Should You Hire A Professional Money Manager?

Pitfalls of Managing Your Own Money

There are many traps that people fall into while managing their own money. And the biggest problem is, just knowing about them doesn't necessarily make it easier to avoid them. Here are the most common ones:

Chasing Hot Returns.

This one is pretty easy to understand and probably the most common, so we'll start here. You open your money magazine, any month will do, and at least one of the article will be about the "Best Performing Mutual Funds (or stocks, or REIT's, or whatever) of the Year!" You read it and you see these incredible returns and very compelling stories about these investments, and you feel like you need to own that list of funds or else you'll be the biggest loser on main street. Then you look at how your current portfolio has been performing and you see that it's nowhere close to what their list has done. Now you really feel dumb! Everything about it makes sense, feels right, looks right, and so you figure Money magazine can't be wrong on this one. The next day, you make some trades and buy a few of their hot picks. Sound familiar so far? Now it gets strange. The next thing you know, those great investments you just bought start to go down. And they don't just go down, they tank! How could these golden investment ideas turn bad so fast? They were doing so well!! What happened? You ask yourself.

Don't feel too bad if this has happened to you, you're not alone. You would not believe how many times in my personal financial planning career people have told me their own version of this little story. It's almost scary how common it is.

The problem here is that too often, when you buy top-ranked, or top-performing investments, you've already missed the boat. You're buying them at a high point, AFTER they've already done well. And to buy them, you're selling your under-performing mutual funds or stocks at a low point. So you're doing the opposite of what a good investor is supposed to do which is buy low and sell high. You're buying high and selling low. And to make matters worse, a few months later, you're frustrated and disgusted with the performance of these new investments, so you start looking around for some better mutual funds and the same cycle starts over. A good professional money manager can help you avoid this common pitfall. He or she will not chase the hot mutual funds of the day. Instead, they will build you a diversified portfolio of investments with solid track records, low fees, and good portfolio managers.

Emotional Investing.

This one is related to the first one because when you start chasing securities with hot returns, you get greedy, so you feel like you have to buy. You also get afraid that you're going to miss the boat. You sell your losing holdings out of fear of losing more. An investors two biggest enemies are fear and greed. Any time you make investment decisions based on one or both of these emotions, you're going to lose.

2008 and 2009 has reminded many investors what it's like to feel fear. The market was down over 50% at one point during that time frame. Banks, insurance companies and brokerage firms were failing, the government was stepping in to bail out AIG, it was a royal mess! And people experienced investment related fear. "I'm not going to be able to retire!" "I'm going to have to go back to work!" "I'm going to run out of money!" Sound familiar?

I know of more than one person who right at the very bottom of the market, couldn't handle the fear any more, and sold out of everything and went to cash. This act of fear may have made them feel better at the time. But what happened next? Very quickly the market turned around and started heading back up. From March 9, 2009 to May 8, 2009 the market was up over 37%!! In less than 2 months! How do you think they felt then? Most likely they were in a lot of pain as they watched the market go back up. Once again, the fear and the greed start to take over, and eventually they will pile back into the market after having missed a great run.

A good professional money manager will help you avoid these situations to some extent because as they invest, they try to remove the emotion from the process. It probably helps that it's not their own money that they are investing (although they are always concerned when clients lose money) but they can take a step back and look objectively at the situation when making decisions. When you call your professional money manager up and say something like, "I think I need to get out of this market." He or she will help you do a reality check to see if something has really changed, or are you just letting your emotions get the best of you.

Fees & Expenses.

This is an area where many investors end up giving up a lot of money unknowingly. This especially applies when investing in mutual funds which have a lot of fees that you never see come out. With mutual funds, all fees are disclosed in the prospectus, but most people don't read those (which is understandable, they are written by attorneys). With mutual funds you have loads or commissions, expense ratios, 12b-1 fees and internal trading commissions. To learn more about mutual funds and their costs, click here. If you are buying funds from a transaction based broker such as someone that works for a bank, Edward Jones, Merrill Lynch, etc. they are most likely selling you loaded funds. Loads are commissions paid to the broker who sold you the fund. With these types of mutual funds, you pay a commission either when you buy or sell the funds. The commission comes out of your investment. This is a big cost and really slows down your performance. Loaded funds do not perform any better than no-load funds. I would recommend that you hire a professional money manager who uses no-load funds, and then commissions or load won't be an issue.

The biggest internal fee with mutual funds is the expense ratio. This is a percentage of the funds assets that are taken out each year to cover operating costs, etc. This is how the fund makes money. They can be as low as .08% per year, and as high as 2.5% per year. Keeping an eye on these fees is a very important part of personal financial planning. The lower your fees, the more return you keep in your pocket. A good professional money manager will make sure that the funds you own have reasonable expense ratios.

12b-1 fees are another internal, invisible expense. This is referred to as a marketing cost by the mutual fund companies. What it really is is a trailing commission paid to your broker. This is supposed to be his incentive for taking care of your account each year. It's usually .25% per year. The best mutual funds usually don't have those at all. Your professional money manager should be using as many funds as possible that don't have 12b-1 fees.

Internal trading commissions. This is another invisible cost that all mutual funds incur. As the mutual fund manager makes changes inside the portfolio, trading commissions are paid. These trades are not done by your professional money manager, but by the mutual fund company itself. Actively managed funds are constantly buying and selling stocks or bonds within the mutual fund. Many funds will turn over the holdings of the fund 100% - 300% per year. That's a lot of trades! And on every trade that is placed, a commission is paid. Now granted, they are paying smaller commissions per share than the average investor. But Morningstar reports that these internal trading commissions can run as high as 2-3% per year even on the best mutual funds. This makes it even more difficult for you to keep up with, let alone beat the market. To learn more about the best mutual funds click here.
A good professional money manager will own funds for you with low turnover rates, or in other words, less internal trading going on. This will keep your internal costs down and improve your performance.

Taxes

Taxes are another big part of personal financial planning that a professional money manager can help you with. He or she can help you avoid needless capital gains distributions that mutual funds make at the end of the year. By doing some quick calculations to see if it makes sense or not to take the capital gain distributions or not. Avoiding unnecessary capital gains each year can reduce your taxes enough to make up for the fee that your professional money manager charges you.

Conflicts of Interest.

This is an important one that all investors need to watch out for, including those who hire a money manager. In the world of investments, just like about any other business, there are inherent potential conflicts of interest. But they are especially bad if you are working with an advisor who gets paid commissions on transactions. Whether it's for selling mutual funds, life insurance, annuities, bonds, or making trading stocks, these commissions can have an influence on what the advisor recommends.

For this reason, you should try to work with money managers who charge an asset management fee. This is a percentage of the assets that they are managing for you. This way, it doesn't matter to him what investments he uses (since there are no commissions involved). He just wants to get the best performance possible for you. This means he will try to use low cost, low internal fee, low turnover type investments.

With a fee-based professional money manager, your best interests are aligned with his. As your account grows and you make more money, he makes more money. If you lose money and your account shrinks, he makes less money. If he keeps losing money for you, you're going to fire him. He is working for you.

Brokers who work for a large company can often find it difficult to make unbiased recommendations to clients. They have quotas to hit and sales goals to achieve if they want to keep their jobs. If they are low on the annuity bucket this month, guess what product they are most likely to recommend to you?

For this reason, it's best to work with an independent, fee-based, advisor who doesn't have a sales manager watching over his shoulder and pressuring him on his performance. Independence really helps the advisor to act in the clients best interest.

The Best Thing You'll Ever Do

There is nothing wrong with managing your own investments, and many people do it very well. But what a lot of people don't realize is, hiring a good professional money manager usually pays for itself. By helping you avoid bad investment decisions, saving you internal fees and expenses, lowering your trading commissions, reducing the taxes you have to pay, helping you avoid conflicts of interest, and saving your valuable time, you end up way ahead in the end. For most people, finding an honest professional money manager may be the best thing you ever do.

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