Depending solely on other people for your investment decisions can mean dying a slow death.
Over the last few decades, the switch from employer-managed pension plans to self-managed retirement accounts (i.e., IRAs and 401k’s) has turned each person into his or her own pension fund manager.
Financial advisors often compare this switch to a scenario in which a person is given a room full of medical equipment, a few medical reference guides and websites, and told that she’ll now be in charge of providing her own medical care for the rest of her life.
The natural conclusion to the analogy is that we need professional help. We need doctors. We need financial advisors. And that’s likely true.
But it doesn’t let us off the hook for educating ourselves.
Making Our Own Decisions
Everyday, we make several health-related decisions for which we don’t have the luxury of consulting a doctor. I don’t call my doctor every time I prepare a meal. You probably don’t either. It’s up to you to have a basic understanding of:
- which foods are healthy (and which are unhealthy),
- how much (and which types of) healthy food you need each day, and
- how much junk food you can get away with.
And that’s just your diet. Yes, it’s important to have a doctor, but there’s still a whole list of things you need to know about how your body works and what you can do to take care of it.
Same thing goes for your finances.
Unless you plan on consulting your financial advisor every time you spend money, donate money, or make any sort of investment decision, it’s important that you have a basic set of financial skills. For example,
- You need to know how to track your spending to ensure that it stays below your income.
- You need to know the difference between a stock, a bond, and a CD. And you need to know what each one is used for.
- You need to know how to decide whether to prepay your mortgage or invest for retirement.
Further, it’s important to recognize that advice can’t be trusted solely because it came from somebody who calls him/herself a financial advisor. After all, some financial advisors are better than others:
- Some advisors give honest, unbiased, sound financial advice, while others are crooks.
- Others, while good people, are subject to conflicts of interest that make it impossible to give unbiased advice.
- And still others–although unbiased and ethical–are simply incompetent.
It’s essential that you have some background knowledge yourself, otherwise you’ll have no ability with which to choose between advisors. (Side note: Asking for referrals doesn’t cut it. Unless your friends and relatives are quite financially savvy, they can receive poor advice for years without ever knowing it.)
About the Author: Mike is the author of Investing Made Simple. He also blogs at The Oblivious Investor where he encourages investors to create low-cost index fund and ETF portfolios.
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Does dependence of a national economy on foreign investment promote economic growth or underdevelopment?
Any investments, foreign, or not, spur economic growth. However, dependence on ANYTHING is not a good thing, and can eventually backfire.
Speaking of 401ks, I hope that they will actually approve the annuity option for 401ks. It would be good, as many people can benefit from consistent and dependable monthly paycheck.
We are the same way with our health and our investments. Unfortunately, few care about obesity until they are having diabetes. Unfortunately, few care about investing until they retired and have no money.
If we can only find a way to scare the heck out of everyone, we would all be more educated about what would make us better long term.
A false alarm would be good to get everyone more alert but I hope that no one will suffer the trauma that we just experienced in the financial markets ever again.
I think you’re right that people tend to put off learning about something until the need is immediate and very apparent.
At the same time, I suspect that encouraging “you can do it.” sort of messages may be more effective at actually getting people to get started than messages along the lines of “if you don’t get started now, you’re done for.”
The other benefit of having some knowledge is that you can ask more specific questions when you meet with your financial advisor. By doing so, it forces him/her to think before they give you their usual sales pitch, and you end up getting more out of each meeting.
The other benefit of knowing something is that you are better able to tell the financial advisor information that he/she needs in order to create a better portfolio or investment plan for you. They can only remember to ask you so many questions after all, so the more relevant info you can offer, the better the result.
The doctor/financial advisor analogy is great. Advisors often equate themselves to “financial doctors”. I’ve never met one that qualifies for this distinction, and, although every doctor I’ve ever consulted definitely knows more than I do about medicine, I’ve met a few advisors that knew less about finance than I do.
Beware of advisors that are just marginally knowledgeable salesmen. I’m sure there are some good ones out there, but this field is not as regulated as the medical profession and they seem harder to come by.
You raise a good point about the level of education required to call oneself a financial advisor. It’s nowhere near that of a doctor.
Two good tips for looking for advisors are to look for somebody with a CFP or CPA certification and to look for somebody who isn’t paid via commission.