The wealth management industry is estimated to be a $75 trillion industry. Investopedia attributes 60% of the market to Institutional Investors leaving the other 40% to personal advising and other services.
The median financial advisor earned $88,890 in 2018, compared to the median wage of all job types of $38,640. Even the lowest 10% of financial advisors earned more than $38,640.
The point here is that financial advisors earn a lot of money.
How is the money earned?
Hourly fees, fixed fees, and % of wealth fees all contribute to the high profitability of the industry.
Where does the money come from?
The customer. Specifically, the customer's future retirement savings.
The Financial Advising Truth
Put simply, individuals choose to shorten their retirement to have another person "manage" his or her money. The managing itself is quite simple and can be done by anyone. However, people pay a premium to "feel secure" that a financial advisor knows how to build more wealth and eliminate risk than the customer. Retirement plans are created, money is invested, hands are shaken, and the customer is sent on his or her way feeling as if they made the right decision to allow someone else to manage the money... for a "small" fee.
What most people don't realize, the no one can control the market. Whether it is the stock, bond, currency, commodity, or any other market; no single person can control the market, even your financial advisor.
Markets have a mind of their own. Market forces are observed as a see-saw between supply and demand. When a product is in more demand, the price goes up. When the supply increases, the markets become more competitive, and the price decreases. These are basic economic principles.
Notice how the market forces have nothing to do with your financial advisor.
The Risk of Investing
Investing is risky. Most academic investors believe that more risk means more reward; that risk-takers are paid for taking risks in the market.
Risk-takers invest when the odds are against them. They buy low, when the rest of the market is selling, or they buy cheap stocks that have limited chances of rising in price.
Typically, financial advisors don’t take these risks. Advisors preach diversification, buy and hold, portfolio balancing, risk-deleveraging. To do this, they often invest your money in standard index funds, or maybe their company’s “premier” fund which is very similar to a typical index fund.
As great as diversification is to reduce risk, it also reduces returns.
Inherent in the market is also market risk. Even if you diversify your portfolio, due to the interconnectedness of all companies in markets, changes in one asset can have impacts on others. Read my diversification and correlation article to learn more. This means, even if you invested in all possible stocks in the stock market, there is still a chance all of them can go down in price.
The point here is that markets are inherently risky, and even unexpected events that occurred in another far away country can have detrimental effects on your portfolio.
Notice there is not much a financial advisor can do to avoid these risks.
The Risk of Not Investing
As risky as investing is, not investing is even riskier. Due to inflation, the growing money supply, opportunity cost, and other investors growing their earnings faster than you, not investing makes your money worth less.
Would you rather have a 100% chance of your money being worth less tomorrow than today, or some % chance that your money will be worth more tomorrow plus some % that your money will be worth less?
The fact that most people have selected and continue to select option 2 is the reason why the stock market continues to grow at ~8% per year.
Why You Don’t Need a Financial Advisor
In today’s technological age, we now have access to easy to use, essentially free, investing platforms. The same diversification that a financial advisor offers and recommends can be achieved by a few finger-taps and purchases of a few index funds.
All that remains for the financial advisor to do is provide a sense of security and a “personalized” plan.
However, as detailed above, there is no security from market forces. Financial advisors are people too and cannot control market down-turns.
The personalized plan is also a misnomer as these plans are typically a one size fits most solution. For example, a young investor may be recommended to invest more heavily in stocks while an older investor will be advised to invest heavily in bonds to “avoid risk”. However, this risk avoidance also comes at the loss of returns since risk-takers are the ones who get paid.
To create this plan, an advisor will have to get to know you. Whether it is a sit-down meeting, or a questionnaire you fill out, there is typically a rapport building process to get you comfortable with the advisor and help the advisor determine which pre-determined strategy he or she will recommend.
However, no one knows yourself better than you do. And if you arm yourself with a few basic principles, you can make these decisions on your own and don’t have to rely on paying someone else to tell you who you are.
- Invest what you can and invest often
The more money you can put away today will mean the more you will have tomorrow. The sooner you can save a large enough nest-egg is the sooner you will be able to stop working and live from your investment accounts dividends and returns.
- Risk = Return
If you have less money, you likely want to take more risk as you have less to lose. If you have more money, you may want to take less risk.
- Diversification eliminates risk
By investing in a variety of assets, you reduce your risk as if one asset falls in value, others may not fall as much (or may even rise) thus reducing your overall loss. To diversify optimally, you want assets that do not change prices in parallel; ie. They do not correlate. Check out our article on correlation to learn more.
- Don’t exit
The best returns often come after an asset has dropped dramatically in price. Most fearful investors sell their assets if the price decreases and miss out of the huge returns when the asset price returns back to normal. Stay in the market even when things seem bleak. Historically, the market has rebounded 100% of the time and you want to be a part of the increase.
What Financial Advisors Actually Cost
I would give financial advising less of a hard time if advisors had a more fair fee structure. Typically, getting a client setup with investment accounts and investments, determining a plan, and getting the client comfortable with investing all take time and effort and there is value here. However, once the client is on-board and investing, the amount of work the advisor has to do is extremely minimal. Similar to a doctor or consultant, once the consultation is done it is onto the next customer while the client has bills to pay.
However, unlike a doctor or consultant, a financial advisor continues to make money on your money well after you have completed the honeymoon stage. Even though there is no additional work required.
As explained above, most financial advisors take 1-2% of your wealth per year as a “meager” advising fee (even if no actual advising, buying, selling, or any activity occurred). This may sound like not a lot, but when you are relying on an 8% market return each year, this is 10-20% of your annual earnings!
Even this 10-20% figure is misleading. Due to compounding, the impact grows, and over many years, a financial advisor will end up taking half of your retirement account in exchange for providing a “service” that you could have accomplished on your own by reading this article and pressing a few buttons on your smart phone.
If you don’t believe this, check out our getting started calculator where you can calculate how much more your retirement account could be worth with and without a financial advisor. The results are staggering.
With this said, financial advisors do provide value for people. However, their value does not seem to be worth shortening your retirement to half of its potential length. A fixed, initial setup fee seems more appropriate for the services they provide, so if you ever find an advisor with this type of structure, it may be a good idea to check it out, but good luck finding that!
With a little bit of education, you can avoid hiring a financial advisor and double the value of your future retirement account. You don’t need a financial advisor to begin investing and having an advisor does not shield you from the inherent risks of the market.
There are incredible tools online that provide commission free investing and portfolio management. However, we are the only site that provides professional grade stock comparables analysis that identifies optimal investment vehicles. However, combine our analysis with a great investing tool and you have you can skip your financial advising appointment.