Overview
As more and more people enter the investing ecosystem, many of them probably want to ensure that they create the best portfolio they possibly can.
So, the first thing that comes to mind for most people is to seek out the counsel of an investment advisor. Surely by availing of the services of an investment professional, they will set themselves up for a lifetime of investing success.
While investment advisors play an important role, investors should be fully aware of what exactly investment advising entails, and to keep certain expectations at bay.
Some Things to Clear Up
First, let me start by saying that this article is not meant to bash, berate, or denigrate investment advisors, or the profession of investment advising. Investment advisors play an important role in the investing ecosystem and have helped countless people over the years achieve their financial goals and avoid major financial pitfalls.
For the record, let me also make it clear that I have never availed of the services of an investment advisor myself. All my investment decisions are the result of my own due diligence and are subject to my own judgments. I have never deferred my investment decisions to somebody else.
Finally, since the topic is about investment advice, let me make it abundantly clear that I do not claim to be, in any capacity, an investment advisor. I will never explicitly recommend anyone to take a certain course of action or recommend any sort of specific security. The purpose of ilucidy is to assist young investors when performing their analysis and to help advance their investment knowledge, not to instruct anyone on what to do.
Now that I’ve cleared some things up, let’s go back to our discussion. The SEC defines an investment advisor as any person or firm that:
- for compensation;
- is engaged in the business of;
- providing advice to others or issuing reports or analyses regarding securities.
Some investment advisors also manage the portfolios of clients, but for the purpose of this article, we will focus exclusively on the element of providing advice/recommendations.
Understanding the Role of an Advisor
Before seeking any sort of professional investment advice, an investor needs to understand what exactly an advisor’s role is.
First, let’s look at what exactly “advice” means. According to the Merriam-Webster dictionary, advice is a “recommendation regarding a decision or course of conduct.“
In the context of investing, an investment advisor is someone who, knowing your personal financial situation and investment goals, gives you recommendations on how to best put your money to work.
Unless you choose to work with an investment advisor who also manages your portfolio, they cannot explicitly tell you to take a specific course of action. An investment advisor can’t say to you “buy $10,000 worth of Company A’s shares as soon as possible”, but they can say “given your investment goals and risk appetite, this is why Company A may be of interest to you.”
Like I said before, unless an advisor also happens to manage your portfolio, the best they can do is point you towards what they believe is the right direction, not carry you there. At the end of the day, the person who has the final say on an investment decision is still the investor, not the advisor.
Herein lies the problem that I see becomes apparent when some people choose to work with investment advisors: some people confuse “advice” with “instructions”. Just because an advisor recommends a certain course of action doesn’t mean their recommendation is irrefutable.
When you ask your friends or family for advice, do you blindly follow their suggestions, or do you subconsciously question the validity of their recommendation? Chances are you do the latter. The same thought process should apply when receiving any sort of investment advice.
When receiving any sort of investment advice, an investor cannot afford to suspend their critical thinking. Given what an investor knows, they should assess whether the advice they receive is solid or not.
This leads to what I believe is another problem: investors believing that investment advice can compensate for a lack of investment knowledge.
Advice Cannot Replace Proper Investment Education
Investors need to realize that investment advice will be of no help if they don’t have a proper knowledge base in investing and other financial topics to begin with.
When receiving any sort of advice, it is implicitly understood that you already have some level of competence and knowledge to judge whether the advice given to you is solid or not.
For example, when a basketball coach gives advice to one of his players on how to improve their jump shot, it’s effective because the player already knows what a jump shot is, understands the underlying theory behind a jump shot, and therefore can ascertain whether the coach’s advice is solid or questionable.
If the coach gave the same advice to someone who has never played basketball, the advice may not be nearly as effective because they might not even know how to shoot a basketball properly, let alone know what a jump shot is.
Let’s pretend for a second that I’m your investment advisor (what I’m about to say is NOT to be taken as investment advice). If you come to me and ask which stocks are poised for the most growth in the shortest amount of time, I could say something along the lines of: “focus on stocks with high P/E ratios, high dividend payouts, and rapidly increasing free cash flow”.
Now, if you have an understanding of these terms and how they relate to a company’s investment merit, you can ascertain whether my advice is sound or ridiculous. If you did not have a basic understanding of these terms, then my advice would simply enter one ear and exit out the other.
Advice cannot compensate for a person’s lack of knowledge because it’s not meant to. Advice is meant to guide a person on the right track or to cause a person to re-consider a potential course of action.
You can hire the best investment advisors in the world, but even world-class advice is worth very little if the one receiving the advice doesn’t have a sufficient level of investment knowledge.
Focus on Building Your Knowledge Base
If an investor insists on seeking the counsel of an investment advisor, that is entirely up to them. However, to make the most of an advisor’s services, then an investor needs to equip themselves with sufficient investment knowledge beforehand.
Although you don’t need to be the smartest person in the world to succeed as an investor, investing is still an activity where one’s success or failure is directly influenced by their level of knowledge, and how well they use that knowledge.
An investor’s most powerful weapon will always be the knowledge they possess. An adequate investment decision cannot be reached if the investor has insufficient knowledge and facts to back up their decision. Why else would Warren Buffett spend 80% of his day just reading?
Now, an investor doesn’t need to be a walking encyclopedia, but they should at least know the difference between a stock and a bond, and why that difference matters.
I’ve talked about the importance of continuous learning in a previous article. I cannot stress enough how important it is for an investor to keep their investment knowledge as up-to-date as possible. The investing world changes every day, and so the advice that an investor may receive is also subject to rapid change. Advice that sounded good 20 years ago may sound ludicrous today.
Investment advising will continue to play an important role for investors now and in the future. However, an investor cannot hope to achieve any major investing success if they just blindly follow the advice of others. Investors will always be responsible for ensuring they keep holes in their knowledge to a minimum.
Wrapping Up
An investor has every right to seek the counsel of an investment advisor, but investors would be wise to keep their expectations at bay.
Advice is meant to help guide someone in the right direction. Advice serves to augment a person’s preexisting knowledge and competence, not compensate for a lack of it.
The responsibility still falls on investors to ensure that they accumulate adequate investing knowledge in order to think for themselves, and to challenge the advice they receive instead of blindly accepting it.
Investment advice plays its role in the investing ecosystem, but it will never serve as an excuse for investors not to educate themselves on investing theory.
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