For many investors, the financial markets and managing a portfolio of investments are far from intuitive.
It makes sense that the average investor would hire an advisor to oversee their financial affairs. Using an advisor doesn’t mean, however, that you can just put things on autopilot and assume that all is well. It’s important to understand how much you’re paying for advisory services and what you’re actually getting for those fees. Those two factors will play a big part in what type of returns you’ll see from your investments.
Financial advisors, in general, do a fairly good job of doing two things for investors. First, they’re able to keep folks in a risk-appropriate mix of investments geared toward long-term goals and, second, they’re able to act as a barrier to impulsive buying or selling. But those services come at a price, and those fees can cost investors a significant amount over the long term.
The use of robo-advisors has grown considerably over the past decade, as investors seek out ways to obtain financial advice at a fraction of the cost of a traditional advisor.
The Appeal of Robo-Advisors
Robo-advisors are an intriguing option because they use computer algorithms instead of people to construct a portfolio. This benefits investors in two ways. First, this structure makes robo-advisors much cheaper. A service, such as Betterment, charges as little as 0.25% annually to get set up on its platform, compared to an actual advisor, who often charges 1% or more annually. Second, robo-advisors often use low-cost index funds to fill out their model portfolios, helping to eliminate any possibility that an advisor may choose high-fee products to ratchet up their own commissions.
Robo-advisory appeals to much of the Millennial generation, which wants to operate online and keep costs as low as possible, but it’s also pulling in older generations, who are drawn by the low-fee structure. Investors today are identifying expenses as the key consideration in selecting funds for their portfolios.
The rise of robo-advisors has been a positive industry change for investors. To learn more about how they have risen to prominence, click here.
Challenges at the Fund Level
When drilling down to individual funds, a different set of risks exists. For example, some strategies try to utilize tactical and contrarian approaches within their portfolios. History has shown that active approaches that try to move in and out of different areas of the market often struggle to keep pace over time.
Turnover can also be an issue. Funds that do a lot of trading can trigger added commission costs and tax consequences that investors may prefer to stay away from.
We’ve also seen an increasing number of funds adding non-traditional assets, such as real estate, commodities and derivatives, in an effort to juice risk-adjusted returns. While they offer added return potential, they can also be risky, illiquid and inconsistent with investor goals.
How the Department of Labor Regulates the Financial Advisory Space
The Department of Labor’s fiduciary rule stipulates that those who act as an investment advice fiduciary are required to act in their clients’ best interests at all time. It also requires that advisors and brokers disclose any potential conflicts of interest, clearly lay out any potential fees and commissions, and meet suitability requirements for where client money is invested. These rules are designed to protect investors from potentially predatory practices that can materially harm investors. The fiduciary rule should help improve transparency, offer clients a wider range of investment options and give investors the potential to generate higher returns.
To learn more about the Department of Labor’s fiduciary rule and how it affects you, click here.
Key Considerations When Choosing Investment Advice
Whether you choose a traditional financial advisor or a robo-advisor to help guide your decision making, investors should keep in mind the following considerations when choosing a path:
Fees are the biggest factor that investors can easily control. According to Vanguard, focusing on low-cost index funds helps keep overall fees low, and allows investors to enjoy better returns.
Keep emotions in check. Market downturns can be scary and worrisome, but they are part of a normal market cycle. Stick to your long-term objectives despite short-term fluctuations, and understand how your advisor can help minimize risk during challenging times.
The Bottom Line
Lately, the funds that charge the lowest fees are tending to draw some of the biggest net flows. This reinforces the notion that investors are focused on ultra-low fee products. Fees and expenses can make the biggest impact in how well your portfolio performs. Understand what an advisor can offer you and what type of fees he’ll charge in order to make sure you’re maximizing your portfolio’s returns.
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