A post in which I skirt the boundaries of the conflict of interest problem(*) by discussing financial advisers.
I generally do not discuss investing (I try to avoid it) because I think anything I could say is just enough to make people dangerous to themselves but not enough to save themselves from doing something stupid. (Investments are like guns. You can easily buy one and there’s a risk of shooting yourself in the foot, but should you really buy one if either a) You can’t treat gunshot wounds; or b) You’re not prepared to lose your foot.). I am a bit torn about it though. I see many, who then go elsewhere and get suckered in by promises of 15% annual returns or even 10% monthly returns using this special investment technique or exciting new product which is going to revolutionize the world of finance (you may have an idea of what products I’m talking about). And indeed, those methods are currently working (that’s why they’re getting promoted and why you see them on the top layer of the news) and because of trending they tend to work well for a while too. The problem is that 6-12 months later, they start failing. This is not a problem for the product sellers since they make their money on fees and commissions (see where the conflict of interest comes in, here 😉 ) because they just go onto selling something else. It is a problem for those who gets stuck with a depreciating asset… like oh so … a 5 bedroom house in the suburbs, guaranteed to go up, because that’s what markets always do *waves arms and mumbles something about “the long run”*.
(*) You see, I now have an affiliate link in the right sidebar which pays me a commission to refer people to a service which I guess—seeing that the service is free—gets its commission by further referring people to a financial adviser.
The “selling” can also come in the form a single book with a system. The danger here is not knowing enough to evaluate whether the system is valid or worse, still valid. An investment book from the 1970’s (resource crunch and high inflation) will likely be about buying gold, postal stamps, art, … at the end of the 70’s it might even have been about stocking up on cans of baked beans and toilet paper. A book from the 1980s (high interest rates and booming stock market) will have been about mutual funds and government bonds. If we go to the 1990’s (trending markets, and market bubble), they were about index investing and growth stocks. You don’t want to use a method which is unsuitable for the era you’re currently in.
Financial advisers come in three or four flavors.
- You can be your own financial adviser. I think it was Warren Buffett who said that any IQ points over 120 are superfluous when it comes to investing. Investing is not rocket science. It is something, where the technical details can be learned in about 3 years. Note that I said 3 years. This will be enough to evaluate whether advise is good or bad. With less knowledge, it simply becomes a matter of trust. I think those who wish to live from their money should be able to evaluate how their monies are working for them. Doing it yourself is also an easy way to save the fees. Investing requires more than intellect though. You can test your intellect with papertrading, but the game changes when real money is involved. You also need to find that in yourself and that can take substantially longer than 3 years.
- You can have a commission based financial adviser. This is typically found in the form a a fund. Even low-cost index funds cost money. To give an example. Suppose the management fee is 0.15% relative to assets. If you have $200,000 invested, that costs $300 per year. You can reasonably assume a 4% return or $8000. The cost of your financial management relative to your income is 300/8000=3.75% or 25 times higher than the stated amount. It requires $7500 extra in savings to accomplish. You may wish to trust the adviser and spend the $7500 or you may feel more comfortable doing it yourself (if you trust yourself more) and spend the $7500 on something else. Here the manager makes his money by increasing the size of assets under management. This can be done two ways a) Investing well b) Advertising for more customers. [Slap in the face tip: If you’re familiar with the an investment company brand, chances are the they’re probably using the second method. Makes sense, right?]
- The fee-only financial adviser charges you a flat rate based on hours rather than based on your assets. This is similar to paying an accountant to do your taxes. He charges you by the hour or the form—not as a percentage of your income. The fee-only adviser may take a look at your portfolio and special circumstances and
telladvise you to “do this and that”. E.g. Say you have $200,000 and you wish to derive an income and have a conservative protection of principal. The adviser will then tell you how to go about that. Like with many other things in life, payment replaces personal ignorance. This may cost you a few hundred bucks in consultation fees.
- You can align yourself with the management of a company if insiders of the company holds a substantial number of the assets. That way managers “live or die” based on their performances. You need to check if the managers are wasting company assets to support their lifestyle. There are certainly small companies where the managers have very generous benefits and pension plans, free country club memberships, and a jet, but where shareholders see very little returns because the operating revenue gets sucked up by “avocational interests”. Berkshire Hathaway is well managed and an example to the contrary. If they paid a 4% dividend, I’d be all over it. Unfortunately, they don’t.
I have personally picked option (1). I find investing interesting. I like the perceived control from understanding what is going on. I don’t like to rely on other people. If I could perform surgery on myself, I’d probably do that too 🙂
However, for those who’d prefer to outsource the problem, I would pick the fee-only approach. It is impartial, it may save you from yourself (losing $25,000 on a crazy idea), and you get to blame/trust a professional rather than your best friend or favorite blogger.