Do I need a financial advisor?
Why do I need a financial advisor?
It's a question everyone asks at some point. I know, investing is scary. I'll be the first to admit that at times I am scared of investing; that's after years of reading about the topic and even working at a wealth management company. Because investing is so scary, and it's something that is so important to our future, most people decide to hire an investment advisor instead of doing the work themselves.
But investment advisors are paid help, and most people will never be able to pay them enough to get really meaningful and personalized advice. I'll get into the math a little bit below if you don't believe me. Perhaps even more importantly, an investment advisor will never know you, your risk tolerance and your goals as well as you know yourself. For some, it may make more sense to avoid professional investment advisors and manage their own portfolio.
Why investment advisors aren't worth the money
Let me outline an enormously depressing fact for you: unless you have upwards of $10,000,000, no investment advisor or wealth manager is going to be able to spend as much time on your investments as you can. If you have over $10,000,000, I honestly have no idea why you are reading this. Get back to your yacht, sailor.
Anyway, as I was saying, wealth managers are generally paid either by a percentage of assets under management, or by a flat rate fee ($1000/yr, for example). Paying by percentage of assets under management (AUM) has been becoming more unpopular recently. There are a couple of reasons for that.
Disadvantages of wealth management with fees for assets under management
First of all, this model incentivizes the manager to take outsize risks to increase the amount of assets under management, and therefore their fee. They might put 25% of your portfolio in a risky junk bond fund, rather than the 5% that is actually prudent.
Second, fixed percentage fees are an enormous weight on returns: even multi-millionaires often pay 1-2% per year, and potentially even more through other fees. At the wealth management firm I worked at, only the 9 figure investors were getting a relatively fair rate: .25-.75% of assets per year. Why'd they get such a good deal? The more money you have, the less the advisor has to charge you as a percentage of your assets to cover their costs. The work an advisor has to do to invest a $100,000,000 portfolio is far far less than 100x the work it takes to invest a $1,000,000 portfolio.
What I am trying to say here is that even people with 7 or 8 figure portfolios get epically screwed by traditional wealth management. What about advisors where you pay a flat fee? That has it's problems as well.
Disadvantages of wealth management with a flat rate fee
First of all, a fee is a fee. If I pay an investment advisor 1% a year to manage $1,000,000, then I am out $10,000. If I pay an investment advisor a $1,000 fee to manage $100,000... I am still paying 1% a year! The sad part is that you can't get much advice for $1000, or even $10,000. If you have a Harvard MBA investment advisor who makes $200,000 a year (+), $1000 only buys 1/200th of their time in a given year. That's just a single workday (given that we work about 210-230 days a year). $10,000 buys you 10 workdays of effort, but who can afford to pay $10,000 a year? Someone who has millions of dollars already. This is simple math. If you have $500,000, even a relatively reasonable 1% fee is still just $5,000.
Why am I obsessing over a 1% fee (or even less?). Over the long run, those fees compound and compound to significantly reduce your returns. Take a gander at the chart below. Even with a modest $100,000 portfolio, you could be giving up over $40,000 in returns over 20 years for a 1% return.
When should you get an investment advisor? When you need cookie cutter advice.
Because most people can't realistically afford to pay very much to their fee based investment advisor without severely damaging their returns, they get cookie cutter advice and templated portfolios. I'm not just guessing on this - I actually tried out a couple of fee based advisers. Pay $500, get a consultation and recommendations. I filled out some worksheets, put in my vital financial stats, and had a 30 minute meeting with my adviser where they gave me a 4 or 5 fund lazy portfolio and advised me to save more. That ticked me off.
I told both of these advisors that I was extremely risk tolerant. I wanted to take more risks, with the understanding that I would be in the market for the long haul and I could handle a 30-40% pullback in exchange for greater returns over the long run. In both cases, they advised me to have an asset allocation close to 30% in bonds, with the majority of my investments in the US market and 10% or less in emerging markets.
Based on my age (30-ish), I'd say that allocation is middle of the road. Definitely not aggressive, but not super conservative. But I'm a unique individual. It was very conservative for me, and I don't like how concentrated it was on the US market. Even worse, if I had followed their advice, I would have around 10% less in my portfolio than I do now... and that's only over three years!
Here's the bottom line. Compared to investing on your own, you can just as easily lose money, miss out on gains, or make an investment mistake with an advisor who doesn't know or understand the intricacies of your goals and risk tolerance. Plus, with tools like Personal Capital to provide you with customized investment advice tailored to your risk profile, you can get a bespoke portfolio for free.
So... if you have a ton of money, or you aren't willing to do the work yourself, feel free to pay an advisor or even a wealth manager. You probably should. If you're like me and you're willing to put in some effort, and take a bit of a risk, you should be able to get a decent return investing on your own with fewer fees.
Next week, I'll take a look at the basics of managing your own portfolio.