is adding.
I’m not sure I agree that benchmarking to specific asset classes is the answer. The mission of a financial advisor should be to help you meet your financial goals over the long term regardless of asset class returns. Absolute returns matter more than relative returns.
For example, if an advisor helps you meet your goals with less risk, that’s good. So what if he/she matches the S&P? If an advisor matches the S&P and the S&P loses 30% right before you retire (undue risk), the benchmark is matched but your goal could be in jeopardy. Just something to consider. Advisors should focus more on goals and risks rather than relative returns …
Rich from http://www.pennyandrich.com recently posted…Rich on HSAs and Socioeconomic Classes in Air Travel
Thanks for sharing Rich!!! I totally agree that a financial advisor should help you achieve your goals with that said I personally would like to see how they properly evaluate themselves. I just feel like it should be something that we can tangibly evaluate 🙂
I don’t have a financial advisor but if I did I would expect the person to provide certain benchmarks for my portfolio. Like if the market went up 15% next year, I would want my portfolio to have around the same up-tick as well and my advisor should honor that commitment. And if not then I would drop the advisor.
Like you said Rob, nobody cares more about your money than you(well maybe my wife too…haha)
Kris recently posted…My Evolving Relationship with Money
Hahhaha…I just read that last line to my wife and she nodded in agreement 🙂
No financial advisor here. But I typically see right around market performance of the s and p. I believe my tilt overcomes some of the give back from bonds .
FullTimeFinance recently posted…Financial Fire Drill
Thanks for sharing Full Time Finance!!! I’m right where you are as well 🙂
Well, I think for most in the FI community it would be fairly easy to measure because of the focus on index funds. I personally, think, I am doing ok. I wonder if I could be doing better. I have my own benchmarks, but it is really about a larger net worth.
Jason recently posted…How Long Will This Bull Market Last?
Thanks for sharing Jason!!! I had no idea that index funds were so huge in the PF community until I joined. Prior to that I thought everyone was geniuses picking their own stocks 🙂
My benchmark is the good old S&P and I almost beat it in 2017. I think if I had more in index funds I may have. Your right that advisors are super clear about fees but may not be about performance. You wanna know what you’re paying for in terms of returns and not just other stuff/fluff like personalized service, or enhanced online tools.
SMM recently posted…The Efficient Frontier – Simply Explained
Thanks for sharing SMM!!! I have been incredibly fortunate to stick pretty close to my benchmark of the S&P 500 as well but it’s always razor thin 🙂