In my upcoming book, I relay a story about a highly educated and accomplished woman who relies entirely on her husband and their financial advisor to make choices about her investments. I suggest that this might not be the best approach for her given that her husband has no more experience than she has with investments, and, also, given the track record that a majority of financial advisors have.
In short, they routinely fail to beat the market. I then go on to say that there are certainly excellent planners, but you won’t know who they are until you understand their approach and how to evaluate their performance.
When I sent out my manuscript for feedback, one financial advisor, Donna*, felt that this doesn’t reflect well on financial planners, and that it’s not an accurate portrayal of her practice.
I get it. It’s not fun to read critical commentary of one’s industry. Remember that I’m the lady who started a Rent to Own company nearly ten years ago when pretty much everyone thought that RTO was a scam and the people setting up the deals were either crooks or greedy jerks. It wasn’t much fun.
So let’s tackle the two questions that arise from Donna’s comments: Am I being unfair to financial advisors, and are my comments inaccurate?
Consider the following:
Do you need a financial advisor in order to put together an effective investment portfolio?
No, you don’t. Daniel R. Solin makes this point quite effectively in his short, easy-to-read book, The Smartest Investment Book You’ll Ever Read. Solin even provides suggestions regarding asset allocation (i.e. how much money you should invest in each type of investment class, such as stocks and bonds). For a much longer, in-depth look at this, read Tony Robbins’ book Money, Master the Game. Robbins has access to some of the best, brightest, most successful investors of all time, and during their interviews with Robbins, they shared their recommended asset allocations as well as their thoughts on the industry. Younger readers might prefer to read Ramit Sethi’s I Will Teach You To Be Rich.
You absolutely can do this yourself.
Should you do this yourself?
Not necessarily. It depends on your personality, your willingness to work out your needs, create a plan and then stick to it. If you’re a total DIY’er and the idea of investing lights your fire, then full steam ahead. Do your research, understand your current, medium-term and long-term needs, put together a risk-balanced, low-cost, market return-based portfolio which you re-balance roughly twice a year, stick to your plan, and you’re good to go. Adjust if your needs change.
If you’d rather stick toothpicks into your forehead, or you’re the kind of person who procrastinates when it comes to money issues, then having a guide is a wise choice.
If you have a complicated portfolio and you want someone to take a 30,000 foot view or keep an eye on things, then working with an advisor is a great idea. My husband and I have experience and interest on our side, yet we nonetheless choose to work with a team of advisors. Why? For us it’s simple: They know a lot more about tax than we do, and we want to be maximally tax-efficient in our investments. Tax considerations are critical.
Bottom line: Financial advisors can be a real asset.
What’s the catch?
Like it or not, the financial industry has a terrible track record when it comes to returns. It boils down to the fact that their funds or fund choices yield less than comparable benchmark index funds, and many advisors do not like it when that gets mentioned.
What that means for investors is that they would have been better off putting their money in a simple index fund and leaving it there, garnering what is called “market returns”. Nobel laureates, researchers, economists and countless financial writers have demonstrated that very few people or funds consistently beat the market (i.e. less than 4% – read above-mentioned books).
They have also demonstrated that the very best approach revolves around passive management (i.e. buy and hold) rather than active management – that is, buy and sell frequently, which triggers a host of costs and reduces the returns.
“Passive investing delivers market, not average, returns. And it does so in a relatively low-cost and tax-efficient manner. The average actively managed fund produces below market results, does so with great persistency, and does so in a tax inefficient manner. By playing the winner’s game of accepting market returns, you will almost certainly outperform the vast majority of both individual and institutional investors who choose to play the active game.”
– Larry E. Swedroe, Playing the Winner’s Game: Think, Act, and Invest Like Warren Buffet
“There is considerable academic evidence that active management (stock picking and fund picking) is not a value-adding proposition. In a large majority of cases, this activity fails to add value. Most advisors are unaware of this fact because they have never been taught about the comparative merits of active and passive strategies. Poor training leads to poor advice, and the advice consumers receive is tantamount to unsubstantiated, industry-specific folklore.”
– John J. De Goey, author of The Financial Professional Advisor; #8 on the list of Top 50 Advisors in Canada, Wealth Professional Magazine, Issue 1.2, January 2014
From my conversations with dozens of financial planners, it’s clear that most of them think they are “one of the good ones”. I have no doubt that their intentions are good and that they genuinely want to serve their clients well. But unless they utilize a passive approach centred on market returns, they are likely to fall into the category of underperformers. The math, and the research, are clear on this point.
The impact of seemingly small fees
If you think that the difference between 1% and 3% is negligible when it comes to fund fees and/or advisor fees, consider the following example found in Tony Robbins’ book (noted above): Three fictional childhood friends – Jason, Matthew, and Taylor -all have $100,000 to invest. Even though they select different funds, they all end up with identical returns of 7% annually. Thirty years later, they compare their returns.
- Taylor, who paid annual fees of 1%, ended up with $574,349.
- Matthew, who paid 2% fees annually, had $432,194.
- Poor Jason, who paid 3% in annual fees, had only $324,340.
Taylor ended up with nearly twice as much money as Jason, all because of a difference of 2% in fees!
As Robbins notes, “”Just” 1% here, 1% there. Doesn’t sound like much, but compounded over time, it could be the difference between your money lasting your entire life or surviving on government or family assistance. It’s the difference between teeth-clenching anxiety about your bills or peace of mind to live as you with and enjoy life.”
For another great article on the impact of fees, read Preet Bannerjee’s Mutual fund costs over time. You will not view a 2.5% fee the same again.
While the above may make it sound like I’m anti-advisor, I’m not. I agree with Banerjee that most people would probably benefit from working with one. That said, I have reservations about the practices that I’ve seen in the market place.
It is important to understand the key factors that affect your results, and to find an advisor whose approach is based on empirical evidence. Stock picking, market timing and active management will hurt your returns. The trick is to find someone who understands that.
David Chilton, author of The Wealthy Barber Returns, puts it this way: “Is your advisor worth one percent? I have no idea. Many are. Many aren’t. You already know that I don’t believe advisors are any better than the rest of us at picking future outperformers among the mutual funds. So I think it comes down to their financial planning guidance. Has your advisor helped you develop a plan? That’s obviously key! Does he or she offer tax advice? Assess your insurance needs? Work with you to build a portfolio of investments consistent with your goals and risk-tolerance level?”
Mark and I look for the following:
- Someone (or a team) who knows the tax system cold and can make tax-efficient recommendations.
- Someone who can evaluate our portfolio and help us make a plan.
- Must understand real estate.
- Passive management approach.
- For-fee only.
- No in-house product recommendations. We want to avoid conflicts of interest.
- Total fees under 1% (i.e. the fund fees in addition to the advisor fees must be less than 1%). If higher, there needs to be a compelling reason. We will not consider total fees greater than 1.5%.
I’m grateful to Donna for her honesty and her feedback. I sincerely hope that she uses the industry challenges to showcase her practice as an ethical, transparent and effective one, just as I had to do in Rent to Own several years ago.
*Not her real name.
(Quick note: Links to books in this post are affiliate links, which means I am paid a small commission if you buy using that link. There’s no extra cost to you and it helps to fund my work. I only recommend books I personally own and love.)
Doris, I love your blog and I want to read some of the books you suggested.
You know, a few years ago I was seeing what I thought was a fee only financial planner, but they kept deferring discussion of payment. I did a lot of work gathering information for them, and one of their top goals seemed to be selling us insurance! By the time we figured out that only my husband was able to get insurance (long story–history of a major illness etc) (luckily I work for the government so there is at least something) it seemed they lost interest in us and I felt we got no further ahead with our “plan.”
So, I think it should be very clear that you are paying UP FRONT for the service, and then and only then should you start working so hard to track down everything they need to see for the financial advice. Wondering if you agree?
Thanks R! Regarding your experience with the planner, I do agree that you should know up front what he/she will do for you, when they will start and complete the work, and precisely how they will be paid. I get all of that in writing before submitting any documentation. That way, everyone is on the same page regarding the work to be done, how much it will cost and how (and when) the planner will be paid. It also avoids wasting your time trying to get documents to them. That said, it’s a good idea to file all documents related to your net worth, for both spouses, in one place so that you have easy access to it when needed. It’s still a pain to compile it, but at least you won’t have to go chasing all over the house.
Thanks again for your feedback and good luck with your planning!
I totally agree with your opposition to active management. “Four Pillars of Investing” by William Bernstein was the book that persuaded me. You likely already know if it, but if not, I certainly recommend it. And I can’t wait to follow along as you bring out your second book… sounds like a great idea.
It’s been a while since I’ve read Bernstein’s book. It’s a persuasive read indeed. Thanks for reminding me about it.
Makes me appreciate our own personal financial advisor! Great points there Doris. One needs to be knowledgeable, even with a financial advisor. You give solid advice in an easy-to-grasp format.
Thanks Dawn. That’s just it – you need knowledge even with a financial advisor. Very important point.