I love to read books, listen to podcasts, and watch videos on personal finance, but some of you may prefer to hire someone to take care of that for you instead. And that’s okay. Whether you decide to manage things yourself or get a financial advisor, it is vital that you understand the basics. Don’t blindly follow someone else’s investment plan without fully understanding it and don’t naively trust a financial advisor to have your best interest at heart. No one is going to care more about your money than you. Before this year ends, make sure you fully understand what is happening with your money. This is why:
1. To ensure you are not being taken advantage of. Many doctors and young professionals who are unaware of how their money is invested and know very little about personal finance get taken advantage of by people they thought had their best interest at heart. They may overpay for things, have their money invested the wrong way, or be overcharged for assistance in managing their assets. When people know you have more money, they tend to raise their prices and fees because they assume “you can afford it.” Having some knowledge of personal finance will allow you to better discern if you are getting charged a fair price for good advice, or not.
2. To ensure you aren’t being charged high fees that decrease your investment returns. In order to have your money grow over time, it needs to be invested. When you invest money, you usually do so by purchasing assets that will increase in value over time. The cost of acquiring those assets can vary but the key is to make sure the fees you are being charged to have those assets are not too high. This is especially true when it comes to real estate and the stock market. Overpaying for a home or investment property can cause you to lose money quicker than you think. Investing in mutual funds (groups of stocks or bonds) with high expense ratios can cut into your profits and minimize the growth of your money. For example, if the average mutual fund has a yearly increase of 8% per year but inflation is 4%, the fund fee is 1% and your advisor fee is 1% then the growth of your money is really only 8% minus 6% which is 2% per year. We cannot control inflation but minimizing the fees we are charged on our investments is within our control. Be aware of what you are being charged for certain investments and make sure it isn’t too high.
3. To ensure you are not invested in things that underperform the market. Another disadvantage of not understanding personal finance is having the wrong investments. Although personal finance is personal, double check that you are actually making good investments, which I define as things that have a high chance of increasing in value over time. There are lots of “good” investments but there are also investments that underperform the market or change in value too frequently to be useful. Learning about personal finance helps ensure that you are investing in things that will increase at an appropriate rate over time.
4. To ensure your investments aren’t just things that provide bonuses and commissions to your advisor. Believe it or not, there are some advisors who will use your money to enrich themselves. They will come to you claiming to help, all the while investing your money in questionable ways and buying products that result in a large commission to themselves at your expense. Although some are sneaky, others have simply been trained or groomed to believe that the things they sell are good. They attended a seminar or class that taught them all the potential benefits of certain products without mentioning the drawbacks of the investments they offer. As a result, they come to you with good intentions but bad information. They may try to talk to you about the benefits of whole life insurance and conveniently fail to mention the large commission they get for selling you the policy. They may suggest that you purchase an annuity but fail to mention the high fees and lifelong commitment to suboptimal mutual funds it requires. Having some knowledge of personal finance will help you avoid this and ensure that your advisor isn’t charging you money to enrich him or herself.
5. To ensure your investments align with your risk tolerance and investment goals. Another perk of knowing about personal finance and investing is being able to ensure that you are investing in ways that give you a good chance to make a profit (with little fees) with minimal risk. You want to make sure you aren't invested too heavily in one thing. It's also important that you plan for the unexpected. If you switch to a low paying job, your child care expenses increase, or the stock market or real estate industry crashes again, do you have room in your financial plan to handle it? You need to take some risk in order to make a profit but be careful not to take too much risk. You don’t want to lose all you have over one unexpected event. Diversify your investments, buy assets in different industries and consider using the combination of stocks bonds and real estate to protect yourself against the unexpected.
6. To ensure that you know your true net worth. As you continue investing and building wealth you should be keenly aware of not only what you are investing in but also where you are in your journey to financial independence. This means you should be able to calculate your net worth. If you stopped working today, how much money would you have? What is the total amount of your assets (the things you own) minus your liabilities (the debt you owe)? If you didn’t make any more money, how long could you still afford your current lifestyle? Are you reliant on your next paycheck or do you have enough money saved and invested to continue to live life and function as you do now? Part of being money savvy is not living paycheck to paycheck. It’s not being dependent on your job. It's being aware of where you are in your wealth creating journey. What is your net worth?
Be Weary of Annuities
As a young professional who will make a lot of money over the course of your career, you may be approached by a financial advisor. Although some advisors can be great assets, others were trained as salesmen and may not have your best interest at heart. They may overcharge for advice or worse, convince you to purchase expensive investment products you may not need. One of the products you should be weary of purchasing is an annuity.
What is an annuity?
An annuity is a type of investment product you can purchase from an agent at a brokerage or life insurance company. You pay a set amount of money to the company (via a lump sum or in monthly payments), the company invests that money on your behalf. After a certain time period, the company will then return the money you gave them back to you in smaller fixed monthly payments (usually for the rest of your life) with interest. In other words, you give the company your money now to invest and the company returns your money back to you later (in small payments) with a certain amount of interest. It some ways, it is similar to a bond (with many more fees attached, as we will discuss below).
When it comes to annuities, there are different types. The main types are immediate annuities and deferred annuities. With an immediate annuity, you pay a lump sum for the annuity and the company starts paying you in monthly installments immediately. There is no waiting period between the time you purchase the annuity and the time you receive your first monthly payout. With deferred annuities, there is a waiting period. You may pay for the annuity with a lump sum or with fixed payments, then you wait a number of months or years before you get your first payment. Along with the timing of when you get your first payout, there are also variations in the amount of your payout. Some annuities have fixed payouts in which you receive the same amount of money each month. Other annuities have variable payouts (in which your monthly payment changes based on how well or how poorly your money is being invested). Lastly, some annuities have payouts that follow a certain index (like the S&P 500).
Why do some financial advisors recommend them?
It may provide a guaranteed income. By purchasing an annuity you get a set amount of money no matter how long you live. If you don’t know much about investing and want to virtually ensure that you will have a certain amount of money each month in retirement you can buy this product. Financial advisors may also state that this product is better than investing in taxable accounts because the profits are tax deferred until you start getting withdrawals/payouts. Annuities are sometimes purchased by retired individuals who fear they may outlive their retirement savings and want to guarantee themselves a monthly payout for the rest of their lives.
Why you should be weary of an annuity?
The agent and company takes a large portion of your investment returns
In order for the company to be able to guarantee you an income for the rest of your life they have to make sure you give them enough money to cover the cost of the payout they will give you while also netting themselves a profit. They need to be able to pay you and make money for themselves. Companies who sell annuities are businesses not charities. Ensuring a profit for themselves is how they stay in business. Unfortunately, this profit is at your expense. While a small cut is reasonable, many of the agents and companies who sell annuities take rather large cuts of your profit, often up to 10% of the total value of your payout.
The money you loan them is invested in inefficient ways which reduces your profit and payout
Along with the agent and company taking a rather large portion of your payout, the payout that you do receive is often not as a large as it should be. Why? Because the money you put into annuity is usually invested in inefficient mutual funds that have a track record of underperforming the market (getting lower investment returns than the average). Plus, many companies charge high expense fees on the profits you do make. In other words, you get lower investment profits and have to pay more even more money in fees for them.
Purchasing an annuity is inflexible and binding.
If you want to take money out of the annuity early (to get payouts sooner or increase the amount of your payout temporarily to pay for a large expense), it is extremely costly. You would have to pay a high percentage in taxes to take money out sooner. Plus, if you want to sell the policy or get rid of the policy at any point, the company will charge you an exorbitant fee (often 10% of the value) to “surrender it.” Lastly, once you start getting your fixed payments, you have to pay taxes on this income at your ordinary income tax rate which tends to be much higher than the capital gain tax rate you would have been charged had you simply invested your money in an taxable account yourself instead of purchasing/investing money in an annuity.
What is a better alternative to an annuity?
Prioritize retirement accounts like your work 403b and Roth IRA. Through employer-sponsored retirement accounts you can contribute money to invest for retirement in a way that lowers your taxes each year. You may also get extra “free” money to invest if your job offers a retirement “match” (extra money employers put in your retirement account free of charge as a bonus for choosing to invest). Along with those two perks, prioritizing retirement accounts lowers your taxable income which can decrease your student loan payments. Retirement accounts like a Roth IRA, even offer a wide variety of investment options and allow you to get tax-free growth on your profits. A Roth IRA also allows you to take out your contributions at any time instead of having to wait until you retire, providing more flexibility and serving as a backup emergency fund should unexpected expenses arise.
Invest money in index funds via taxable accounts (after maxing out retirement accounts). Instead of purchasing an annuity, you can simply open a brokerage account and invest the money in low-cost index funds. Doing so, will allow you to invest even more money, on top of what you already invested in your retirement accounts, to build your net worth sooner. With taxable accounts, you can withdraw the money at any time and your profits will be taxed at lower rate.
My point? Annuities may seem like good idea but many young professionals should be weary of them because they tend to be costly, expensive, and inflexible. The money in them is often invested in suboptimal ways and the agents and company who sell the policy take a large chunk of your money. Instead of opting for an annuity, invest money in low-cost index funds since they have low fees, good profits, and lots of diversification that decrease your risk of losing money. When investing in low-cost index mutual funds, you may first want to prioritize doing so through retirement accounts (due to the tax advantages) then opening up a brokerage account to invest the rest. Unless you are currently retired and fear you may outlive your savings, annuities may not be the best investment option.
What Are Your Top Financial Goals?
It can be easy for us to get caught up in the busyness of life. We are so focused on progressing in our careers that we may lose sight of the main reason(s) we are working so hard in the first place. When you reflect on some of the biggest financial benchmarks you want to accomplish, what comes to mind?
Some people want to pay off their student loans. Others want to be completely debt free. Some people want to buy their dream home, others want to fully fund college for their children. Before you hire a financial advisor or start investing money in various places, figure out what’s most important to you and create a specific plan to meet that goal.
Do you want to pay off your student loans? Doing so may require you to live below your means for the next 5 or 10 years so that you can increase your monthly student loans payments and lower the loan balance quicker. If you work in a non-profit job that qualifies for loan forgiveness, you may want to make sure you’re enrolled in an income-driven repayment plan so that your student loans payments are lowered to an amount you can actually afford. If your job doesn’t qualify for federal loan forgiveness and you have already refinanced your loans with a private company, perhaps you should see if your job would be willing to pay down some of your student loan debt directly – some professions may use this student loan payment as a type of salary bonus. Regardless of the route you take, if being student-loan debt free is a goal, you may want to think of ways to pay it off within the next few years and align your financial priorities to meet that goal.
Do you want to purchase your dream home? For many young professionals, buying a home is the ultimate sign of adulting. This desire to have a place of their own intensifies when young professionals reach their early to mid 30s, get married, or become more settled in their careers. If you desire your own place as well, perhaps you should meet with a specialist at your bank to see if any unique mortgage programs are available to buyers in your profession, income bracket, and geographic region. You may be surprised at the options mentioned. Along with seeing what’s available, you should also re-shift your focus to saving a larger amount of money in your savings account than you otherwise would. Having this money available will help you pay for the house down payment, closing costs, moving expenses, and other associated home-buying fees.
Do you want to retire early or work part time? Many people who like their careers may decide that other things are more important to them. Perhaps they enjoy their work but want to be able spend a little more time at home with their children. Maybe they want to cut back to part-time. Other people may choose to retire early and do something else altogether. If working less or retiring early is one of your goals, then it may require you to invest aggressively in retire accounts from a very early age. While some people may only contribute 10% of their salary to retirement, you may want to double or triple that amount. Perhaps you should consider maxing out your work retirement account then setting up additional taxable accounts to invest even more money. My point? If you plan to retire soon or work part-time, you will likely need to invest more money toward retirement from an earlier age so that you can let the magic of compound interest work in your favor and actually afford to make that change in your career.
Do you want to pay for your kids’ college? Perhaps you are someone who would like to finance your kid’s educational costs. Because the cost of college has continued to increase over the years, paying for an undergraduate education can be quite expensive. Many parents who plan to pay this cost end up saving/investing money for many years in a 529plan that saves them money in taxes. Other parents may opt to save money in a Roth IRA, set up a custodial account for their kids, or purchase educational bonds. Regardless of which method you choose, you will likely need to save money each month which will require you to think over your monthly income to see just how much you can afford to spare in order to stack up enough money over time to cover the cost of college.
Do you want to be completely debt free? Many people are risk averse and hate debt. The thought of owing someone, or some financial institution money, bothers them and adds bills to their monthly expenses that decreases the amount of money they can spend on other things they enjoy like travel, entertainment events, and fancy restaurants. If you feel similarly, and would like to get rid of all of your debt, doing so may require some changes in your finances. Perhaps you need to decrease the amount you contribute to retirement investments and instead pay down your credit card debt and car loans more aggressively? You may also need to learn to save aggressively and pay for everything in cash instead of credit.
My point? Many of us have financial goals we would like to accomplish. Achieving these goals may require some sacrifice and a shift in how we think about our money. It may also change how much we invest for retirement or spend on various debt repayments. Think about what is most important to you financially and make the necessary shifts in your finances to bring these goals into fruition.
5 Questions to Ask Before You Hire a Financial Advisor
Many young professionals are quite busy and don’t want to spend what little free time they do have learning the ins and outs of investing. If you, or someone you know, plan to hire a financial advisor to handle your money, there are 5 questions you should ask before you entrust that advisor to your hard-earned cash.
1. How are you paid? Believe it or not, many financial advisors have incentives to invest your money in suboptimal ways. They get large bonuses from insurance companies to sell you unnecessary whole-life insurance policies that are insanely expensive. They get even more money from their own companies to invest your money in actively-managed mutual funds that tend to underperform market expectations cost of you lots of money in added fees.
As if that weren’t enough, some financial advisors charge too much for their advice. Instead of charging a set rate of a few hundred dollars per hour or a few thousand per year, many advisors are “fee-based.” This means they charge much more than that and can even have rates around 1-2% of all the money you want them to manage. 1-2% may not sound like a lot initially, but average yearly returns are only about 7-9% and 3% of that is inflation. Paying an advisor another 1-2% plus an additional 1% in added fees leaves you with a mere 2-3% return on your money which isn’t much more than what you’d make in a savings account or with a government bond. My point? Ask the financial advisor how much they charge and inquire about all of the other ways that person gets paid or earns bonuses. The goal is to find someone who charges a flat fee at a reasonable price.
2. How much experience do you have working with people in my career? There are millions of different jobs in a variety of industries. Each job can have different pay structures and hierarchies that may influence your income and level of financial security over time. Make sure the person you hire as a financial advisor is familiar with the financial incentives and barriers of professionals in your field.
If you’re a doctor, you should ensure your advisor is well aware of the pay difference between a new resident and an established attending. There are certain tax-advantage accounts that may only be available to you when you are in the smaller pay range and exclusive investment opportunities that may become available when you get into the large pay range. If the financial advisor you hire is not aware of the way the pay structure works in your field, you may miss out on some of valuable programs and investments that could save you thousands of dollars in taxes each year. My point? If you are going to spend your money hiring someone to handle your finances, make sure you are paying for advice specific to your own situation and financial goals.
3. Have you assisted clients with “X” amount of student loans recently? Many of us took out a substantial amount of student loans while we were in school. Paying them off is a priority, but navigating the different repayment options without going bankrupt in the process can be challenging. There are so many different repayment plans and some of them may be more or less appealing for people in certain situations. Make sure the person you hire as a financial advisor is well-versed in all of these options.
There are pros and cons of each payment plan and one-size fits all does not exist. Some of the repayment plans are on an expedited schedule to help you pay off your loans in 10 years, others are income-based to ensure they aren’t taking a huge chunk of your income while you are still getting on your feet. There are even plans that provide government subsidies and may lower your taxes. If you have a substantial amount of student loan debt make sure your financial advisor knows about all of the different options and can adequately advise you on which one to choose.
4. What training did you get to become an advisor? Unlike people in other professions, the vast majority of financial advisors did not go through years of training or have to pass a series of difficult board exams to get their current job. Many of them were trained in sales and became an advisor with a few weeks of on-the-job training. As a result, some of them may not be as helpful as they claim.
Money management can be complicated so ensure the financial advisor you hire is as qualified as possible. Some of the most knowledgeable financial advisors are the ones who elected to get extra certifications to become a certified financial analyst (CFA), certified financial planner (CFP), or a chartered financial consultant (ChFC) so it may be wise to look for someone who has these credentials.
5. What financial plan do you think would best meet my financial goals and WHY? Before you hire someone to manage your wealth, you should make sure that person is giving you tailored advice that meets your specific situation and life goals. If you are in your late 20s with student loan debt, get an advisor who can help you make payments that don’t require you to eat Ramen noodles for the substantial future. If you are a young female planning to get married soon, you may want an advisor who can help you save for a wedding or the down payment on a home without charging too much or putting your financial future at risk. If you are a 32-year-old male who wants to save for a new car and lower your taxes, then someone who specializes in tax-efficient investments like real estate may be a great fit.
Although we would all love to be wealthy one day, we each have different financial goals and priorities that change the timeline and route we take to get there. Hire an advisor that takes these things into account to help meet your needs. More importantly, make sure you understand why your advisor has made certain recommendations and investments. The more you understand, the better you’ll be able to predict your investment returns and make better decisions in your life going forward. Once you understand your specific financial plan, follow up with your advisor once or twice a year to make sure you are still on track.
My point? If you plan to hire a financial advisor to handle your money, make sure you ask the right questions so you can choose the best fit for you.
4 Reasons I’m not a big fan of financial advisors
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.