Do you need a financial advisor?
Many people ask me if they need a financial advisor. I usually tell them that I don’t have a financial advisor. But I also tell them that they probably shouldn’t take financial advice from people who aren’t financial advisors, much less random people on the internet. By the way, I am not a financial advisor, and my blog is for entertainment purposes only.
Financial advising is a service industry
I like to compare personal finance to cooking, and financial advisors to chefs. You can either cook food yourself or have your meals prepared by others. If you know how to cook, but you are happy to pay for a chef or go out for a meal, then more power to you. But what if you don’t know how to cook? Is cooking so incredibly complicated and overwhelming that only people with years of training and professional licenses can do it? Obviously not. In fact, just about anyone can learn to cook, and there’s an abundance of free cooking resources, lessons, and recipes out there. And the food you cook yourself is probably cheaper and healthier than any meal you can buy.
Despite this, however, professional cooks and chefs provide a valuable service. Even with COVID, the food services industry is massive, and it isn’t going anywhere. Here, I feel compelled to confess that I don’t know how to cook, and I enjoy a good restaurant meal as much as anyone. Good thing this isn’t a cooking blog.
But everything I said about cooking also applies to personal finance. You probably don’t need a financial advisor in the same sense that you don’t need a chef. Just about anyone can learn to manage their finances and make sound investments. And when you do it yourself, you can probably save money and get better results too. Regardless, financial advising and wealth management is a massive industry, and is also here to stay.
So obviously, my starting position is that you probably don’t need a financial advisor. But the industry exists for the same reasons that any service industry exists. Therefore, I think that if you want to get a financial advisor, more power to you. But you should make sure you do plenty of research.
How can I tell if my financial advisor is legitimate?
As with any field, the financial advisory industry is full of titles, certifications, and designations. Only a few of these certifications, however, require lengthy, formal study, demonstration of expertise via exams, oversight by a professional board, and continuing education. Many certifications, on the other hand, are designed to sound impressive, but have no backing by a certifying board, require little more than paying a fee to acquire, and are essentially marketing schemes.
For example, according to CNN Money, the C.R.F.A “certified retirement financial adviser” credential involves only minimal study and a $595 fee to take a multiple-choice exam. The group that grants the C.R.F.A is owned by a firm that markets annuities (an insurance product) to seniors. Not very confidence inspiring.
The Financial Industry Regulatory Authority, or FINRA, maintains a list of professional designations on their website. Note that this list has over 200 entries! And the overwhelming majority of these designations are not accredited by any reputable agency. In fact, only nine of these designations are accredited by either the American National Standards Institute or the National Commission for Certifying Agencies. The most well-known of these is probably Certified Financial Planner, or CFP.
This is not to say that all designations outside the accredited ones are worthless. Be wary, however, of “letter bloat” behind someone’s name. This happens in many industries, (including mine, healthcare), where designations of dubious credibility are used to suggest expertise in an area. When it comes to financial advisors, most sources seem to agree: look for someone with a CFP designation.
Your advisor should have fiduciary duty
If you get a financial advisor, make sure you get one with fiduciary duty. Advisors with fiduciary duty have a legal obligation to put your financial needs above their own and always act in your best interest, not theirs. No profit can be made from a fiduciary relationship unless a fee is agreed upon upfront. Fiduciaries also must disclose any potential conflicts of interest, such as any commissions they might earn from a particular product recommendation.
Another benefit of hiring a CFP as your financial advisor is that all CFPs are held to fiduciary duty by the CFP Board of Standards. Of course, fiduciary duty doesn’t prevent mistakes or bad investment outcomes, and breaches of fiduciary duty can be difficult to prove and enforce. Nonetheless, fiduciary duty is kind of a financial version of the Hippocratic Oath that all doctors must swear. Whether all doctors can uphold the oath in practice is a different matter, but why would you see someone who refused to swear the oath in the first place?
What can a financial advisor help you with?
Broadly speaking, financial advisors can offer advice on a wide variety of topics, including setting financial goals, major life events, insurance, taxes, estate planning, retirement planning, and investments. Their services can range from a one-time consultation to answer a specific question, to long-term, hands-on management of one or more areas of your personal finances.
In my opinion, financial advisors are most useful in these situations:
You are completely ignorant about money and have been neglecting your personal finances for years. You have no idea where to even start and need someone to hold your hand and come up with a plan.
You simply do not enjoy financial planning or management. You are not inclined to read or learn about financial topics. You are happy to pay a fee and outsource this to someone else.
You are prone to making impulsive or emotional financial decisions, even if you know better. You need someone to be the angel on your shoulder.
You have an unusual or complex financial situation and need specialized advice. Your circumstances fall outside the scope of most publicly available resources.
Before you get a financial advisor, however, consider the following:
You do not need a financial advisor to invest. Anyone can open a brokerage account and invest.
Financial advisors do not have secret, higher performing investments compared to what is available to the general public.
Financial advisors do not save you money, all else being equal. Financial advisors cost money, in fees or commissions.
In most cases, you will not do better investing with a financial advisor, compared to investing on your own in index funds.
Financial advisors cannot change your fundamental financial math. This is determined by your income, expenses, assets, and debt, and very little else.
A word about fees
One particular pet peeve of mine is that people seem to think getting a financial advisor will somehow save them money. This is akin to believing that going out to a restaurant will save money. There is no altruism in financial services. Financial advisors need to make a living too. Their paycheck comes from you, the client. No service industry is exempt from this fact.
But with most service industries, the fee for service is upfront and obvious. And when someone tries to “upsell” you, that’s obvious as well. Because before you leave, you have to whip out your credit card and pay. But financial advisors can be compensated in several different ways. And in some cases, their fees are not obvious at all, because their consultations seem to be “free”, they seem sincere about helping you, and you never actually pay them directly. This tends to occur more frequently with non-fiduciary financial advisors.
Rest assured that there’s definitely a fee, but the fee is either not disclosed, disclosed offhand in a manner that is not fully explained to the client, or buried in the fine print somewhere. Let me provide two personal anecdotes.
The salesman in disguise
A few years ago, as my residency class was approaching graduation, we all received emails from a financial services company inviting us to a free dinner and seminar with a financial advisor who specialized in the unique financial needs of physicians (actually, physicians have no special needs except an inflated desire to keep up with their peers). The group dinner was held at a nice steakhouse and was indeed free. During the dinner, the financial advisor introduced himself, talked about his background and his experiences working with physicians, and gushed about how much he looked forward to working with all of us on our future financial goals. He also explicitly stated that his services were free to residents, and that after graduation, if any of us wanted to continue his services, fees could be discussed then. There was no real sales pitch during the dinner, except to set up a free one on one consultation with him. He briefly talked about a few general topics during the seminar, such as loan repayment, but did spend a fair amount of time discussing a specific type of disability insurance called true own specialty disability insurance.
I never followed up with him after the dinner. Some of my classmates, however, did set up one on one consultations. One of them said that the consultation started off vaguely with a discussion of long term financial and career goals. However, he quickly pivoted to emphasize that all physicians need true own specialty disability insurance, that any employer-provided disability insurance is woefully inadequate, and that the resident physician should purchase true own specialty insurance as soon as possible. At least one classmate ended up purchasing an insurance policy during this meeting. However, they did not receive much financial advice.
In retrospect, I believe that this financial advisor was basically an insurance salesman masquerading as a financial advisor. He was certainly knowledgeable enough about other financial topics to speak about them superficially, but his ultimate goal was to convince physicians that they need an insurance policy and sell it to them. My suspicions were confirmed when I looked up his profile online, and found, among other things, a number of awards from the insurance industry, including an award based on the commissions from insurance policies that the agent sold. My gripe in this case is not with the business of selling insurance, or with the merits of true own specialty disability insurance. Instead, it is with the business of selling insurance disguised as financial advice.
The advisor who works for “free”
In my second example, a close friend of mine who recently graduated residency revealed that he was investing with a financial advisor from a large financial services company. He was one of those people who thought that “professional” money management would be superior to anything he could do on his own. He met with the advisor, talked about his financial goals, and the advisor promised to help him invest to meet those goals. The approach was quite hands-off for my friend, as the advisor managed my friend’s account and asset allocation. He sent the advisor money periodically to invest, and happily watched his account balance grow over time.
My friend was under the impression that the advisor didn’t charge any fees. This is because he never had to pay the advisor any money. He and his advisor never had a frank discussion about how his advisor makes a living. I think he was under the impression that the advisor got paid a salary by his financial services company, which, if true, begs the question of how the parent company makes money. My friend was also not aware of how his money was invested in terms of specific investments and asset allocation. Part of the hands-off approach, of course, is that the client doesn’t need to worry about the details, because their money is supposed to be in good hands.
When we looked at his actual investments, we discovered that they were all front-loaded, high expense ratio, actively managed mutual funds by the American Funds company, such as the American Funds Investment Company of America (AIVSX) with load of 5.75% and expense ratio of 0.59%. If you’re not familiar with mutual fund fees, check out my Investing 101 article on mutual funds and index funds.
My friend sent his advisor approximately $20,000 over five years to invest, and his account balance is now around $35,000. Not bad on the surface! But out of his $20,000, the front load of 5.75%, or $1,050, never gets invested and instead went into the advisor’s pockets as commission. Only $18,950 went into the fund. Every investment he makes loses 5.75% immediately! Furthermore, every year, the fund takes an additional 0.59% of his account balance as expenses. Actively managed funds with loads or high expense ratios are almost never worthwhile compared to index funds. Without digressing too much, check out my articles about fund fees and active versus passive investing.
What is the problem with this particular fund? Nothing, as long as the investor understands the fees and is still willing to invest. But this information was never clearly explained to somebody who was a beginner investor. And his advisor was happy to maintain the illusion that his services were free; he never once addressed any fees but repeatedly prompted my friend to send more money to invest.
Just to finish out this example, let’s look at real numbers. A $20,000 investment in AIVSX in January 2016 is worth $34,385 five years later in January 2021, after accounting for the front load and expense ratio. On the other hand, a $20,000 investment in Vanguard’s S&P 500 index fund in January 2016 is worth $39,930 in January 2021.
Not all actively managed funds trail the S&P 500, but most do. And the ones that outperform the S&P 500 are still likely to underperform at some point in the future. So my friend paid his advisor $1,050 in order to underperform the S&P 500 by about 2% per year. Even if his advisor had the best of intentions, it’s hard to argue against the numbers. No matter what your financial goals are, having more money always puts you closer to those goals. When you sit down to talk with a financial advisor about financial goals, recognize the following mathematical reality: at minimum, your goals will be set back by an amount equal to the financial advisor’s fees. And given the power of compound growth, fees of an ongoing nature can balloon to massive discrepancies in portfolio balance after years or decades.
Conclusion
You might say that my opinion of financial advisors is mixed at best. This article is just that – my opinion. I don’t use a financial advisor, because I prefer to manage my own finances. I learned how to “cook”, so to speak, even though I still can’t cook food. But there is nothing inherently wrong with any service industry, and it is okay to outsource tasks, so long as you know exactly how much it costs and what you receive in return. It just so happens that in the financial advising industry, these two factors are often obfuscated. Therefore, before you get a financial advisor, do the following:
Have a specific question or need for your advisor to address.
Make sure your advisor has an accredited designation such as CFP, not a heap of random letters.
Have an immediate and upfront discussion about the advisor’s fees.
Make sure the advisor has fiduciary duty.
And finally, consider learning to cook instead. My Investing 101 series is a great place to start.
Happy investing!
