Should I Use a Financial Advisor?

Financial advisors–can’t live with them, but can you live without them?

Before I answer this, let’s clarify what I mean when I say “financial advisor.” There are two types of people who can call themselves financial advisors, those that purely provide advice and those that actually invest your money for you.

We’ll cover the ones that manage your money for you first. I’ll refer to them as money managers.

Money Managers (those who invest your money)

So, do you need a money manager? Not only no, but heck no. Why? They don’t always have your best interests in mind, they are sure to disappoint you with their performance, and they feed your dependence on them. Kinda like the Kardashians, but they are not as entertaining.

1. Fiduciary versus suitability standards

Similar to how financial advisors and money managers aren’t created equal, not even all money managers are created equal. Money managers are generally either licensed as an investment advisor, broker, or both.

Investment advisors are mostly paid a flat percentage of assets under management for their services. Their fees vary greatly but most start at 1%. This is not 1% of profits. They charge 1% of your portfolio regardless of if they made or lost you money that year. Since they aren't paid by commission, they’re less inclined to offer you products that don’t jive with your financial goals, which is a good thing. They also make more money by making you more money and increasing the assets under their management.

Brokers are primarily paid in commissions, when selling some type of investment (looking at you, life insurance salesmen). Because of this, brokers are incentivized to continually buy and sell assets that increase their profit. This frequent trading results in higher fees and more taxes for the people they represent.

They're also both held to a different standard of advice for their clients. Investment advisors are held to a fiduciary standard, meaning they are legally required to act in their clients' best interests when making investment recommendations. Alternatively, brokers are held to a "suitability" standard, meaning they can recommend "suitable" products for an investor. These “suitable” investment choices may just so happen to earn them a higher commission at your expense. Conflict of interest, much?

Even if you suspect someone is not acting in your best interests, proving this can be challenging. If your doctor knowingly prescribed you a less effective cure for your illness simply because they get a commission from their prescription of choice, you’d be mad. This is the risk you face when letting a money manager take the wheel of your finances.

It's even possible to be dually registered as both an investment advisor and broker, making it even more complicated. While there are plenty of money managers out there that genuinely care about your financial well-being, I prefer to steer clear altogether.

For those like me who read SparkNotes more than actual books during school…

Investment advisor = suspicious. Broker = bad.

2. Stock pickers suck at picking stocks

Well, at least money managers are professionally trained so they’re likely to make you more money than if you were to invest your money on your own, right? Wrong.

Money managers are bad at picking stocks. Like Wilson mentioned in this newsletter, even the great Warren Buffett knows this. And he put his money where his mouth was, winning a $1 million bet with a hedge fund that they’d underperform the S&P 500 over a 10-year period.

And if hedge funds with billions of dollars under management and the brightest financial minds making investing decisions struggle to beat the market, what makes you think Tim at Schwab knows the secret sauce to hacking the stock market? News flash: he doesn’t. No offense, Tim.

Even if your broker beats the market consistently over the short-term, they will more likely than not revert to the mean at some point. Passive index funds wipe the floor with almost all actively managed funds over longer investment periods. Almost 95% of funds run by money managers underperformed the S&P 500 over a 20-year period (fact check me, bro - see page 9). The number of failed Tims only increases over longer periods of time.

As a token of appreciation for their underperformance, money managers charge you hefty fees, shown as a percentage known as an expense ratio. The average actively managed fund charges investors 5x more in fees than index funds. Over time, these fees can eat away hundreds of thousands of dollars that could be yours to keep.

Now, can a money manager invest in index funds? Yes. Those that do are better than those that don’t. If you refuse to invest without a money manager, find one who exclusively invests in index funds on your behalf.

For my SparkNotes brethren, here’s your updated summary:

Money managers who day trade = most bad. Money managers who buy index funds = less bad.

3. Money managers feed your dependence on them

It’s in a money manager’s best interests to constantly convey how complicated investing is, making you feel unqualified and unprepared to manage your finances. Fearmongering can be an effective tool to keep you dependent on their services.

I've read and heard the following statement quite a few times, and it really grinds my gears. "You wouldn't try to perform surgery on yourself; you would trust a doctor to do it for you. Why would you try to handle your own investments?" If I had the right skills and could effectively perform surgery on myself, I'd choose to do so every time. The difference is that investing doesn’t require decades of education and practice. Investing is pretty simple once you know the basics. All the financial knowledge in the world is available to you online for free. I even have a newsletter recommendation for you if you want it. Develop the knowledge you need and perform your own vasectomy (metaphorically speaking).

Financial Advisors (those who provide you advice as you manage your money)

While I'm aggressively opposed to having other people manage your investments for you, I think it can be beneficial to have someone to discuss your goals with, review your finances, and refine your retirement plan with you (although this certainly isn't a requirement).

A good advisor or financial coach can arm you with the knowledge and confidence to make financial decisions. A second set of eyes on your portfolio can help expose any potential blind spots and poke holes in your plan, which can sharpen your portfolio and improve your confidence in it.

If you decide you want a second set of eyes to check your work or additional advice, visit an hourly-fee, fiduciary financial advisor. Find someone who gets paid exclusively for their advice and not for selling you a product. Find someone with experience in your areas of weakness to complement your plan and help you consider the entire picture. But for the love of God, don't have them manage your investments for you.

If you don’t have a good feeling about the one you’re talking to, look elsewhere. There’s no shortage of financial advisors out there.

At the end of the day, it’s important to invest time into learning how to manage your finances. It’ll give you confidence as you plan for retirement and help you properly vet a financial advisor, should you choose to use one.

Call to Action

If you have someone manage your investments for you, ask them to see your recent investment statements and look at how much money they’re charging you for their services.

What We’re Reading/Listening To:

Podcast: The $100 MBA Show. If you’re looking for bite-sized tidbits of actionable advice related to entrepreneurship and business in general, check out Omar’s podcast.

Debrief on Deck

Next week, Wilson will talk about the robotic alternative to financial advisors, Robo-Advisors. If a TI-84 calculator and Warren Buffett had a baby, a Robo-Advisor is what you would get.

As always, please reach out to us with any questions or comments you have. You can reply directly to this email or find us on social media (Twitter and Instagram).

Until then, stay the course.

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