, , ,

The Worst Question Financial Advisors Ask You

I recently read an article about “what should I do with my extra cash?”

The basic premise here is cash loses value over time so you want to minimize how much cash you’re holding keeping only enough liquidity around to deal with your needs and provide a buffer so you’re not forced to sell investments when they are down.  With this in mind the question makes perfect sense.  Unfortunately, the answer reflected the common nonsense you often hear from financial planners.

Let’s start with the basics.  FINANCIAL PLANNERS ARE NOT INVESTMENT EXPERTS!

What?  You ask isn’t that the point?  Maybe it’s supposed to be but in practice virtually none of them do better than the market investing their own money in fact most do worse.  In other words they aren’t necessarily great sources of information.  Worse, they are USUALLY incentivized by getting commissions based on the products they sell you, hardly an impartial source of information.  This isn’t always true of course there are financial fiduciaries who can be very good but they are the rarity and still aren’t necessarily skilled investors.

That’s a buyer beware.

Now back to the main subject here, which is a question I hear from financial advisors and planners all the time “how much risk are you willing to take on?”  AWFUL!

Why is this question so bad?

Well, we’ve talked before on numerous occasions both in our training and blog posts as well as books, etc. about how risk is defined and how it isn’t defined in a meaningful way.  Technically, the answer to the question should always be “I want the best risk weighted return”.  Here’s an example, it is NEVER sound financial advice to tell someone to buy lottery tickets.  I don’t care what their tolerance for risk is it’s bad advice but that’s what the question implies.  In other words the question comes from a place that is uneducated, which is a good reflection of the investment knowledge of most financial advisors.

Good financial advice should maximize the risk weighted returns for clients, always period there is really no other value or purpose of a financial advisor if they aren’t helping you to get a better return on a risk weighted basis then they aren’t doing their job well after all why would you pay them if not for this?

So let’s talk about what the real question should be when you get into the conversation.  “What is the time horizon in which you’ll need this money and consequently how much volatility is safe?”  In other words if you buy something with a fair bit of volatility there’s a risk you’ll be forced to sell when it is down.  That is the ONLY risk that should be considered in this part of the equation the so called “risk appetite” because all the other risk should be balanced against returns so on a risk weighted basis you’re getting ahead.

Why are other questions about risk nonsensical to ask a client?  Because it implies that there is somehow a correlation between risk and return.  In other words to get higher return you have to take on more risk.  The problem is that’s false.  You might…maybe, have to take on more volatility.  You’ll definitely have to take on greater exposure to the underlying asset but that’s not the same as risk.  Remember the way we define risk that is actually meaningful to people?

“What is the chance of loss and severity of loss?”  That’s risk the way it matters.  In this sense as we’ve noted in other articles increased volatility can actually decrease returns so decreasing risk by that definition actually increases returns.  Likewise for choice of asset class and price of asset class.

Financial advisors should be helping you to simultaenously decrease risk while increasing returns.  To do this they need to consider your financial needs over the next little while and they should educate you about potential investment performance and how to cope with potential events psychologically.  But on no planet should they be guiding you into higher risk weighted investments that’s just bad financial advice.