Hiring a Financial Advisor? Read This First

Trying to pick winning investment funds feels a lot like searching for a needle in a haystack. And if you try to pick them based on recent hot performance, you’re more likely to end up disappointed than successful. It's a common challenge for anyone new to . So, it’s natural to think, why not just hire a professional?

You could turn to a financial consultant at a big Wall Street firm, a registered investment adviser (RIA), or even an insurance agent selling investment products. RIAs often work on a “fee-only” basis, while others earn commissions. They can be a huge help, but when it comes to the specific task of picking funds that beat the market, I’m skeptical.

While some advisors succeed, most don't. Their real value often lies elsewhere. A good advisor excels at asset allocation, tax guidance, and helping you figure out how much to save for retirement and how much you can safely spend. They can be a steady hand, helping you navigate the complexities of and avoid classic blunders like chasing past performance or trying to time the market. These services are crucial and can genuinely improve your financial outcomes.

The Helper Dilemma

A huge number of Americans lean on professional advice. It's estimated that out of 55 million families who own mutual funds, about 40 million use an intermediary. But do these helpers actually add value when it comes to fund selection? It’s hard to imagine that, as a group, they perform any better than average. Before you even account for their fees, their fund picks likely track the average fund, which already lags behind a simple market index like the S&P 500.

Now, there are ways an advisor give you an edge. If they simply steered you toward funds with the lowest costs, you’d already be ahead. If they focused on tax-efficient, low-turnover funds, you’d save even more. And if they built your portfolio around low-cost index funds, that would be even better for you. Perhaps their greatest value would come from preventing you from jumping on a trendy bandwagon, like the tech stock mania of the late 1990s.

Unfortunately, the evidence doesn't support the idea that advisors are doing this. In fact, it points in the opposite direction. A study from two Harvard Business School professors looked at data from 1996 to 2002 and found that funds sold through brokers significantly underperformed funds that people bought directly. The annual return for broker-sold funds was just 2.9%, compared to 6.6% for direct-sold funds. The study concluded that advisors often chased trends and recommended funds with higher fees, costing investors around $9 billion a year.

A Cautionary Tale from Merrill Lynch

For an even starker example, look at a study prepared for Fidelity covering 1994 to 2003. It found that funds managed by brokerage firms had the lowest ratings of any group. Merrill Lynch funds were a staggering 18 percentage points below the industry average, with firms like Goldman Sachs and Morgan Stanley also lagging behind.

This isn't just abstract data. In March 2000, right at the peak of the dot-com bubble, Merrill Lynch launched two new funds: a “Focus Twenty” fund and an “Internet Strategies” fund. Their brokers did an incredible job selling them, pulling in $2 billion from clients. It was a massive marketing win for the company.

For the clients, it was an absolute disaster. The Internet Strategies fund imploded almost immediately, losing 86% of its value before Merrill quietly shut it down. The Focus Twenty fund fared a little better but still ended up losing 79% of its value over its lifetime. The $2 billion marketing success story resulted in clients losing about 80% of their investment. This is a powerful lesson in how the pressure to sell can conflict with a client's best interests.

So, What's an Investor to Do?

Despite these sobering stories, financial advisors aren't useless. They can provide peace of mind, help you build a sensible portfolio tailored to your risk tolerance, and be a voice of reason when markets get choppy. For anyone managing earnings from a income, this guidance can be invaluable. However, the evidence is clear: you can't rely on them as a group to pick funds that beat the market. For those just learning , this is a critical distinction.

In recent years, robo-advisers have emerged as an alternative. These platforms use technology to offer low-cost, automated investment advice, typically recommending portfolios of bond and stock index funds. With fees often around 0.25%, they are becoming a significant force in the industry.

Ultimately, this all points back to a familiar conclusion: simplicity often wins. For most people, the best strategy is likely buying a broad-market, low-cost index fund and holding it for the long term.

If you still decide to hire an advisor, be smart about it. Make sure you’re paying a fair fee, as every dollar paid to an advisor is a dollar less in your return. Look for someone who is “fee-only” and operates under a fiduciary standard, which legally requires them to put your interests first. And, perhaps most importantly, favor advisors who believe in the power of index funds. As investment adviser William Bernstein puts it, you want someone with “asset-class religion”—a commitment to passive indexing because they know they can’t consistently beat the market, and they don’t pretend they can.