Do you really need a financial advisor?
Preparing for retirement can feel like a giant weight on your shoulders while you’re climbing 70 floors of stairs. Makes you think, “Why don’t I just take the elevator?”
The elevator in this case is a financial advisor. They take that weight off your shoulders and safely guide you towards retirement. But at what cost?
The Unfortunate Reality of Financial Advisors
It’s easy to assume that a financial advisor is a professional who knows the ins and outs of the financial industry and can do their own due diligence to create a tailored portfolio for their client’s best interests.
I was surprised to find out, after job shadowing a financial advisor for a day back in college, that a financial advisor is way more of a salesman than an investment professional.
In order to become a financial advisor, the company who’s hiring you is less worried about your education and expertise and more concerned about how large your network is and how many people you can call during your first few months on the job.
All of this isn’t to say that financial advisors aren’t knowledgeable about investing because they obviously need to be in order to handle such an important part of people’s lives. But what I worry about are the fees they charge for their “expertise”.
Fees That Financial Advisors Charge
The different types of fees a financial advisor can charge include:
- Consultation Fee: This is the amount you’ll pay up front for a consultation and the creation of your full financial plan
- Management Fee: A % fee based on the amount of assets being managed (i.e. a $1,000,000 portfolio with a 1% management fee will be charged $10,000 each year)
- Commission Fee: Some advisors can get paid to buy specific funds. Therefore, if a certain fund offers a higher commission rate, the advisor has an incentive to buy that one instead of a fund that may be better suited for the client.
- Annual Fees: On top of the other fees, an arbitrary annual fee may be accessed as well.
Not all financial advisors charge every type of fee listed above. They will usually choose between either commission-based or fee-based. When it comes to how advisors charge their clients, they fall into one of the 3 categories:
- Commission-Based: A financial advisor is compensated by selling investments and insurance to their clients and earning a percentage of the amount sold.
- Fee-Only: A fee-only advisor receives no compensation based on the investments or products they recommend. They only get paid for each appointment they have with their clients. It’s usually a flat-rate or an hourly charge. This is recommended since the advisor has no conflict of interest to sell you anything other than something in your best interest.
- Fee-Based: This is a hybrid of the two categories listed above where the advisor will charge an hourly or flat rate for the creation of their financial plan, but also may include commission-based products in that plan that they will earn a commission from.
The True Cost of a Commission-Based Financial Advisor
Commission-based financial advisors are expensive. To demonstrate how expensive, I’ll provide you with an example:
Let’s say your financial advisor charges a 1% assets under management (AUM) fee and they can return 8% on your money each year. If your yearly contributions are $10,000 a year, then your first year doesn’t look too bad. You only pay them $100 ($10,000 x 1%).
I know 1% doesn’t seem like a lot of money. Especially when your portfolio balance is so low at the beginning of your retirement journey. But this doesn’t last long.
Let’s stay with the assumption that your financial advisor has built you a portfolio that returns 8% annually and charges you 1% of AUM. Over the course of 35 years you will pay $147,481 in fees to your financial advisor and retire with $1,382,369.
But that’s not all! What if you could make 8% a year without that financial advisor? By simply not paying the 1% AUM fee, your portfolio balance at the end of 35 years would be $1,723,168! So, you’re not just losing out by paying fees, you’re losing out on lost returns by not investing that money.
To sum it all up, you’ll be paying $340,799 to have a financial advisor.
Can you justify paying this person over $300,000?
How to Invest Without a Financial Advisor
Managing your investment portfolio is the only service that isn’t covered with a fee-only financial advisor. Therefore, if you can figure out how to build and manage your own investment portfolio then you’ll never need to pay commission fees. If you ever need a financial advisor then you’ll only be paying a consultation fee.
But how easy is it to build and manage an investment portfolio? Extremely easy. All you need to do is max out all of your tax-advantage accounts. You can learn more about setting up and contributing to those accounts by reading “I Will Teach You To Be Rich” by Ramit Sethi.
I also have a great tutorial called How to Start Investing: A Step-by-Step for Beginners. This will get you started by having you invest in a safe and well-diversified mix of stocks and bonds.
Additionally, you can learn everything you need and more about this subject by reading all the books in my Top 5 Best Books about Saving for Retirement. If you bought all the books in that list, it would run you about $60. That’s a hell of a lot better than $300,000!
Investing truly is easy. The “professionals” who try to make it seem overly complicated are the same people charging you $100,000. Pick up a few books on retirement, read them, and evaluate whether a financial advisor is worth it. If you still have questions, then fee-only financial advisors are always there to help you draft and execute a retirement plan.