Based on some personal, yet unscientific, interaction with investors and advisors, it seems clear that most investors know they are paying some fee for financial advice. Yet most of them rarely know what the fee is, or what services they are getting for the fee. Even in circumstances where the fee is transparent it is not always clear that a linear relationship exists between the work performed and the fee charged. 

I think this really comes down to a lack of understanding about what role your advisor plays. For example does your advisor provide investment advice, and if so, is their focus on asset mix, security selection or strategic initiatives? 

Can your advisor make discretionary decisions on your behalf, or must they discuss any transactions with you before they are implemented? If they do provide advice on securities, what approach do they take; financial statement analysis, technical analysis, quantitative analysis? 

If they provide advice on strategic initiatives – i.e. tactical versus strategic asset allocation, sector selection, growth versus value, hedge funds, etc. - do they follow a passive indexed approach, or an active philosophy. 

If the former, then your advisor owns the asset mix decision, and you should understand what approach they use to make an appropriate asset mix selection. If the latter, then your advisor owns the style decision, and you should understand whether he or she follows a growth or momentum strategy, or some combination of these?

Some advisors focus their advice on tax, estate or retirement planning. In these circumstances, the advisor will often work with other investment professionals to provide advice on the portfolio. If so, your advisor’s role is to manage the tax efficiency of the portfolio, not the performance objectives of the portfolio. I would suspect that this type of advisor will provide optimum risk management guidance, making certain that the targeted asset mix ties directly to the financial plan.

Unfortunately most investors seek advisors who can promote great track records. Mainly because they believe that investing is only about performance. Just as Will Rogers once described it; “buy a stock that goes up, if it doesn’t go up, don’t buy it.” No thought is given to relative performance against a benchmark, or when adjusted for risk. Nor does it take into account the value of other services unrelated to performance. 

In a raging bull market – a.k.a. the 1990s - it is easy to overlook the latter value proposition. In a prolonged period where portfolio returns generally exceed the investor’s objective (whether or not that objective is realistic), who needs to understand the advisors role, much less evaluate how well the advisor performed that role. 

But that was then and this is now. Much has changed since the turn of the century. Most specifically, the 2000 to 2003 bear market, where portfolio returns were less than targeted rates, and more likely, were negative. In this scenario investors naturally lay blame, which is usually directed at the advisor. Performance issues become paramount, and still, we have no understanding as to what role the advisor plays. 

But it doesn’t matter the role, because weak performance data is center stage, and there is a lot of blame to go around. When laying blame, advisor compensation becomes a major source of contention. Investors believe they are paying too much for an ill-defined service package. And just about that time, articles appear in the financial press supporting the notion that management expense ratios are too high and that everyone should get out of actively managed products and into indexed funds. Maybe they should, but the decision to alter ones approach is not based on solid information but rater gut feel. 

In reality, if you know what fees you are paying and what service you are receiving, compensation should be a moot point. Regardless of performance numbers! That we tie one to the other is the real problem, because the link is being made on the basis of return expectations versus the reality of the marketplace. 

So what is the reality? To begin, we have come through a serious three year bear market that ended in 2003. Since then we have been in a prolonged period of stable interest rates, with risk free returns coming in somewhere between 3% and 4%. 

Equity returns will probably come in below the average client’s targeted rate, which means that investors should re-evaluate their position. Either lower their targeted return (the preferred option) or set up a more aggressive portfolio (the fall back position). 

The key message, is that one cannot separate investing from investment planning. Making an investment with little of no thought as to how it fits within your personal financial circumstances, is akin to investing in a vacuum. And “vacuum block” can lead individuals down a road to speculative excesses, that may be more damaging to the pocketbook than if they never invested at all. 

So rather that mis-directing blame based on performance numbers, take the time to understand what your advisor brings to the table, and make certain that is what you need. In the end your advisor needs to be compensated appropriately, and you need to get proper value for your money.