What do financial advisors do?
Investing is scary. I'll be the first to admit that at times I am scared of investing; and that's after years of reading about the topic and even working at a wealth management company. Because investing is so scary, and it's something that is so important to our future, it’s only natural to look to someone with deep experience in the area.
It’s not too different from other areas of life. Although many people do their own taxes, there is a certain feeling of security that comes from entrusting your taxes to your accountant, knowing they will “take care of it.”
A good financial advisor will help you get to where you want to be
So what does a financial advisor do? A good one will do a lot of things!
An initial financial review and discussion about life goals, expenses, etc
Help creating a budget and savings plan
Assist with selecting investments and asset allocation
High level tax minimization techniques
Advice for large purchases (e.g. home, wedding, etc)
Sounds awesome, right? There’s just one problem…
There is one thing that is important to keep in mind: investment advisors are paid help, and many people will never be able to pay them enough to get really meaningful and personalized advice. What’s more, there are a lot of people who market themselves as investment advisors but who are only thinly veiled salespeople working for large insurance and investment companies.
Although I think it is a good idea for everyone to seek investment advice, it is very hard to pay them enough to get the in-depth and personalized attention that everyone deserves. This leads to templated, cookie-cutter advice. Plus, there are tons of useful tools that can help to achieve some of the same benefits of investment advisors without their return-sapping fees.
Let’s start at the beginning, though. Why is it so hard to get good advice from investment advisors?
Why it’s hard to get the attention you deserve from investment advisors
Let me outline an enormously depressing fact for you: unless you have upwards of $10,000,000, no investment advisor or wealth manager is going to be able to spend the time and care on your investments that you deserve. If you have over $10,000,000, well then I honestly have no idea why you are reading this. Get back to your yacht, sailor.
Anyway, as I was saying, wealth managers are generally paid either by a percentage of assets under management, or by a flat rate fee ($1000/yr, for example). I’ll take a look at both in this post.
Disadvantages of wealth management with fees for assets under management
First of all, this model incentivizes the manager to take outsize risks to increase the amount of assets under management, and therefore their fee. They might put 25% of your portfolio in a risky junk bond fund, rather than the 5% that is actually prudent.
Second, fixed percentage fees are an enormous weight on returns: even multi-millionaires often pay 1-2% per year, and potentially even more through other fees. At the wealth management firm I worked at, only the 9 figure investors were getting a relatively fair rate: .25-.75% of assets per year. Why'd they get such a good deal? The more money you have, the less the advisor has to charge you as a percentage of your assets to cover their costs. The work an advisor has to do to invest a $100,000,000 portfolio is far far less than 100x the work it takes to invest a $1,000,000,000 portfolio.
What I am trying to say here is that even people with 7 or 8 figure portfolios can end up paying an enormous cost for traditional wealth management that is tied to assets under management.
What about advisors where you pay a flat fee? That has it's problems as well.
Disadvantages of wealth management with a flat rate fee
First of all, a fee is a fee. If I pay an investment advisor 1% a year to manage $1,000,000, then I am out $10,000. If I pay an investment advisor a $1,000 fee to manage $100,000... I am still paying 1% a year!
The sad part is that you can't get much advice for $1000, or even $10,000.
If you have a Harvard MBA investment advisor who makes $200,000 a year (+), $1000 only buys 1/200th of their time in a given year. That's just a single workday (given that we work about 210-230 days a year). $10,000 buys you 10 workdays of effort, but who can afford to pay $10,000 a year? Someone who has millions of dollars already. This is simple math. If you have $500,000, even a relatively reasonable 1% fee is still just $5,000.
Why am I obsessing over a 1% fee (or even less?). Over the long run, those fees compound and compound. Take a gander at the chart below. Even with a modest $100,000 portfolio, a small 1% fee could add up to over $40,000 in returns over 20 years.
What type of advice do investment advisors give?
Because most people can't realistically afford to pay very much to their fee based investment advisor without severely damaging their returns, they get cookie cutter advice and templated portfolios. I'm not just guessing on this - I actually tried out a couple of fee based advisers. Pay $500, get a consultation and recommendations. I filled out some worksheets, put in my vital financial stats, and had a 30 minute meeting with my adviser where they gave me a 4 or 5 fund lazy portfolio and advised me to save more. That ticked me off.
I told both of these advisors that I was extremely risk tolerant. I wanted to take more risks, with the understanding that I would be in the market for the long haul and I could handle a 40-50% pullback in exchange for greater returns over the long run. In both cases, they advised me to have an asset allocation close to 30% in bonds, with the majority of my investments in the US market and 10% or less in emerging markets.
Based on my age (30-ish), I'd say that allocation is middle of the road. Definitely not aggressive, but not super conservative. But I'm a unique individual. It was very conservative for me, and I don't like how concentrated it was on the US market. Even worse, if I had followed their advice, I would have around 10% less in my portfolio than I do now... and that's only over three years!
Where can you get good investing advice for free?
Now, to be clear, I am not saying that you shouldn’t get an investment advisor. My only point with this post is that investment advisors will not have the time to give you the personalized attention you deserve unless you are a multi-millionaire. So, I plan to pay for cookie cutter advice on a periodic basis, but I also take their advice with a grain of salt and am educating myself in other ways.
Learn about index investing at Bogleheads
Bogleheads is a fantastic online forum named in the spirit of Jack Bogle, the founder of Vanguard and the father of index investing. The basic premise of index investing is that, on average, it is very hard for individual investors to correctly choose the right stocks to outperform the market. It’s better to just buy an index.
The forum has now expanded to cover everything related to investing and personal finance. It’s a great read!
Create and test your portfolio with Portfolio Visualizer
Portfolio visualizer is an incredible, free tool that you can use to test the theories and investment strategies you learn at Bogleheads. Go on, take a look and model a few portfolios! Obviously you’ll want to read my full post on the subject, as well.
Keep track of your portfolio with Personal Capital
I use tools like Personal Capital to provide me with customized investment advice tailored to my risk profile. Using Personal Capital I can connect all of my accounts and see my performance over time, for free.
Pay for the advice once or twice, but do your own homework too
In summary, investment advisors are an important resource that everyone should consider and periodically use. However, it is important to remember that they cannot always give the attention or time to give customized advice. That is why I always do my own research and budgeting as a supplement to professional advice. Maybe some day I will have enough money that I can get the personalized attention I deserve, until then I will have to stay engaged with my own financial plan.