I recently received a question from one of the subscribers to the 52-Week Financial Game Plan that seemed like an excellent topic to share with all of you.
This person asks:
As I read more and more on the topic of financial planning, it seems there are 2 factions. One faction is the adviser that manages/advises mainly on matters concerning investments (IRAs, retirement, etc.). The other seems to be the nuts and bolts kind of guy……answers questions on insurance, budgets, everyday financial concerns, and such.
Can you get both in one or, at least to get started, with regards to advice, should these two different interests be handled by one adviser or separated?
Once on the road, what is the function of an adviser? Do you see it as that of a physician, checking in from time to time and providing a check-up, getting you back on the straight and narrow when need be, or someone actively reaching out when they sense a concern?
To which I replied:
Mr. or Mrs. X–
I’d offer a slightly different take on your division. To me, there are two types of advisors:
- The person who wants to invest your money for you takes a % of your invested assets each year, and for whom the financial planning is ancillary. The financial planning is a loss leader for the assets under management fee that he will get every year from you. There’s a big discussion going on in the financial planning industry about the role of financial planning as it relates to getting people to invest their assets with financial planners. The planning runs from “invest your money with me! Goodbye!” which you’ll get at any of the strip mall “financial advisory” firms (you can probably figure out the names of the firms to whom I refer). They’re giddy when you buy 5.9% front loaded mutual funds and then pay 1-2% of your assets each year on the back end. The other end of the gamut are the firms who will still take some percentage of your assets under management each year but will go through an entire financial planning process with you, covering estate planning, tax planning, financial management, and the like, minus teaching you about investing, since that’s what they want you to think they can do better.
- The person who won’t manage your money and will do the entire gamut of financial planning, including teaching you how to invest your own money. This is what I do, so I have an obvious bias, which I’ll explain shortly. In general, these people either don’t want to deal with the hassle of the regulatory requirements associated with having a broker-dealer relationship and investing your money for you (which is not insignificant) or they don’t feel like managing someone else’s money is in the best interest of their clients.
I fall into the latter of the latter categories. There are few of us out there (I feel like a wizard in Middle Earth – strange and rare) because, honestly, there’s just not a lot of money in it. An average engagement with me will cost around $2k (give or take), and even though I’m a lot cheaper than someone who’s charging a percentage of assets under management, due to cost deferral and the fact that Monkey Brain doesn’t have to ever stroke a check for the services, it’s easy to pretend that the costs aren’t there and that I’m actually more expensive than the investment advisor who’s charging you that percentage of your assets that he “manages.” Therefore, there are few people who a) have the strong convictions about what they do like I have, and b) have the financial wherewithal to have a comparatively low income from what they do (which I do, thanks to both my own prudence and to selling a company), since this route is not as lucrative as taking 1% of their client’s money every year. My goal is to teach my clients what they need to know, and then, unless they just want a check up, or their life circumstances change (“you mean Bill Gates was my illegitimate uncle and I’m inheriting everything from him?!?”), they shouldn’t need to come back.
Thus, the decision really comes down to a tradeoff of time for money. If someone REALLY wanted to, they could scour the Internet for every piece of relevant information that is out there, or take the CFP core courses, and get a pretty significant portion of the knowledge I possess. There are a ton of DIYers out there who spend a lot of time on Bogleheads and other similar forums and sites doing just that. Or, they can have the teaching tailored to their needs and pay for the education.
Now, back to why I think model #2 is superior.
- Conflict of interest. If I’m managing your assets, then I have an incentive to grow those assets as much as possible. Sounds good in theory, but in reality, it means that I’m encouraged to take inappropriate risks, which, more often than not (discussed below), wind up not working out the way that they were supposed to on paper, and you wind up with even less. Once you’re down some, I’m encouraged by prospect theory to try to win it all back – effectively a Martingale system for investment management.
- Nobody can systematically and consistently outperform the market in a replicable manner. Statistically speaking, investment performances are more and more a function of luck than skill (see my article “Do You Have to Be Lucky to Beat the Market?” for more). As a result, you’re paying what could wind up to be a significant portion of your potential net worth to someone to, from a probability standpoint, underperform the market.
Therefore, with regard to your question about the fees you paid, you have to ask yourself two questions:
- If I simply went with an appropriately allocated index strategy, what would my returns have been compared to the returns I received?
- What guarantees that I’ll continue to receive the same investment performance, relative to an appropriately allocated index strategy, year over year?
Unless you simply do not have the time because you’re pursuing activities which have a higher value to you than the few hours a year necessary to manage your own portfolio or you do not have the cognitive ability to do said management, I see no reason why you (or anyone) should be paying someone to invest your money for you and run a high probability risk of underperforming the market.
Furthermore, the level of effort to manage a $1 million portfolio is not twice as much as the level of effort to manage a $500,000 portfolio, so why do people who pay others to manage their money get charged twice as much?
By the way, I did not even include commission-based front-load mutual fund salespeople, because they’re not worth me wasting my breath on. Spend money with them and you’re lighting it on fire.
You’re darn right, I’m biased.
What do you think? Sound advice or am I blowing smoke? Tell us your thoughts in the comments below!