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Do you need a financial adviser?

Here are some ways to tell if you need help with investing

Many investors are not sure whether they need a financial adviser. To know, you must evaluate your financial situation.

Let us begin with the deceptively simple question: How much help do you need?

It depends on several factors:
First, how complicated are your personal financial circumstances?

The simplest financial situation is a young single working person who rents his or her home.

At the other end of the scale is someone like this: A successful entrepreneur who owns a company (or three); is facing large capital gains reflecting the sale of a business; has children and grandchildren to pass wealth to; has multiple sources of income and a fairly involved tax filing to go with it including loss carryforwards; owns multiple real estate properties in the US and other countries.

Your situation is probably somewhere between these two extremes.

The more complex your circumstances, the more likely you would benefit from some professional help.

Secondly, what are your long-term financial goals for the next five years or more? Are you on track for making them?

These are the most common answers from investors: saving to buy a home; paying for college for children; retirement planning; outpacing inflation; generational wealth transfers; estate planning.

BREAK DOWN

A useful way financial advisers conceptualise this is by breaking down your financial life cycle into three phases: accumulation, preservation and distribution.

These three phases usually track age. Younger people, such as those in their 20s and 30s, have a longer time horizon, not a lot of cash flow, and the ability to embrace more risk for potentially greater returns.

Middle-aged people, such as those in their 40s and 50s, typically have more assets such as a home, portfolios, pension accounts, along with greater financial obligations such as paying for college and saving for retirement.

They have a moderate time horizon and should embrace somewhat less risk.

People closer to retirement, those in their 60s and 70s, have less potential time for markets to work in their favour and should be taking even less risk.

The distribution phase is exactly what it sounds like - planning to draw down your assets to live on them in retirement.

Reward is a function of risk - and risk brings with it the possibility of failing to yield expected returns.

Assess where you are on these timelines and determine whether you can manage adapting to each phase of your financial life cycle.

Thirdly, how disciplined are you? Behaviour is where most people run into problems. It is also where financial advisers deliver the most value, in my opinion.

When it comes to assessing risk in the capital markets, you're just not built for it.

The biggest obstacle to your success is not your stock-picking prowess or ability to time markets, but rather the one thing that actually is within your control - your own behaviour.

Whenever I speak to a large group of investors, I like to ask how many of them rank themselves as "above-average drivers".

Typically, 70 per cent to 80 per cent will raise their hands, considering themselves better drivers. That is, by definition, incorrect.

That is followed by the same question about investing: How many of you are above-average investors? How many of you expect to beat the market this year?

The same optimism bias appears - about 75 per cent think they are better than average and will beat the markets.

That is just the beginning of a cascade of cognitive, emotional and psychological errors that lead the majority of investors to do poorly.

The average investor, according to numerous studies, is a terrible investor.

Here are some specific questions for the 70 per cent to 80 per cent of you who are above average: Do you follow specific rules when investing? When do you overturn those rules? How actively do you trade? What is your portfolio turnover? How long do you hold your average investment? How much does your strategy depend on news? What did you do with your portfolio in 2008-2009? 2000-2003? 1997-1999?

DETERMINE

If you answer those questions honestly, you should be able to determine whether you have the temperament and discipline to manage your own money.

If you have the time, interest and discipline, there is no reason you cannot do it yourself.

It is relatively easy: Select an asset-allocation model, review it quarterly, rebalance once a year, wait 30 years, retire. Voila!

For the rest of you, financial advisers are standing by.


This article was first published in The Business Times.
The writer is chief investment officer of Ritholtz Wealth Management and author of Bailout Nation. He runs a finance blog The Big Picture.

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