Financial Planning
Word problems are taught in school to develop critical thinking and problem solving skills. Students typically have difficulty with word problems, especially when unnecessary / irrelevant information is given in the problem. Unfortunately, life is just one big word problem, for example:
You are married with three teenage kids and are in general good health.
You have been saving for your kids college education.
You have some credit card debt, a 401(k) and are 16 years into a 30 year mortgage.
Your father died at age 77, mother at age 82.
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The decision to hire a financial planner depends on your individual financial situation, goals, and preferences. In my humble opinion, it boils down to a cost-benefit analysis; will a financial planner generate more income than their fees? This page attempts to analyze the pros & cons of using a financial planner.
Risk comes from not knowing what you're doing. Warren Buffett
Analysis
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Investment Management A financial planner can help you develop a customized investment strategy tailored to your risk tolerance and financial goals, like buying a home, saving for retirement, or sending your children to college. Time and Expertise A financial planner can accelerate your financial literacy and save you time learning about managing investments, retirement planning, tax optimization, and estate planning. Second Opinion Financial planners can provide a second opinion regarding your finances and help you make rational financial decisions. Regulatory Credentials Certified Financial Planners are certified and regulated by reputable organizations like Certified Financial Planner (CFP) Board or the Chartered Financial Analyst (CFA) Institute. These credentials can provide assurance of their expertise and ethical standards. |
Cost Financial planners can be expensive, with fees based on assets under management, hourly rates, or flat fees. Even a 1% AUM fee compounds to over 30% of market returns over 40 years. Consider whether the potential benefits outweigh the costs. If you don't perceive enough value in the services provided by financial planners, then you may opt to handle your finances on your own. Simplicity If your financial situation is relatively simple, such as having a job with a steady income and straightforward financial goals, you may be able to manage your finances on your own. Do It Yourself™ Some people prefer to manage their own finances and view it as a hobby or interest, believing they can educate themselves and make informed decisions without professional help. Here are some ideas to help you get started. The availability of online tools and resources for investing, budgeting, and planning can empower you to manage your finances independently. Trust Issues A negative experience with a previous financial advisor, concerns about conflicts of interest, mistrust of financial advisors or privacy concerns can can discourage investors from seeking professional advice.
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Whether you use a financial planner depends on your unique financial circumstances and needs. If you find that your financial situation is becoming more complex or you lack the time and expertise to manage it effectively, consulting with a financial planner can be beneficial. Planners can help you create a financial plan, provide guidance, and assist in reaching your financial goals. You can seek referrals from friends, family, or colleagues to find a reputable financial professional to help you.
Fees and Expenses
Financial planners are compensated by management fees and a portion of sales loads and expenses for the products they sell. Fees can be a percentage of AUM, hourly rates or flat monthly fees. It is common for a financial planner to charge 1% of your portfolio for advice / recommendations, though fees will often vary between 0.5% to 1.25% depending on portfolio size, where larger portfolios command lower fees. While 1% doesn't sound like a lot, the effect of compounding fees over longer time periods outpaces the fees themselves.
Management fees and expenses represent guaranteed risk-free income for financial planners and investment companies. These fees and expenses are charged regardless of good or poor market performance. If your financial planner takes those fees and expenses and continues to invest them, they will earn the compound interest portion of the market return illustrated in the charts below. You can think of management fees as slowly transferring ownership of your portfolio to your financial planner over time.
The following charts depict a hypothetical market return of 7.5% that you might earn with a financial planner who charges a 1% management fee and a 1% expense ratio charged by the funds they recommend. Total expenses are 2% per year. A $10,000 investment will grow to $180,443 with a 7.5% market return over 40 years. In this scenario, your portfolio will grow to $85,133 and expenses account for 52.82% of market return over 40 years.
The following charts depict a lower hypothetical return of 6% since you aren't using a financial planner. In this case you invest in a low-cost no-load index fund which has a 0.1% expense ratio. Total expenses are 0.1% per year. A $10,000 investment will grow to $102,857 with a 6% market return over 40 years. In this scenario, your portfolio will grow to $99,046 and expenses account for 3.7% of market return over 40 years.
As the investor, your goal is to maximize the size of your portfolio in these charts. While using a financial planner can generate additional market returns, in order for you to come out ahead investment income must exceed investment expenses.
In these hypothetical scenarios, you would be better off on your own. While a financial planner can help you get a higher market return of $180,443, that higher return is offset by the fees and expenses they charge you for working with them ($27,322). In the first scenario, the planner charges $13,661 in fees, and $13,661 is lost to higher fund expenses. The hidden cost is the compound expense of $67,988 which is amount of market return lost in addition to paying $27,322 in expenses. The financial planner must outperform the market by 1.9% (the difference in total expenses) every year for you to breakeven between these two scenarios. If you invest in a low-cost total stock market index fund, or the S&P 500, it is very difficult to outperform these investments by 1.9% per year for 40 years.
Fiduciaries
I have a passion for helping people with investing and wanted to become a fiduciary so I can recommend the best investment products for investors. I started training with an investment company that said I could become a fiduciary with them and obtained my Series 7 and Series 66 licenses and became a broker / investment advisor. After receiving my licenses, I was hired as an investment advisor.
As part of my training on becoming a fiduciary, a popup window came up on one of the videos which said:
| Because there is no legal definition for fiduciary, we revert to a suitablity standard. |
The suitability standard is an ethical standard that financial professionals must follow when working with clients. It requires recommendations to be suitable for the client's investment objectives and risk tolerance. The suitability standard is less strict than the fiduciary standard, which requires advisors to put their clients' interests ahead of their own. The suitablity standard allows financial professionals to recommend products that are in the best interest of the advisor without regard for the client's best interest.
There are many rules financial professionals must follow. These rules are designed to protect clients from bad actors. For example, an investment advisor is not allowed to trade a security on the same day as their client to avoid the illegal practice of front running. Front running is where you buy a security, then recommend your client buy it causing the price to increase, then selling it for a profit.
Investment advisors are only allowed to recommend products that are approved by their employer. This is to help prevent advisors from recommending non-suitable investments to their clients. Unfortunately, an unintended consequence of this rule can be morphed into an organizational advantage for the employer. My employer stated I could become a fiduciary, which meant I was able to recommend the best investment products for my clients, however because any products I recommend must be approved by my employer, I was not allowed to recommend outside products to my clients. They would not approve my request to recommend Vanguard products as it constituted a conflict of interest. They stated that there are similar index funds available with a 0% expense ratio and asked how recommending a 0.03% Vanguard fund to clients would be in the best interest of my clients. I was denied recommending Vanguard funds and was told I must shut this website down because it constituted a conflict of interest. I felt so strongly about helping people with their investments that I maintained my website and was asked to leave the company.
No one cares more about your money than you.