Last week I sat down with a gentleman, an old friend of mine, who wanted some advice.

First, a brief history . . .

Many years ago I had offered him some suggestions on how to allocate his Vanguard funds within his 401k plan.  He ended up owning a Coffeehouse type diversified portfolio of low-cost index funds.

Active vs. Passive Funds

During our recent meeting he informed me he is switching jobs and thinking of rolling his 401k into an IRA.  He had met with a financial advisor who wanted his business and had presented to him a proposal similar to his current allocation.  However, this financial advisor didn’t recommend low cost index funds, but a line-up of 5 to 7 actively managed funds, all ranked 4 or 5 stars by Morningstar’s rating service.

So I offered my friend some advice:  Stick with the low cost index funds and get on with your life.  After our meeting, I got to thinking . . .

• Why aren’t there more financial advisors out there who embrace the simple Coffeehouse Investor philosophy when constructing diversified portfolios for their clients?  Why are they all so obsessed with “beating the market?”

• When a financial advisor/stockbroker recommends actively managed 5-star mutual funds, they are setting themselves up for a fall, because the client is then inclined to judge the advisor on his or her ability to pick the top performing funds.  What does the advisor do 3 years from now when a 5 star fund turns out to be a dog? Switching to another 5-star fund is what most advisors do, even though this strategy kills long term performance.

• Unfortunately, most advisors think that they bring value to a client by picking top-performing stocks and mutual funds.  That is a big mistake, in fact it is ridiculous. The real value an advisor brings to a client is to help clients clarify financial goals, and then implement a plan, build a portfolio, and work with a client to achieve those goals over time through life changes and market changes.

• When a client and/or advisor start focusing on top performing funds, they focus their attention on something that is largely irrelevant, if not counterproductive to building wealth; one’s ability to beat the market.  Instead, both client and advisor should be attending to financial planning issues that matter most of all, like building a tax efficient portfolio, like rebalancing and risk-monitoring, and discovering whether or not one’s saving and spending are on track to reach short and long term goals.

Sadly, I don’t think we are going to see much change in the dynamics of a client/advisor relationship anytime soon, which is too bad, because more folks than ever before could benefit from some common sense financial guidance.

Have you had any experiences like the one mentioned above when seeking out financial advice?  If so, post a comment, and let the readers know how you stand on this topic.