My Financial Advice? Be Skeptical Of Financial Advisors
If (like me) you have a really really nice friend who’s willing to share her HBO account with you, I highly recommend watching this movie. Not only are the performances great, but you’ll also learn a lot (especially how bad things can go when you trust the wrong person with your money).
Not coincidentally, this leads to today’s letter.
Who can you trust with your money?
Ah, that’s a tough one.
In fact, I think this might be one of the hardest problems to solve if you want to reach financial success.
Let’s see why.
Can you trust an advisor?
It sure seems like most people do.
The number of Americans who use a financial advisor increased from 28% in 2010 to 40% in 2015.
You can’t blame them though. Not everyone loves finance as much as I do, so why would they spend hours studying the subject? After all, most people have better things to do (like spending time with their friends and family or traveling around the world).
This does create a problem though. This “blind trust” makes people very vulnerable preys to all the charlatans out there.
Who are these advisors?
It’s a big pool. Especially since there are over 200 (!!) designations for financial advisors (e.g.: “wealth managers”, “investment consultants”, “financial consultants”, etc…).
According to Tricia O. Rothschild (Morningstar’s CPO), there are something like 310,000 financial advisors in the U.S. now!
“Gee, that’s a lot of people. Who can I trust?”
I’m sure many of them are great people. But I’d rather err on the side of caution and say “almost no one.”
Why? Well, let’s take a deeper look at those 310,000 people.
1. 90% of them are Brokers. [279,000 people]
This means these people are paid (via commission) every time they sell you a financial product.
Remember Matthew McConaughey in Wolf of Wall Street? Yeah, that guy.
“What’s wrong with them?”
Have you not seen the movie?!
Your benefit is not the broker’s priority. They just want to sell you as many products as they can (whether or not those products do well doesn’t matter, they already got paid).
I’d stay away from them.
“Your broker is not your friend” — David Swensen (Yale University Chief Investment Officer)
2. 8.4% of them are Brokers AND Fiduciaries. [26,040 people]
These are the sneakiest of the bunch. All because they found a gray area in the legal system.
Be very careful with these people.
Why? Because they start by telling you they’re fiduciaries (see below). This is how they get your trust.
However, at the same time, they have a broker license!
What does this mean? That you never know whether the advice they’re giving you is as a fiduciary (good for you) or a broker (good for them).
Nasty, nasty people.
3. Only 1.6% are pure Fiduciaries. [4,960 people]
These people, by law, have to put your interests ahead of their own.
This means that whatever advice they give has a high chance of being good.
“Why are there so few of them?”
Because they make a lot less money than brokers.
However, the right fiduciary can be great for you. They can help you with your taxes, your assets, and all your investments.
Sidenote: This is where the UK and Australia have a leg up on the US. They have what is called a “fiduciary standard”. Which means every financial advisor is required by law to act in their client’s best interest.
At the same time, right now I don’t think you need an advisor.
“What?! But I want someone to manage my money!”
I think this is a great idea if you have a high net worth and/or several assets (many real estate properties, for example).
However, this series isn’t aimed at multimillionaires. It’s aimed at future multimillionaires!
Until you have a high net worth, several assets, several investments, and more than 2 people living under your roof, you don’t need someone else to manage your money.
Sidenote: If you don’t want to listen to me, fine. Send me an e-mail and I’ll send you some good recommended tips before picking a fiduciary. I tried adding them here but it made this letter too long. Either way, I don’t think 99.9% of people reading this need an advisor, at least not right now.
Here are some possible excuses.
Their fees are really low.
You’ll pay more than you think.
Let’s say you ignore me and decide to go with an advisor. What will she charge? Let’s say it’s “only” 1%.
“Oh, come on Richard. I can afford 1%!”
Sure you can, but here’s the problem.
On average, when you invest your money you’ll get a 7% return per year.
However, inflation will eat 3% on average. Leaving you only with a 4% profit.
But wait! Remember you’re paying your financial advisor 1%? That means you only get 3%. Which means 1/4 of your profits will go to someone else!
And remember, their fees range from 0.75% to 1.5%. Depending on the advisor.
I’d rather keep my money.
I really trust my advisor.
As JL Collins said, “Advisors are expensive at best and will rob you at worst.”
If you’ve watched “The Wolf of Wall Street” or the HBO movie I recommended at the beginning, you know how bad things can go if you trust the wrong person with your money.
I’m not saying your advisor is stealing your money. I’m saying “I trust my advisor” is a weak argument.
Where else can you put your money?
First I have to remove the thought of “Mutual Funds” from your mind. Forever.
What is a Mutual Fund?
A Mutual Fund is a company created by a group of people with the goal to invest your money for you.
Their promise? That they’ll “beat the market.”
You put up all the money (of course, they charge many fees). They’ll invest it. If their investments go wrong, you pay the full price. If their investments go right, you both share in the profits.
Sounds like a horrible deal right? It gets worse.
Mutual Funds charge astronomical fees.
In 2016, there were 9,511 Mutual Funds in the United States (funnily enough, there are only 4,900 individual stocks).
Why so many, you ask? Because they make a boatload of money.
Remember I criticized financial advisors for charging 1%? Well, many Mutual Funds charge an average of 3.93%!
If you made 4%, you only get to keep 0.07% of it. Woo!
How’s that for fair?
“Some years ago, a Wells Fargo representative was asked how the firm could justify such high charges. The answer: ‘You don’t understand. It’s our cash cow.’” — John Bogle
Most Mutual Funds have horrible results
When I say “most”, do you think I mean “a little over half”?
Dead wrong. When I say “most”, I mean 96% of Mutual Funds fail to beat the market over a 15-year period!!!
“So, shouldn’t I simply pick one of the 4% that beats the market?”
Nope. The 4% changes constantly!
Even Mutual Fund managers don’t trust Mutual Funds
According to data provided by Morningstar, only 49% of mutual funds have at least one manager who has invested in the fund!
If they don’t trust their own product, why would you?
The final nail in the coffin — You shouldn’t trust their ratings either
“What about Mutual Funds with a 5-star rating from Morningstar?”
A study looked at all the Mutual Funds with a 5-star rating in 1999. There were only 248 of them.
What happened after 10 years? Except for 4 of them, EVERY mutual fund lost their 5-star rating!
What are the odds that those who have a 5-star rating today will still have the same rating 10 years from now? Very very low.
“The mutual fund industry is now the world’s largest skimming operation, a $7 trillion trough from which fund managers, brokers, and other insiders are steadily siphoning off an excessive slice of the nation’s household, college, and retirement savings.” — Senator Peter Fitzgerald
My advice? You don’t need advisors.
In the past, it’s understandable people needed banks and businessmen to help them invest.
Nowadays, we can do everything ourselves. Thanks to the internet.
If we don’t know how, we have thousands upon thousands of great resources at our fingertips (including your favorite resource, this series).
You don’t need anyone’s help with investing your money.
How do you invest?
Remember what all these advisors sell? They sell the “promise” that they will beat the stock market results.
Here’s a small hint: Almost no one can beat the market over the long-term!
The very very few that can are billionaires (and trust me, they won’t invest your money for you).
“Gee, so how do I invest?”
The answer is simple, don’t try to beat the stock market. Buy the stock market!
The short answer is called Index Funds.
Unfortunately, this letter is long enough. I’ll explain everything next week.
So, that’s it for today!
Today, we looked at why trusting ANYONE with your money is a terrible terrible idea the vast majority of the time.
See you next week (follow the series here to be notified).
P.S.: Happy 4th of July beautiful America! 🇺🇸 May your festivities be as fun and crazy as the Instagram Explore section 🙂
Since I write about finance, legal jargon is obligatory (because the guys in suits made me). Before following any of my advice, read this disclaimer.
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