The stock market is scary. I completely understand; there was once a time when I wouldn’t touch it with a ten foot pole. In fact, according to Ally Invest, 65% of survey respondents are intimidated by investing. It seems like a Wild West proposition, and surely only well-trained professionals are equipped to predict the future success of individual companies. You realize the potential of investing, but you wouldn’t know how to start. It’s probably best to pay a financial advisor for this service, right?
Some say the answer to whether you need a financial advisor is “maybe,” but I’m more strongly in the “no” camp. Here’s why.
How a Financial Advisor Gets Paid
According to Chris Hogan at the Dave Ramsey blog, financial advisors are paid in one of three ways. While the cost structures in the article seem reasonable, it’s rather important to note that I wholeheartedly disagree with one statement Hogan claims: “Over the long term, an advisor is going to make you more money”. Nay, I say. We’ll get back to that in a moment. First, costs…
Commission-only: Your advisor may charge a (seemingly small) commission to work with you and your money. Let’s say an advisor charges a 3% commission. If you have $10,000 to invest, you pay the advisor $300. Not too bad, right?
Fee-only: This is a fairly straight-forward hourly or flat fee for their time, much like an attorney will charge. This may be an hourly or fixed fee for financial advice or selection of services. Fees can run as low as around $150 per hour for hourly fees, and exceed $10,000 for retainer fees of annual financial planning.
Commission and Fees: You guessed it, this price structure is a combination of the two listed above. The financial advisor may sit down with you to discuss your plans at an hourly rate, and then pick some commission-based stocks, bonds, or mutual funds as an investment.
Financial Advisor Fees Crush Investment Growth
A 1% or 2% fee may sound really inconsequential, right? We’re still keeping 98%-99% of our money, so how can there be a problem?
Let’s look at an example:
The stock market as a whole returns around 8% yearly, on average, over the long-term. Let’s say I invest $20,000 today in a single broad-based whole-market index fund (on my own, no advisor). I also continue to invest another $10,000 yearly ($833.33 per month) for 40 years. That’s it, as displayed below in the model inputs.
The math shows that I will wake up and choke on my spit when I realize I have $3,025,045 in year 2059.
However, let’s say a relationship with an advisor costs me 2% per year. In essence, I’m effectively reducing the return to 6% per year. With the same investment schedule ($20,000 initial/$10,000 per year) in 40 years I wake up and realize I’ve only cleared $1,753,328.
That small 2% yearly fee will cost me well in excess of a million dollars, cutting my return by 58%!
And that’s assuming the advisor is picking funds that are in my best interest. That leads me to my next point.
Financial Advisors Make Money by Staying Busy with Your Money
A financial advisor may collect commission on the transaction of stocks, bonds, and other mutual funds. They’ve perhaps convinced you that they, a trained professional, have a special power to pick individual stocks that will “outperform the market” (run if you hear this). As such, they’ll need to be constantly evaluating your portfolio.
Their explanation seems reasonable: as individual stocks or bonds underperform, the advisor is warranted with replacing them with what he or she suggests are going to be better-performing picks. Interesting…
EXCEPT…every time your advisor shuffles around your portfolio, buying and selling and rebalancing, they are collecting further commission. It’s in their best financial interest, not yours, to be constantly screwing with your account.
And let’s understand one very important truth. No one — not Warren Buffet or anyone else — can accurately predict the future success of any given stock. If your advisor is that good, why would they be sitting at an Edward Jones on the third floor of a strip mall in a cheap suit? Wouldn’t they be sipping Rosé on the French Riviera right now?
Do you have a financial advisor now? Take a look and see how many transactions have occurred in the last year (regular contributions and asset allocation rebalancing withstanding). I’m guessing it’s a lot more than zero.
But Isn’t the Performance Worth It?
According to a brand new Wall Street Journal article, citing S&P Global, greater than 80% of actively managed funds underperformed the S&P Composite 1500 from 2008-2018.
For the vast majority of investors, the best you can ever expect is to match the overall market performance. Everyone tries to beat the market, they usually underperform, and in the case of using a financial advisor — they pay to underperform.
The goal of passive index investing is to simply track the performance of the stock market as a whole. And it works shockingly well.
A financial advisor can promise to do better, perhaps justifying their cost, but there’s a very high likelihood that your assets under management will underperform.
Where else in life would you pay someone for a service you can perform better for free?
When Might A Financial Advisor Be Warranted?
As I mentioned above and in many other posts, investing in the stock market is a psychologically demanding endeavor. Success requires you to stick with your plan (which is to only put money in, never out) during good times and bad.
If you can’t sit on your hands during a correction or bear market, when equities prices are free-falling, perhaps there is value in having the paid advice of a professional.
A financial advisor can be worth the cost of basic guidance to help design a plan, ensure proper asset allocation, and then keep you on that plan. What I don’t recommend is the heart of this article: assets under management.
You have every ability to create the value of investment returns on your own, and there is little additional value in the fees and commissions associated with someone handling your money. However, if you don’t feel absolutely 100% certain that you will stick to your plan, it might be worth the cost of having someone talk you off the ledge. Know thyself.
Remember Two Words: Fiduciary Duty
If you choose to move forward with a financial advisor, or if you already have one, ask if the advisor acts as a Fiduciary. If you wish to have your assets managed, it’s imperative to inquire of whether they act with Fiduciary duty, a legal responsibility to act in the client’s best interest.
A fiduciary financial advisor must act with great transparency and avoid making decisions with your money that don’t benefit you. Without this legal responsibility, you could be inadvertently putting your hard-earned dollars in the hands of a borderline criminal. Please, inquire of this if you are considering or already have a financial advisor.
Our Journey Without a Financial Advisor
As I mentioned in our two-part post on our investing strategy, I knew next to nothing when I tossed my first hard-earned dollar into the stock market around summer of 2011. And the truth is, I tried too hard. Hiring a financial advisor seemed like something for someone older, wealthier, and closer to retirement to do, so I tried my hand picking individual stocks with a small sum. I’m glad I was too cheap to hire someone.
I researched companies and assessed their potential for growth, and it was pretty much a complete waste of time. I should have just bought $10,000 worth of VTSAX. Doing that alone, with no further investments, we would now have nearly $25,000 from that just that relatively small purchase. That doesn’t include the piles of money we’ve since pounded into these accounts. Of course, an investing timeline should be considered over decades, not eight years.
From the start of our “time to get serious” passive investing strategy in early 2016, we’ve more than tripled our net worth. We’re essentially at a point now where we can never work again, all due to the exponential capital growth of our money in the stock market.
So am I telling you this to rub it in your nose? Of course not. I’m just trying to make the simple case that we’re normal people doing relatively simple, automated, brain-free investing. Over time, whether or not you partake, it matters.
So is there a 20% chance out there where some investing shark could have made us even more money, perhaps justifying their cost? Maybe…but I doubt it. Plus, we’re at a happy place, so I’m happy. What else matters?
So, How Can I Start Investing on My Own?
I’ve pasted our quick guide from our Part 2 of the CC Family Investing Strategy below. Please see that post for more details.
- Max out any tax-advantaged accounts you can. These include 401(k), HSA, IRA, 403(b), etc. You’ll pay less taxes by maxing out these accounts first. Exciting!
- If you have surplus funds, open a taxable brokerage account. Do this only after you’ve maxed out the tax-advantaged accounts, or if you are saving for something on a longer horizon, but before retirement. We recommend opening all accounts with Vanguard, wherever you have the option.
- Fund these accounts with low-fee whole stock market index funds. Allocations should be heavy on stocks and light on bonds. Keep things very simple, with no more than 2 or 3 funds.
- Regularly contribute to these accounts. We have an automatic contribution that is made to our taxable account at the beginning of each month. All other contributions are automatic through our employer and are deducted from our paychecks.
- Don’t pay attention to the market. I’m going to keep saying this. The reason the stock market gets a bad rap is because of speculation and emotion. Success requires 100% trust and discipline to the plan.
Summary
It’s been shown time and time again that a financial advisor probably will negatively impact your bottom line in the long run, often substantially so. You can 100% do this on your own, securing your financial future with surprisingly little effort. It’s really not that difficult once you’ve dialed in on how to save money. Damnit it’s great, give it a go!
However, if you simply can’t fathom the idea of investing on your own, or don’t trust yourself to stick to the plan in bad times, some basic financial guidance can be appropriate. It’s better than not investing at all.
If you decide to move forward with a financial advisor, please make sure they act with Fiduciary duty, bound with ethical and legal standards to act in your best financial interest. Stay downwind of the predators, my friend.
Remember, the best laid plans mean nothing if you can’t take action today. Have questions? Need some feedback? Hit us up on the Contact page.
We talk about investing and investment strategies here. Please remember, we are not financial professionals and only speak from our own experiences. We are not responsible for any decisions you make from information gathered on this site. More over at the Disclaimer Page.
Another “cost” of financial advisors to consider is Capital Gains Taxes. A smart investment strategy works to minimize taxes paid on investment gains. Many Financial Advisors do not consider the tax implications of their endless fiddling with “your” portfolio, and this can lead to huge tax bills that could have been avoided by holding investments until your Taxable Income is vastly reduced (like it will be in retirement).
TLDR: We had a Financial Advisor for a while, and it was the biggest financial mistake of our lives—it cost us tens of thousands of dollars over a ~5 year period.
Excellent point, thanks Mark. Taxes are yet another reason for a set-it-and-forget-it investment strategy. At least until — as you pointed out — you are withdrawing in a much lower tax bracket (i.e. you are retired or make a very modest income).