Butch on a Budget

When you first start taking your finances seriously it can be easy to jump to the conclusion that you should get a financial advisor to help you set up and manage your investments. Starting to invest can feel confusing, scary, and jargon-y. You may not know where to start or be afraid of messing it up and losing your money – better to leave it to the pros, you think. 

Don’t. 

The truth is, the most successful investment strategy is also extremely simple, easy, and hands off. And you can easily set it up and manage it yourself without a finance degree. 

Unless you’re working with a fee-based fiduciary advisor, you’re probably getting ripped off. 

This is because most “financial advisors” are actually sales people. 

You probably won’t feel like you are paying them anything because they aren’t charging you directly. But I can guarantee they aren’t helping you out of the kindness of their heart. 

Financial Advisors earn money through AUM Fees (a percent of Assets Under Management) and commissions they earn from selling you various financial products like life insurance policies and from trading transactions. 

Here’s the deal, if you’re paying an advisor, you are paying for two things:

1. To not have to manage your investments yourself.
2. The hopes of better returns on your money.

If you truly do not ever want to look at or think about your investment account and you are willing to pay a premium for this luxury or otherwise would not invest at all, fine, keep your financial advisor. But you should understand what that is costing you –  and I still plan on convincing you that you can manage your investments better yourself and with minimal effort/time. 

But if you are using an advisor because you think they will help your money grow more/faster, let me explain why this is very very unlikely to be true. 

AUM Fees Impact on Returns

In this post I’m only going to dive into the AUM fees and expense ratios when calculating the costs of a financial advisor, but you should be aware there are other trade commissions likely eating away at your returns. 

AUM Fees are typically 0.5% – 2% of “Assets Under Management.” For the calculations in this article we’ll stick with 1.5% as our standard AUM fee. This means if you have $100,000 invested and managed by a Financial Advisor the advisor will take $1,500 in that first year. This doesn’t sound that bad. But the thing is, your advisor will take that 1.5% fee every year and it will compound as you contribute more and your investments grow.

Over the life of your investments you will likely pay the financial advisor tens if not hundreds of thousands of dollars. 

For example, even if you never contributed more, but just let that $100,000 sit and grow for 20 years, at the end of 20 years you will have paid your advisor over $95,000 in fees – almost as much as your original investment.

This 1.5% fee doesn’t sound like a lot, but when you are looking at an average return of 7% per year, that’s over 20% of your return being eaten away by fees – not to mention the transaction costs and trading commissions, which brings me to my next point. The higher cost of actively managed funds.

High Cost Actively Managed Funds

If you self-manage your investments you should be invested in low-cost broad-based index funds or target-date retirement funds. Both of these have very low expense-ratios – which is the fee you pay to own a fund to cover its operating and administrative costs. These types of funds typically have expense ratios below 0.12% and often closer to 0.06%. 

Not always, but oftentimes, financial advisors will put you in more actively managed funds trying to beat the market. These funds typically have higher expense ratios between 0.5-0.75% but it’s not uncommon to see funds with expense ratios at 1.5% or even higher. 

These expense ratios eat into your returns in the same way as AUM fees. Let’s say you had a financial advisor who was charging 1.5% and had you in a number of actively managed funds with an average expense ratio of 0.75%. This would mean you would be paying 2.25% in fees annually,  or 32% of your expected annual returns. 

If we use the same $100,000 example above, over 20 years. You would pay nearly $134,000 in fees, compared to less than $6,000 in expense ratio fees if you self managed with low-cost index funds. 

You can see the dramatic difference these fees have on your overall returns, and this is without making any additional contributions. You can play around with your own numbers here.

Financial Advisors rarely beat the market

Now you might be saying, “Kaylie, I pay the advisor to beat the market. They’re a professional! They know what they’re doing, so I’ll definitely earn more than that measly 7% if I have an advisor managing my money.” 

First, it’s highly unlikely they will. Especially over the long term. Over a three-year period 80% of fund managers underperform the S&P 500. Over a 20 year period, 93% of fund managers underperform compared to the market. Meaning the odds are overwhelming that you will pay more for worse results. 

Second, even if they managed to outperform the market. They would have to beat the market by more than the combined percentage of their AUM fees and expense ratios – in our example, they would have to beat the market by 2.25% just to break even for your bottom line (again, not even factoring in any transaction costs). 

What should you do?

So, what should you do?

Give yourself more credit. Know that within a couple of hours you are fully capable of setting up and automating your very own investment portfolio.

A successful investing strategy boils down to a few simple principles.

1. Automatically invest every month. Even if it’s a small amount at first. 
2. Buy low-cost broad based index funds like VTSAX, VTI, VOO, etc or target-date retirement funds for the year you hope to retire. 
3. Check in once or twice a year to see if you are able to increase the amount of your automatic contributions. 
4. Let it cook. Don’t worry.    

That’s it!

Feeling inspired? I have a post that walks you through how to open your very own Roth IRA with Vanguard here.

If you already have an advisor, and after reading this post have started to regret it, don’t worry, it’s not too late! I’ve recently helped a number of clients break up with their financial advisors and  transition their investments to self-managed accounts, and I can help you too.

P.S. Don’t ever buy a whole life insurance policy, no matter how great your financial advisor says it is – but that’s a post for another day.