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3 Ways Financial Advisors Mislead You

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Probably way more than three ways personal financial advisors can mislead clients. But the article I want to link mentions three, so we will start there.

I agree with two of the three, but you can come to your own conclusions.

Okay, so what are these evil secrets financial advisors use to hurt clients? 

Ramit Sethi writes about financial “experts” who offer advice that never actually works. In his article [4], Mr. Sethi describes three “money secrets that the money pros won’t tell you.”

Secret #1: Cutting back on lattes almost never works

I would have linked to the article just for this point alone. So, so, true.

“Latte” can be substituted for many other things advisors tell you to skip and invest the savings.

The issue is never saving $3.00 per day by not buying the latte (and I would like to know where I can get a $3.00 latte these days!). The issue is more fundamental. For most individuals, $3.00 is not the tipping point to wealth creation. It is the reasoning behind the spending, as well as the other daily expenditures that occur.

If you can develop an ethos to save and invest, your daily caffeine high will not get in the way. But you need to develop a saving mentality. That usually requires a fundamental change in behaviour, not giving up one coffee a day.

Yes, I know the longest journey begins with a single footstep, every penny helps, and so on. But I would rather focus on positive techniques that aid in the investing [5] process. Tools that may still allow for your daily dose of joy.

Secret #2: As an individual investor, you’re probably being ripped off

Ripped off? Toi? Say it ain’t so.

1. High fees

High fees? Where have we heard that one [6] before?

As a small investor, use low cost index funds!

2. Commission-based financial advisors get fat fees recommending inappropriate funds

Commission-based financial advisors [7] make their living from product sales. Does not make them bad people (or at least most of them), nor do I think that all of them recommend inappropriate funds. But that is how they pay their own bills, so be aware that a potential conflict of interest exists.

Same with bank employees providing in-house products [8] to clients.

Always know how your advisor is compensated [9] and apply a healthy degree of skepticism to recommended products. You do this when buying a car, television, etc. Financial products should be treated exactly the same.

And understand whether your advisor will be a fiduciary [10] or not. An important distinction.

Also, those high priced mutual funds and structured products generally do not outperform [11] passive investments or designated benchmarks. If someone tries to get you to invest in a product with high annual fees, demand to see performance comparisons [12] to benchmarks and peers. Perhaps the fees are worthwhile. But I doubt it.

In my opinion, active portfolio management is not optimal [13] for smaller investors (and large ones for that matter). Put your money to work for you. Do not let it go into the pockets of the bank, fund company, brokerage house, or product salesman. Minimize your costs [14] and you will maximize your long-term growth.

3. Unnecessary accounts

True, except for the part on using target date funds [15].

Also, smaller investors should try and consolidate investment accounts with one bank or firm. The more assets in one place, the more leverage you may have when negotiating loans or other financial services. For example, many online brokerage houses offer reduced transaction fees if you maintain (say) $50,000 in bankable assets with the institution. Often, this threshold applies to family assets (those who reside in same household).

If you are starting out and still live at home (or use your family address), you may be bundled in with your parents, thereby allowing you preferential fees. But you usually need to specifically request the linkage. So check the small print at your financial institution and see if you can reduce your costs.

Once you develop a substantial asset base, diversify between at least two banks. Partly for protection in case one bank fails. But mainly to play one against the other when negotiating for products and services. Banks live for new assets under management. The promise of new money coming in is a big motivator for flexibility.

Secret #3: Getting a tax refund is a good thing

I see the point. People take positive wealth accumulation steps with the refunds, but would (foolishly) spend it otherwise (probably on lattes).

But I do not agree. That is why I like individuals to contribute to their tax-deferred investment accounts as early in the year as possible, then have their source deductions reduced [16] to reflect the tax-deductible contribution.

First, the interest foregone is small at today’s rates. Fine. But when rates were 10% or more (not that long ago), that $3000 refund lost interest becomes much more significant.

Second, there is the whole time value of money [17] thing. A dollar today is worth more than a dollar tomorrow. If you are not getting a return on your cash (as is the case with tax refunds), you want the money in your jeans (to start earning a return) as fast as possible.

Third, and perhaps most important, is the stronger compounding [18].

You contribute $3000 annually for 20 years, earning a return of 8% each year. You make the contributions at year end, reflecting your tax refund. At the end of 20 years, you have $137,286. Or you decide to make the contributions at the start of each year and not wait for a tax refund. After 20 years, your capital would be $148,269. By investing at the beginning of each year, you would accrue $10,983 more than by waiting until year end. Or in easy to understand terms, 3,661 lattes at today’s prices.

Yes, I agree that psychologically it may be easier to wait for a tax refund, then invest it or pay down debt.

But from a pure finance perspective, get the money owed to you back in your pocket as fast as possible. Then put it to work immediately. The extra wealth that you will accumulate over the long-term is worth it.