- Goal Formation. Individual investors have a great deal of trouble establishing appropriate, realistic and manageable goals. Often they don’t even know what they should be concerned with or what they should include as part of a list outlining what they want or need to accomplish. These goals go beyond investments and include life goals.
- Investment Policy Statement. An IPS should state one’s investment philosophy, goals, guidelines and constraints. It also is a communication device that instills structure and discipline. A good advisor will review IPS annually with client. Great tool in making sure investments have not drifted.
- Asset Allocation. The total return of any portfolio has three components, which may be positive or negative: (a) returns from overall market movement; (b) returns due to asset allocation; and (c) returns due to, security selection. Research suggests that, in general, about three-quarters of a typical portfolio’s variation in returns comes from market movement (a), with the remaining portion split roughly evenly between (b) and (c). The exercise of allocating funds among various investment vehicles and asset classes is at the heart of investment management. Asset classes exhibit different market dynamics, and different interaction effects. Thus the allocation of money among asset classes and among investment vehicles within asset classes will have an enormous effect on the performance of an investment portfolio.
- Persistence. Establishing items 1, 2 and 3 works as long as everyone stays focused. Various studies demonstrate that certain investment characteristics can and do outperform with persistence over time (even though they can and do underperform for significant periods). These include size (the small-cap premium), value, momentum, low beta and concentration.
- Risk Management. Passive management (at least as generally construed) looks to “stay the course” through all times and seasons. Proactive Management can make adjustments more effective. It can also provide other tools for managing risk, including such as tactical adjustments various hedging and insurance strategies. It is smarter to protect against market corrections than to try to predict them.
- Behavioral Management. We are all prone to behavioral and cognitive biases that impede our progress and inhibit our success. We are flitting hither and yon chasing after the next new thing, idea, strategy or shiny object. Since we frequently act too fast, a good advisor can alsoslow us down to allow us to “check our work.” A good advisor prevents the panic decisions made at the wrong time for the wrong reasons. Refocusing on pre-established goals keeps us focused and expectations grounded. Doing so is vital, not the least of all because we tend to disbelieve that we are susceptible to them.
- Productive Simplicity. Simplicity is a good thing, but with a careful qualifier. Per Einstein, the goal is to make things as simple as possible but no simpler. A competent advisor will know the difference.
- Senior Protection. Research confirms what most of us have seen among our families and friends. The ability to make effective financial decisions declines with age. Thus those age 60 and up unnecessarily lose nearly $3 billion to fraud annually. Despite that decline, our self-confidence in our financial abilities remains undiminished as we age. That’s a scary combination that a good advisor can guard against.
- Tax Efficiency and Planning. Experienced money managers routinely argue that you shouldn’t “let the tax tail wag the investment dog.” And it’s true that a poor investment isn’t often salvaged by good tax treatment. But tax efficiency still matters a lot and a good advisor providing the best approaches for dealing with taxes offers tremendous value.
- Financial Planning. Each item on this list relates to financial planning in one form or another. Yet consumers often mistake investment management with financial planning. Financial planning is much broader, involving far more than the managing of investments. It involves budgeting, goals, insurance, comprehensive planning for lifestyle, retirement, legacy and more. It also involves crisis prevention and management. Great investment management can be undone in a hurry with poor financial planning. A good advisor can work to help individuals formulate, monitor, adjust and meet their personal and financial goals. Real expertise is required to do so.
Ultimately, a good advisor can and will influence and even change your behavior. In a world where personal financial issues have become increasingly and often unnecessarily complex, a good advisor can help you figure out what is true and what isn’t, what works, what matters, what is useful, and what can go wrong. There are few enough people with the expertise sufficient to begin to do that for themselves. Nobody can do it objectively. That’s why good advisors are an absolute necessity.
Source: Bob Seawright, Chief Investment & Information Officer for Madison Avenue Securities