“Why is it that anyone driving slower than you is an idiot, and anyone going faster than you is a maniac?”
People hate buying cars from dealerships. The stereotypes abound. The white-shoed salesperson. The slimy process where he has to go “check with his manager” to see “what we can do for you.” The paperwork. The additional fees that get tacked on in the end. The enormous price tag that goes with buying most cars. It’s no wonder that most people would rather experience brain surgery without an anesthetic than go through buying a car.
There is one way which car dealers work to make the buying process appear easier. Instead of making you write a big honking check for whatever the car is worth, which makes Monkey Brain scream in his cage, they reframe it in terms of small amounts – “only” $400 a month. They don’t even, usually, tell you the interest rate. They just want you to think in terms of a small payment compared to the potentially large payment that you could make if you paid in cash up front. They also divert your eyes away from the total amount of money that you’ll pay over the life of the loan, which is significantly higher than what you’d pay right now if you just wrote a check.
If they’re smart, they go even one step further. They have the payment auto-drafted out of your bank account when the payment is due rather than making you actually go through the pain of having to write a check. As Dan Ariely explains in his book Predictably Irrational, it’s not necessarily the amount of the payment which causes pain, but, rather, the payment itself.
Thus, when you’re at the car dealership, signing up for that loan, Monkey Brain thinks that he’s avoiding pain now by not having you write a check to pay for the car in cash. Instead, he’s signing Future You up for dozens of additional psychic knife wounds each time you have to make that payment. But, if the money is automagically drafted out of your account, you don’t have to write the check, and you don’t have to activate those pain centers in your limbic system. Monkey Brain gets to have his cake (“VROOM!”) and eat it too!
It’s not until later when you do a little accounting and wonder “if I made all of this money, where did it go?” that you start to realize that you were had. You could have written the check up front and not paid the car dealership or the bank all of that interest. You would have more money now and could buy MORE bananas! Bad Monkey Brain!
When you look for financial planning advice, it’s easy to fall into the same money pit that Monkey Brain falls into at the car dealership. You go to your strip mall financial advisory firm with branches nationwide and you walk in looking for some advice on what to do with your money so that you have a better chance at retiring when you want without having to eat cat food when you stop working.
The advisor beams with glee. He explains to you that he can invest your money for you and that his great “skill” will help you out against all of the vicissitudes of that mean, nasty, old Mr. Market. Just hand him the keys to your accounts, or, better yet, let him move it over to his brokerage, and he’ll take care of it for you. Plus, even better, you don’t even have to pay money up front! All he’ll do is remove 1-2% of your total net worth every year at the end of the year so that you don’t have to be bothered with writing a check.
This is called an assets under management (AUM) model of financial planning, and it will slowly rob you blind. The problem with this model, from you, the investor’s perspective is that you never have to write the checks. You avoid the pain. Monkey Brain can participate in willful blindness about what this is doing to your nest egg because you don’t light up pain centers in your brain by having to write a check to your “investment advisor.”
Let’s compare how that model looks against an hourly model (mine). If you use me, you’re probably going to have to lay out about $2,000 up front. Monkey Brain is going to scream and scream and scream about how many bananas that could buy, and he’s going to send images of the 183” flat screen TV or the closet full of Jimmy Choo shoes flashing through your mind’s eye.
At the end of our work together, barring an unexpected major turn of events in your life (“Really? The lottery numbers were 1-2-3-4-5-6?!? AND Bill Gates was actually my illegitimate uncle and left all of his money to me?!?”), you’ll be done. You’ll be educated, set, and have a plan tailored to your specific life circumstances, and you’ll know what to invest in and WHY to invest in it (hint: no front-loaded mutual funds).
If you go to the strip mall financial planner with offices nationwide staffed by the fresh-out-of-college with no real world experience wide-eyed
salesperson “investment advisor,” you’re going to pay, on average, 1% of your invested assets every year.
Let’s assume, for the sake of a simple set of mathematical assumptions, that you have $250,000 worth of investable assets and you’re contributing $10,000 a year to that amount through age 65. You’re 35 and will live another 50 years. At age 66, you’ll start withdrawing $75,000 and increase it 3% each year for inflation. The market returns 5% every year (remember, this is a simple example; the real market doesn’t work this way AT ALL).
How much are you going to pay the strip mall financial planning firm with the AUM model to, in all probability, underperform the market?
You’ll, in this example, die with $1.44 million in the bank. However, you’ll have paid the strip mall financial advisor $436,969.52 for the privilege of playing with your money.
How much does this assets under management fee cost you?
If you weren’t paying the fee and instead paid $2,000 up front one time to get proper financial planning and training so that you didn’t feel like you needed someone else to manage your money for you and earned the same return (statistically likely), you’d die with $1,975,498.29 in the bank.
That’s $533,303.31 more.
So, you’re engaging in a wealth transfer from yourself to your “investment advisor” of $436,969.52 over your lifetime. In exchange for this “service,” which, as a matter of probability, means that you underperformed the market, you wind up over a half a million dollars poorer than you would have otherwise been had you been willing to pay a little up front to fully educate yourself and properly plan to manage your own assets.
A half a million poorer because Monkey Brain didn’t want to write a check up front and preferred to stick his head in the sand and pretend that other payments weren’t occurring.
Furthermore, a recent survey of investment advisors found that 93% of them suffered from “post-traumatic stress disorder” symptoms during the crash of 2008. Why? Because they were trying to “tactically” invest money; yet a study in 2012 showed that investors who try to time the market (another phrase for “tactically” investing money) underperform the market.
Yes, if you’re paying someone else to manage your money, your Monkey Brain is paying their Monkey Brain to play with fire.
This doesn’t even account for the lack of actual financial planning associated with many of these strip mall investment advisors. They just want to take your money and invest it (while taking their fees) without even covering the entire gamut of your financial life. As a result, you don’t change your behaviors, save more, spend intelligently, or have any sort of actual plan. They’re just playing the markets with your money.
If you go to an investment advisor who wants to manage your money and take a percentage of your assets, you’re doing the investment planning equivalent of walking into the used car lot and financing your purchase on a 96 month note. You’re falling for the same psychological tactics used by car salesmen to make paying much, much more money seem like you’re paying less. Except, this time, because you’re financing, you’re doing the equivalent of buying a car with a major oil leak and horrible gas mileage. You might not pay up front for it, but you’ll pay a lot more in the end. There are very few scenarios where it’s more cost effective to use the assets under management type of financial advisor, and in almost every case, you won’t have enough capital to get the attention of one of these advisors.
Do you want to see how this arrangement would affect your situation? I’ve included a worksheet so that you can play around with the numbers to see just how much you’d be impacted. Feel free to use your own assumptions!
Has an investment advisor tried to convince you that he could outperform the market? Have you asked him how much you’d wind up paying over your lifetime for him to manage your money? Have you asked him to prove to you in a statistically significant way how he can consistently outperform the market while maintaining the same amount of risk? If you want to talk in financial planning terms, tell him to statistically prove his alpha; if he doesn’t understand that phrase run far away.
Does the thought of potentially losing an enormous sum of money because of hiding fees make you want to throw up? Every time I hear someone tell me a story about a strip mall “financial advisor” who takes people’s money, it makes me sick.
What have your experiences been? Tell us about it in the comments below, and please share this article with your friends!
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This article appeared in the Carnival of Wealth. Click on that link, and read the other articles included. You’ll be wiser. Then read the rest of the Control Your Cash articles. You’ll be even more wise than you were after the first round of reading!