Every now and then I’ll get a spam email to my work account from some financial advisor offering an expensive dinner in exchange for an hour or two of my time. I usually ignore them. As a resident physician working 80+ hours a week, my time is valuable. Unlike a struggling college student, free food, even if it’s free good food, isn’t enough to get me to go somewhere or do something I know will waste my time. That being said, something unusual happened last week.
A business associate I met a few years ago reached out to me. He told me that he was starting a new personal finance company and asked if I would be interested in hiring him to manage my finances. I told him congrats on starting his new firm but made it clear that I didn’t plan on working with him or any other financial advisor any time soon. He seemed a bit taken aback and asked why. I stated that many financial advisors don’t have my best interest in mind. Here were my top 4 reasons why:
1. Many financial advisors sell subpar financial products to increase their own commissions
This is one of my biggest gripes with many financial advisors. They get paid a lot of money in commissions when they sell products like whole life insurance. Although life insurance gives us a way to provide for our families and loved ones after we die, term life insurance is sufficient. Whole life insurance, on the other hand, has poor investment returns, doesn’t pay out nearly as much as we may need, and is insanely expensive. Most of us can provide for our families by investing a certain amount of money each month in index mutual funds. We can also purchase a cheap term life insurance policy to cover us in case we die before we are able to make enough money in profits. Despite this fact, many financial advisors try to convince their clients to purchase whole life insurance instead.
They claim it’s a guaranteed death benefit that is better for the client but the real reason they sell that type of insurance is because they make tens of thousands of dollars in commission when they get their clients to purchase a whole life insurance policy. All the money in premiums you pay for the policy for the first 6months to a year goes directly into the financial advisor’s pockets. I don’t want to be affiliated with someone who is incentivized to make money by selling me something I don’t need.
2. Many financial advisors encourage their clients to invest in actively managed funds or individual stocks which have higher fees and add unnecessary risk
Financial advisors who have their clients’ best interest in mind, should encourage their clients to invest in diversified low cost funds. The goal is have the client invest money in a way that maximizes profits and minimizes risks. One of the best ways to do this is to invest money in many different stocks in a variety of industries through index mutual funds. That way, if one company’s stock goes down, you have investments in many other companies that can cushion the blow.
The index funds are weighted so that a larger amount of your money is invested in the stocks that are larger and more likely to increase in value. This kind of investing helps minimize the risk that you could lose a large portion of your money and increase your chance of making a profit. Unfortunately, many financial advisors don’t advise their clients to invest money in this way. Instead of explaining to their clients why trying to “beat the market” via individual stocks or actively managed funds is a terrible idea they encourage their clients to invest their money in funds that charge high fees or take on too much risk.
3. Many financial advisors over-charge for advice
Some financial decisions aren’t as clear cut. While some parts of personal finance such as investing in mutual funds, saving money for retirement, and getting a 401K match from our employer are relatively easy decisions to make, others are not so clear. Should we focus on paying off debt or investing money for retirement? Should we purchase a house or keep renting? Should we do a pre-tax account or opt for a Roth? The answers to these questions vary depending on our individual circumstances and this is why some people seek out a financial advisor. There are other people who simply need help getting started and want to make sure that they have various accounts set up correctly. Whether which camp a person is in, we all want to get great advice at a good price.
Unfortunately, many financial advisors over-charge for advice. Instead of charging a flat fee, may financial advisors base their rate on the value of the investment you want them to manage and can charge 1-2% per year. A 1% fee per year may not sound like a lot initially, but given that average yearly returns (after inflation) are only about 4% per year, giving 1% of that to a financial advisor can really eat into your profits. If you have a portfolio valued at $500,000, paying $5,000 a year to keep doing the same thing you did last year is quite a bit of money. The truth is, unless you’re ultra-rich, it simply doesn’t take much more energy to manage $20,000 vs $200,000. Once you have a solid financial plan in place, you just have to follow it each year as your money grows. If you want some help managing your finances, find an advisor that won’t overcharge for advice. Paying a few hundred bucks an hour or a flat fee of a few thousand dollars to get started seems fair. If they are charging a lot more than that, think twice.
4. Many financial advisors fail to help their clients lower their biggest expense – taxes
If you ask people what their biggest expense is each year many of them will mention their mortgage, student loan payment, or childcare. Although these payments can be high, most people’s largest expense each year is actually taxes. Many people, especially those in the upper middle class pay 20-30% of their entire income in taxes. Finding ways to lower this expense can have a drastic impact on our income. While we will likely still pay a certain percentage in taxes each year, finding a way to lower them, by even a few thousand dollars, can make a big difference.
One of the best ways to do this is to invest in index funds thorough you work-sponsored retirement plans. Many of these plans give you a pre-tax deduction so maxing out this account can reduce your taxes by $4000-$5000 each year. Unfortunately, many financial advisors don’t emphasize this tax advantage. They instead convince their clients to set up brokerage accounts, with after-tax money which has higher fees and results in higher taxes. If I’m going to pay someone to manage my money, I’d at least like to make sure they are helping me invest in ways that will reduce my tax bill, not add to it.