You don’t need a financial advisor

You don’t need a financial advisor. In fact, you’re better off without one. In most cases, you will be dramatically better off acting as your own advisor. However, you may be saying, “but I don’t know anything about investing” or “I don’t have time to deal with it.” But here are some truths the institutional investment community hopes we don’t learn:

  • It’s extremely unlikely your advisor has any useful knowledge that you do not
  • One way or another, advisors are expensive
  • Advisors are not incented to serve your best interest
  • Successful investing isn’t that hard or time consuming

We learned these things the hard (and expensive) way. It’s been several years since we fired our financial advisor. Below I will cover each of these bullets point by point so perhaps you can avoid the same mistakes we made.

Professional looking man describing a chart to a young couple. Perhaps a financial advisor looking for new ways to rip off his clients.
That’s not us or our financial advisor (or us), but it still kind of looks like the guy from the stock photo is full of it.

It’s extremely unlikely your financial advisor has any useful knowledge that you do not

Over time, no one can successfully time the market or pick individual stocks. There are numerous studies and articles that explain this, but I think it’s most compelling to hear the advice of perhaps the only human being who has ever been successful in picking stocks over a long period of time.

In Warren Buffett’s 2013 annual letter to shareholders he shared the investment advice he had provided to his wife in the event of his death.

“My advice to the trustee could not be more simple. Put 10 percent of the cash in shortterm government bonds and 90 percent in a very lowcost S&P 500 index fund. I believe the trust’s long-term results from this policy will be superior to those attained by most investors—whether pension funds, institutions, individuals—who employ high-fee managers.”

The most prolific individual investor in the history of the US stock market, who has an incredible network of financial wizards at his disposal, doesn’t believe there is a more effective method of investing than purchasing low-cost index funds.

WASHINGTON, DC – OCTOBER 13: Warren Buffett speaks onstage during Fortune’s Most Powerful Women Summit – Day 2 at the Mandarin Oriental Hotel on October 13, 2015 in Washington, DC. (Photo by Paul Morigi/Getty Images for Fortune/Time Inc)

Convinced that if you work hard enough you can beat passive investors? Think again.

I historically believed that if someone worked hard enough studying a specific company or industry that they could certainly beat the other (lazy) investors. My personal experience has led me to believe this is absolutely false. In my previous job I worked in the finance department of a major publicly traded company. As the chief finance associate of a major division, I was a financial insider that routinely helped prepare external press releases and financial disclosures. Inside the company, we always joked that even with 100% proprietary and confidential information in advance there was no way to reliably predict how the price of the stock would move after the release. Even if insider trading was not an extremely serious federal crime, it would mostly be ineffective since you need to not only understand the financial information, but more importantly, understand how the market (i.e. individuals with their own, often misguided, perceptions and expectations) will react to those results.

Insider trading should always be avoided. Not only is it unlikely to be very profitable, finance guys probably don’t do well in federal prison.

What other kind of advice might an investment advisor have?

Another type of knowledge advisors could potentially have would be strategies for tax minimization. Unfortunately, most advisors are unfamiliar with the strategies that early retirees should be considering. I found myself constantly bringing ideas to my financial advisor versus the other way around. I am certain that the guy who manages my parent’s retirement funds (whose previous work experience is comprised entirely of managing a car wash) is not qualified to do anything other than push the funds his superiors tell him to.

Car entering an automated car wash. Seems unlikely running a car wash adequately prepares you serve as others' financial advisor.

Investment advisors are expensive

Many people (including my own mother) like to argue this point with me. “I don’t pay them anything” is a common (incorrect) perception. There’s actually a lot of creative ways that investment advisors get their hands on your money. And even if it doesn’t seem like a lot it can really add up. At the point I started questioning the value of the advice we were receiving from our financial advisor, I did what I always do…. I prepared an Excel spreadsheet. I had started looking at the funds our advisor had recommended and I was blown away at how expensive they were to own. I did some quick math to arm myself for a discussion with our advisor.

We paid way too much for financial advice early in our journey to financial independence

Being the inexperienced suckers that we were, we had been paying fees in three different ways. (We’ve made many poor spending and investment decisions. We’ll cover as many as we can in future posts. A few of them are listed at intothemiddle.com/about/.) First, we had paid a few hundred bucks up-front for a “comprehensive financial review.” We got some impressive looking charts in a fancy binder, but I’m not sure what it was good for aside from potentially propping up the leg of a very wobbly table.

Large group of binders. Probably some boiler plate financial plan that looks impressive but provides no value.
Maybe not this many binders, but it was a big pile of unhelpful boiler plate crap that looked really pretty.

We were invested in funds that were very expensive. These were separated by the company as “A Shares” and “B Shares”. With the B Shares the expense ratio of the fund was 1.3%. At the time, I compared this to the 0.06% expense ratio of Fidelity’s total stock market index fund.

Was our advisor really so awesome that she could beat the stock market by 1.24%?

Of course not. No one could consistently perform that well. What was even worse was the expenses on the “A Shares”. The name alone makes them sound superior; however, it appears they were only superior from the investment company’s perspective. With these funds, we weren’t only paying an expense ratio of 1.3%, but also a “management fee” of 1.2%. “Management fee” was basically a fancy name for them taking 1.2% of our invested money each year for the “privilege” of being able to invest in this supposedly superior fund. There was effectively no chance we could get a decent return on any dollars invested in this fund.

Do the fees your investment advisor charge really make that big of a difference?

Therefore, I took the following comparisons to our investment advisor to give her the opportunity to review my analysis and point out anything I may have gotten wrong. Using an imaginary investment of $10k per year I looked at how much the advisor would need to outperform the overall market to cover her fees and also what the performance would be after 19 years if she did not outperform the market.

First, to invest $10k per year and reach $300k after 19 years we would need the following returns:

Table comparing different growth rates necessary for a financial advisor to pay for their own fees.

Looks scary, but even more astounding is looking at the difference in real dollars if (as one would expect based on all available research) these “special” and expensive funds do not perform any better. The chart below assumes that each fund produces and 5% return (before fees).

Chart and table showing that is extremely unlikely that a financial advisor could pay for themselves and it could cause extreme damage to your ability to reach financial independence.

As you can see, you don’t really notice a difference in any particular year, but over time the differences are drastic. Investing in index funds versus the high fee fund with which we were invested would have produced nearly $80k less in returns over 19 years. Subsequent to this discussion with our advisor, Fidelity started to offer a zero fee index fund, which I also included this in the graph. However, the differences (even after 19 years) between 0.06% and 0.00% are fairly negligible (about $2k).

Advisors are not incented to operate in your best interest

It is more profitable for financial advisors to put you into high-fee investments. Therefore, advisors have an inherent conflict of interest that would be difficult for even the most honest advisor to overcome. To put you in funds that will likely make you more profitable, they must purposefully lower their own income. I personally believe that most investment advisors are good people. However, as human beings we tend to believe what we want to believe. Therefore, when advisors are being told by their superiors and fund managers that certain funds are superior to other more passive approaches and it would be best for themselves and their clients to purchase those particular funds – it’s difficult for them to resist. Advisors will typically refute this type of conflict with worthless sayings like, “the more money you make, the more money I make.” While this may technically be true, who cares? They also continue to make money off you even if they are doing a terrible job. They are definitely not saying, “if you don’t make money, I don’t make money.”

Successful investing isn’t that hard or time consuming

It is way easier than anyone (especially financial advisors) want you to believe. If you think it’s hard or time consuming, you’re doing it wrong. Invest in low-cost total stock market funds and leave it alone. That’s it. Trying to get fancier than that is likely going to hurt your returns, increase your expenses or both.

You don’t need a financial advisor. In fact, you really, really don’t want one.

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