Why Do People Hire Their Financial Advisors*?
As an advice-only financial planner, a blog post about why people hire advisors to help with their finances may seem self-serving. Indeed, one of the reasons I write blog posts is to give readers some insight into the mindset and analyses that can help them solve some of their financial problems themselves. Most of my clients tend to be DIY investors so it is often the case that they are looking less for specific investment advice than a second opinion on their current investment strategy.
Oddly enough, however, according to a recent study conducted by Morningstar Behavioral Research, people tend to hire advisors less for their number-crunching abilities than for behavioural, emotional, or psychological needs. This blog post will discuss some of these findings. Acknowledgements are due Danielle Labotka and Samantha Lamas, researchers at Morningstar, for this fascinating study.
Analysis of the Issue
While specific financial needs are certainly a factor, the emotional needs of the clients of financial advisors are significant.
That emotions play such a significant role may be unexpected for many. After all, aren’t questions about affording a new house, a home renovation, whether to lease or purchase a new vehicle, planning for retirement, or the adequacy of a household’s insurance coverage purely numerical calculations?
However, it doesn’t take much scratching beneath the surface to recognize the emotional factors involved. Taking on hundreds of thousands of dollars in debt to buy a house can hardly be anything but emotional. Home ownership is considered a part of the journey through adulthood, one of the rites of passage, and some (many?) young couples may view a home as a prerequisite for starting a family. Is any of that language rooted in finance?
Even something that may seem purely financial on the face of it – a financial windfall received through an inheritance, for example – is freighted with emotional significance. A beneficiary of a will may feel a need to honour the deceased relative by spending the money for certain things only. Other heirs may feel unworthy of the gift and decide it needs to be passed on to their children and not used for their own needs. And yet another heir may harbour feelings of resentment toward the deceased person and spend the money frivolously as a deliberate expression of disrespect.
Do I need to get into a discussion about how testators of wills have “punished” children by cutting them out of any inheritance, or how beneficiary children have fought over whether one or another sibling is deserving of their share?
Findings
Referring again to the work of Labotka and Lamas, they found that there were three broad categories of motivations for hiring financial advisors: emotional, financial, and other.
Emotional Motivations
The authors found several emotion-based reasons for seeking out the services of an advisor. They were:
Discomfort Handling Financial Issues
If you feel poorly equipped to manage your financial affairs or reach your financial goals, then finding someone with training in the field is a reasonable thing to do. You might ask whether this is an emotional motivation or a financial motivation, though. The point here is the feeling that motivates this decision. I suspect that a lot of Canadians worry about their finances but don’t know what to do or when to do it. Do I have enough to retire? Should I take CPP at age 60 or 70 or somewhere in between? Hiring someone to alleviate those concerns can be liberating for some.
Quality of Relationship with Advisor
If you have financial advisors, whether their licensing and credentials cover, for example, investments, insurance, or taxes, you may have hired them or continued to work with them because you feel that you have a good relationship. Perhaps their values are compatible with your own or you simply have a good rapport with each other.
I worry about this one a bit because an advisor can be quite skilled in relationship building but inadequate for the financial task you require of them. Hopefully, they recognize their limitations and only offer services to clients who are requiring support that is within their “wheelhouse.”
Quality of Communication with Advisor
While the content of the communication is of equal or greater importance, being able to communicate appealingly is essential. This is a challenge, of course. Personal backgrounds make a huge difference in communication styles. Not a lot was written about this in the report, but I suspect that clients hire advisors who communicate with them in a style that they find compatible.
Self-Presentation of Advisor
Communication is more than verbal, of course. Presentation is important. I work remotely from my home office using video conferencing tools. That sort of presentation may have its drawbacks for some for whom tactile experiences like the furnishings and general appearance of an office as well as handshakes are evaluative experiences.
Recommended by Friends/Family
Whether you are looking for a plumber or an accountant, a referral from someone you trust is important. There is some logic to this form of motivation in that you will expect to be hiring someone who is good at their job or else they would not have been referred, but it is also an emotionally motivated decision in that it is based on a relationship with someone with whom you have a personal connection.
Behavioural Coaching
This emotional motivation fits into a category of its own, in my view. Prospective clients may have had difficulty sticking to a plan or understanding some of the complexities of personal finance. Hiring someone who cannot only draw up a plan or manage their investments but can also explain compellingly the reasons for the recommendations, thereby helping the client stick to the plan, may be very valuable. Sometimes the coaching could be as simple as showing how certain financial transactions can be automated, giving the client more mental “bandwidth” to address other parts of their life.
Financial Motivations
While emotional motivations assume much greater importance than many might think, financial reasons certainly have their place in the choice of an advisor.
Specific Financial Needs
The most prominent financial motivation that the researchers found was for a specific financial issue. Issues that came up included planning for retirement, the financial implications of the loss of a spouse, or tax planning.
Certainly, retirement planning can be a complex issue. In the years leading up to retirement, most of us have to decide only three things: how much to invest, which account types to use, and how to balance the investments between stocks, bonds, and cash, or their fund equivalents. And, if you have had a workplace pension, some of that decision-making may have already been taken care of for you. In retirement, however, you could be faced with a bewildering combination of assets and account types. Plus, you probably have Canada Pension Plan (CPP), Old Age Security (OAS), and possibly the Guaranteed Income Supplement (GIS) to contend with as well. It would not be unusual for someone to enter retirement with a combination of several or all of the following: a Defined Benefit (DB) pension, a Defined Contribution (DC) pension, a Locked-In Retirement Account (LIRA), a Registered Retirement Savings Plan (RRSP), a Tax-Free Savings Account (TFSA), and a non-registered account. Add in a spouse, and the combination of accounts can be even more complex.
The loss of a spouse, while certainly an emotional event, also has financial implications. At the government level, there may be a CPP survivor pension. There is also the loss of OAS because no portion of the deceased’s OAS goes to the survivor. There may be life insurance proceeds that need to be invested. If the deceased spouse had significant RRSP/RRIF assets, the survivor is the most likely successor to those assets, which will have tax implications. The survivor will also ordinarily be the successor to the deceased’s TFSA. It should also be noted that it is common for one spouse to be the main financial manager in a household. If that spouse is the one who has died, the survivor will likely feel a need to reach out for financial advice.
As for tax planning, certainly business owners will want to avail themselves of financial advice, but even for an employed or retired person, the need for financial planning advice around taxation will have its place. As mentioned above, a surviving spouse may be confronted with new taxes, but there are several tax deductions and credits that can be used, especially after reaching age 65, that Canadians may not be aware of, as well as tax implications when holding US-domiciled securities.
Quality of Financial Advice and Services
A lot of Canadians choose the Do-It-Yourself (DIY) route, but even DIYers may recognize that they need services beyond their skill levels to reach their financial goals. This is an issue of perception so there is probably an element of the emotional here, too, but for the person seeking financial advice, searching for someone with the proper credentials and a clear philosophy of financial advice will go a long way toward finding quality.
Return Performance-Driven Factors
Years ago, before I was involved in financial services in any form, I had an interview with an investment advisor. Until then, I had been investing in an RRSP and a non-registered account using a mutual fund portfolio set up at our local bank branch. One of the questions I remember asking the advisor candidate was about reasonable return expectations. I remember 10% being the number that came out. Frankly, I didn’t know what the right number was to expect at that time. But, the point remains, when the financial advisor specializes in investment advice, you want to hear that they can deliver returns above the expected long-term average. Now, whether that is a legitimate expectation is another matter, but I’m confident that is an expectation of many who seek out financial advisors.
Free to Me
I don’t know the American financial advice landscape well enough to know whether this is an issue, but I am sure this is the case in Canada. “Why should I pay someone for financial planning advice, when the advisor at my bank does that for free?” For years, recommendations to purchase the mutual funds that are on offer at the banks have been perceived as not costing the investor any money. The planning advice, such as it is, is little more than a recommendation to buy a particular set of funds in specified allocations on a monthly basis.
I don’t think this does any favours to either the client or the advisor. The diligent advisor may work hard to develop a custom financial plan but does not make any money unless the potential client invests in the products that are available through the advisor. For the client’s part, they may not adequately recognize that they are paying a fee for the funds they purchase that includes the advice they received.
Nevertheless, this is the system that many seekers of financial advice are dealing with: embedded fees that are not fully recognized even when disclosed. Client-focused reforms by the regulators are slowly making a difference, but there is certainly work to be done.
Other Motivations
There may be many other motivations in the emotional and financial categories that are not listed here, but one of the findings mentioned by the author was that either the advisor or the client had moved away.
Moved Away
This may be an issue for clients who want to have someone local to deal with who they can meet face-to-face periodically. However, with the mobility of Canada’s population, it is not unusual for advisors to be licensed in multiple provinces. A relationship with an advisor begun in British Columbia, for example, may continue even after the client moves to Manitoba or Ontario, for example. Nevertheless, it should not be discounted as a motivation, or even an opportunity, to change advisors.
Lessons Learned
What are the lessons to be learned from these findings? If you are a prospective client looking for advice, recognize that your financial needs are wrapped up in emotional motivations. Indeed, they are unavoidable. The same might also be said to my fellow financial planners, including me! We bring emotional motivations to our actions, too. I think I can even say that the person who displays little to no emotion may be very emotional but has learned to suppress their expression of them. Of course, people are raised differently and, therefore, express themselves differently. Where to start? For prospective clients, I would suggest that there is nothing irrational in choosing to not work with someone because they don’t feel like a good “fit.” For advisors, I will suggest politeness, careful observation, and sensitive inquiry will go a long way toward uncovering reasons that may not be directly expressed. No doubt there is more to be said, but perhaps those comments will serve to start the conversation.
*Financial advisor is a general term as used in this US-based research paper. In Ontario, title legislation in the financial services sphere distinguishes between a financial advisor and a financial planner and requires specific credentials to use either term. Other provinces are also enacting legislation. Quebec bans the use of the term financial advisor altogether.
This is the 204th blog post for Russ Writes, first published on 2023-07-03
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Disclaimer: This blog post is intended for general information and discussion purposes only. It should not be relied upon for investment, insurance, tax, or legal decisions.
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