During a recent trip to Ohio I caught up with RMak, a fellow member of a motorcycle forum I frequent. Later he posted a report on our meeting and in describing me said:
“Out stepped a mountain of a man…this guy looked to be a cross between John Wayne, Justin Bieber and Bigfoot.”
Kinder than many descriptions over the years.
Anyway this, for the first time ever, put Justin Bieber in my mind. You can imagine the feeling of disconnect when a week or so later there he was on the cover of…….wait for it….
The self-described “Capitalist Tool.”
Interestingly, he wasn’t in there as part of their “richest celebrities” list or some such, but as a venture capitalist and a new darling of high-tech startups. Courtesy of his manager and investment advisor. Seems a key part of their strategy is that other VC firms and entrepreneurs will be willing to invite him to join in only the very best, most lucrative deals because….
…well evidently just because he’s Justin Bieber. This has Forbes positively gushing over his business savvy. Justin, buddy, you need to start reading jlcollinsnh!
Start here—Simple Path to Wealth—and refer to Step 2:
2) Avoid Money Managers. They are expensive at best and will rob you at worst. Google Bernie Madoff. Seek advice cautiously and never give up control. It’s your money and no one will care for it better than you. But many will try hard to make it theirs. Don’t let it happen.
When I say Money Managers, I am also referring to Investment Advisors, Financial Planners, Brokers and the like. Any and all who make their money managing yours.
Now, I’m sure there are many honest, diligent, hard-working advisors who selflessly put their clients’ needs ahead of their own. Actually, I am not at all sure about that. But just in case, I put it out there in fairness to them.
Here’s the problem.
1. By design, structurally, an advisor’s interests and that of their client are in opposition. To do what’s best for the client requires the advisor to do what is not best for himself. It takes a rare and saintly person to behave this way. Money management seems not the calling of first or even second choice for the rare and saintly.
2. Well intentioned but bad advice is epidemic in this field. Advisors who put their clients’ interests ahead of their own are, to steal a phrase from Joe Lansdale in his novel Edge of Dark Water, “rarer than baptized rattlesnakes.” And then you’ve got to find one who actually is any good.
3. Advisors are drawn not to the best investments but to those that pay the highest commissions and management fees. Indeed, often they are compelled by their firms to sell these. Such investments are, by definition, expensive to buy and own.
4. Not surprisingly a field that provides access to people’s life savings is a magnet for….
Investment Advisors earn their money in one of three ways:
1. Commissions. The advisor is paid each time you buy or sell an investment.
It’s not hard to see the potential for abuse here, and the conflict of interest is stark. There is no “load” (commission) charged to buy a Vanguard Fund. But American Funds, among others, charge a princely load. It goes into the pocket of the advisor. Mmmm. Wonder which he’ll recommend?
Still other funds offer a 1% (from your money) recurring management fee to the advisors who sell them. That means you get to pay a commission not once, but every year for as long as you hold the fund. No surprise advisors favor these too.
Insurance investments are some of the highest commission payers. This makes them perhaps the most aggressively recommended products advisors offer and certainly among the most costly to you. Annuities and whole/universal life insurance carry commissions as high as 10%. Worse, these commissions are buried in the investment so you never see them. How such fraud is legal I can’t say. But it is.
Hedge funds and private investments all make their salespeople wealthy, along with the operators. Investors? Maybe. Sometimes.
If this weren’t enough, if you’re not paying attention, there is more money to be mined at your expense by “churning” your account. Churning refers to the frequent buying and selling of investments to generate commissions. It is illegal. But it is also easily disguised, principally as “adjusting your asset allocation.”
Time was, people begged him to take their money.
His credentials were impeccable. His track record too.
Only the “best” investment advisors could get you in.
Mr. Madoff paid them handsomely to do so. As did their clients.
2. Management fees, the AUM model. The advisor charges an annual fee to manage your money. Typically 1-2% of assets under management (AUM).
With the rampant abuse of the commission model, in recent years charging management fees has grown in popularity. It is presented as being more objective and “professional.” But there are snakes in this grass as well.
First, 1-2% annually is a HUGE drag on the growth of your wealth. Let’s say your portfolio earns 8% per year. 2% goes to the fee. Let’s say 3% to inflation and maybe 3% to taxes and…. Suddenly there’s nothing left for you. Investment returns are precious and under this model your advisor is skimming the absolute cream.
Let’s hop over to our pal Dave Ramsey’s site and borrow his calculator. Suppose you have a nest egg of $100,000. That’s about the minimum to interest an advisor. Let’s suppose you invest it for 20 years and earn 8% per year. You end up with $492,680. Not bad. Now suppose you give up 2% to a management fee. Your net return is now 6% and after 20 years that yields $331,020. $161,660 less. You not only give up the 1-2% each year, you give up all the money that money would have earned compounding for you over the 20 years.
Second, we still have the problem of a conflict of interest. It is not as pervasive as the commission model but it’s still there. Maybe you are considering paying off your $100k mortgage or whether to contribute $100k to your kid’s college education instead of having them go into debt. Most advisors will consul against either of these courses. For you, depending on your situation, that may be good or bad advice. For your advisor, it is the only advice that preserves the $1000 to $2000 in annual fees that $100k puts in their pocket.
Third, the vast, vast majority of advisors are destined to cost you still more money as they underperform the market. You won’t know for 20 years or so if you got lucky enough to pick one of the exceedingly rare ones who don’t.
3. Hourly fees.
If you really need advice, this is the most straightforward way to pay for it. But pay for it you will. Rates of $200-$300+ per hour are not uncommon. You are less likely to be cheated, but you still have the challenge of knowing if the advice itself is going to be good or bad for your financial health.
4. Some combination of 1, 2 & 3 from above.
That’s our last option. If your advisor is using it, likely the reason is not for your benefit.
Pretty grim, eh? Here’s an article written by investment advisor, Allen Roth, with some revealing admissions as to how the game is played. He certainly spells it out. Bravo, Allen!! But where he and I part company is he also provides advice on how to pick a good advisor. That’s probably even more vanishingly difficult than picking winning stocks or mutual funds.
If you are a novice investor you have a two choices:
- You can learn to pick an advisor.
- You can learn to pick your investments.
Both require effort and time. But the second not only provides better results, it is the easier path.
The great irony of successful investing is simple is better. Complicated investments only benefit the people and companies that sell them. Not only do you not need complex investments, they actually work against you. At best they are costly. At worst, they are a cesspool of swindlers. Not worth your time. You can do better.
Nobody will care for your money trees better than you.
With less effort than choosing an advisor, you can learn to manage your money yourself.
….with better results.
In the comment section below reader Prob 8 posted:
“If anyone doubts JLC’s claims regarding the impact of fees and commissions on your portfolio, please check out this video from PBS: http://www.pbs.org/wgbh/pages/frontline/
It’s called The Retirement Gamble. (You’ll have to paste that into the search box to find the video.) There are interviews with Jack Bogle and all you’ll need to know to realize fees and investment advisors are hurting your portfolio more than helping.”
I just finished watching it. Very powerful stuff and I highly recommend readers here check it out.
The math on how damaging even seemingly modest 2% fees really are is nothing short of breathtaking; and even I didn’t fully appreciate just how laden with fees 401k plans have become. Yikes!
Thanks Prob 8!!
Prob 8′s comment above set me to exploring today’s 401k plans further. See: Stocks– Part VIII-b: Should you avoid your company’s 401k?
Addendum III: Just what does that management fee cost you?
Addendum IV: Life insurance sales people are taught by their companies to masquerade as investment advisors. It makes it easier to sell high-fee products like the seemingly endless varieties of whole life insurance. Don’t buy these products. If you need life insurance, buy term insurance for exactly what you need and only for as long as you need it. Take the money you save and invest it in a low-cost index fund like VTSAX. If you are interested in a detailed analysis of why, Jason Hull has an excellent one: Another evaluation of an indexed universal life insurance
Addendum V: My pal Kathryn who writes the weekly MSB Cheat Sheet just introduced her readers (and me) to Todd Froemlin and his new tool Stockchoker. Plug in three bits of info—the name of a stock or mutual fund, a date and an amount invested—and it will instantly spit out what you would have made along with a smart-ass comment. Very nice to have when some advisor is urging you to dump your index funds for his high-fee super-duper fund with the secret proprietary logarithms sure to make him, er, you rich.
Addendum VI: My pal Physician on FIRE shows just how Investment Fees will Cost You Millions
Addendum VII: From Can I Retire Yet, the Worst Investment Advice ever Heard