Should You Invest with a Financial Advisor? Probably Not
Updated: Nov 28, 2021
Financial advisors may not have your best interests in mind and they really don't even try to beat the market.
Before we get into why you shouldn't invest your money with a financial advisor we do want to give them some credit. Financial advisors are often very useful to help you put together a long-term financial plan. They usually are more knowledgeable than the average person about everything that goes into planning for your financial future like how much money you will need and how certain things like taxes and inflation will affect your finances. That being said, when it comes to investing your money most financial advisors aren't going to do any better than you would if you were to just throw your money in the S&P 500 and forget about it.
So, the first thing you need to know is how financial advisors actually make money. Financial advisors make money in two main ways: commissions and fees. Some financial advisors are commission-only advisors, some are fee-only, and others use a combination of the two. Here are some examples of how these fees and commissions work.
Commission-based financial advisors generally charge you a percentage of the total amount of money you have invested with them on an annual basis. These commissions generally range between 1-3% depending on the firm and how much money you have invested with them. So, if you invested $10,000 with a financial advisor that charged a 2% commission then you would pay them $200 to invest that money for you each year. If by the following year your money had increased in value to $11,000, then the next year you would pay them $220 and so on.
A fee-based financial advisor on the other hand might charge a flat rate to invest your money for example $2000 per year to put a plan together for you and manage your money. These advisors might also charge their fees based on an hourly rate. As mentioned above many financial advisors often combine commissions and fees. For example, they might charge an initial fee for putting together your financial plan and then charge commission for actually managing your money.
One more way that financial advisors get paid is by the ETF's and mutual funds themselves. Now if you think this is a conflict of interest, that's because it is. You see many of the mutual funds and ETF's that financial advisors convince you to invest in are actually paying the financial advisors to get you to invest your money in those funds. You might have thought this would be illegal, but it's not. This means that financial advisors will often make investment recommendations based on financial incentives for themselves rather than what they think is best for you. Now we're not saying that all financial advisors do this, but many do so make sure that if you do decide to invest your money with a financial advisor that you're making sure they put your interests first.
So, now that you have a basic understanding of how financial advisors make money, let’s talk about why they don’t try to beat the market. Now it’s important to understand here that the main goal of most established financial advisors is to keep clients. That might surprise you. If they don’t keep their clients and occasionally gain new ones, then they don’t make money. But here’s where the problem lies. Financial advisors have realized that they are far more likely to lose a client based on the client under performing the market, rather than the client not outperforming the market. In other words, people tend to care more about not losing their money rather than making money.
So, because of this, financial advisors have come to the conclusion that the risks of trying to outperform the market are greater the rewards. And so what most of them have decided to do is adopt a strategy of mirroring an index like the S&P 500 or Dow Jones Industrial with their clients money. This way when their client loses money, the entire market is also losing money and the financial advisor can easily point to the greater economic picture and argue that this was unavoidable, and that’s a good enough explanation for most people. Also, on the flip side if the market is up, then the client is making just as much money as most other people and so they are happy. Very few people are going to leave a financial advisor because they aren’t making more money than the overall market.
That being said there are people that would leave if they weren’t making enough, but generally these are the type of people who tend to manage their own money. You see the people that tend to use financial advisors are usually people who don’t understand the stock market either because they have tried and found it to confusing, or didn’t even try at all because they don’t have the time or the interest.
This means that they are much less likely to question their financial advisor’s decisions or even have the knowledge to tell whether or not their financial advisor is making good decisions. All of this means that financial advisors have little to no incentive to beat the market. As long as their client is making money when other people are making money and not losing more money than others around them when the market dips, then the client is happy and the financial advisor is happy. And that is why financial advisors generally don’t beat the market, and usually don’t even try to beat the market.
Now, some of you might be thinking what if I know nothing about the stock market, I’ve tried to invest and I’m not good at it. Wouldn’t it be better if I used a financial advisor rather than not invest at all? Maybe, but just consider this first.
The average annual return for the S&P 500 over the last 90 years is right around 10%. If a financial advisor is basically going to invest your money into something that roughly tracks the S&P, then it’s safe to assume you’ll get roughly the same returns with them, but the financial advisor will take their commission or fee which will usually end up being around 2% so now you’re only making 8%. This may not seem like much. Although to put that into perspective, if you invested $5000 in the S&P 500 each year from the time you were 30 until the time you were 65, you would end up with about $1.5 million by the time you were 65, but if you invested that same amount of money with a financial advisor who took their 2% fee every year then you would only have about $930,000. That’s over $500,000 you’re missing out on. In fact, it would take you another 6 years to reach the same $1.5 with a financial advisor. Who wants to work another 6 more years than they have to? If you ever want to check this concept out just Google compound interest calculator and you’ll see just how much of a difference a couple percentage points really make over time.
So if you just feel more comfortable with a financial advisor managing your money for whatever reason, just make sure that you keep this in mind and be sure to choose wisely. Whatever you decide to do with your money we hope this video has shed some light on some little known facts and helped you make an informed decision. If you did find this article helpful, please consider liking and subscribing for more content like this. Have a great day!