Personal Finance FAQ: What Are the Types of Financial Planners?

Ask, and ye shall receive!

I recently received a question from one of the subscribers to the 52 Week Financial Game Plan that seemed like an excellent topic to share with all of you.

This person asks:

As I read more and more on the topic of financial planning, it seems there are 2 factions. One faction is the adviser that manages/advises mainly on matters concerning investments ( IRA’s, retirement etc.). The other seems to be the nuts and bolts kind of guy……answers questions on insurance, budgets, everyday financial concerns and such.

Can you get both in one, or, at least to get started, with regards to advise, should these two different interests be handled by one adviser or separated ?

Once on the road, what is the function of an adviser? Do you see it as that of a physician, checking in from time to time and providing a check up, getting you back on the straight and narrow when need be, or someone actively reaching out when they sense a concern?

To which I replied:

Mr. or Mrs. X–

I’d offer a slightly different take on your division. To me, there are two types of advisors:

  1. The person who wants to invest your money for you, take a % of your invested assets each year, and for whom the financial planning is ancillary. The financial planning is a loss leader for the assets under management fee that he will get every year from you. There’s a big discussion going on in the financial planning industry about the role of financial planning as it relates to getting people to invest their assets with the financial planners. The planning runs from “invest your money with me! Goodbye!” which you’ll get at any of the strip mall “financial advisory” firms (you can probably figure out the names of the firms to whom I refer). They’re giddy when you buy 5.9% front loaded mutual funds and then pay 1-2% of your assets each year on the back end. The other end of the gamut are the firms who will still take some percentage of your assets under management each year, but will go through an entire financial planning process with you, covering estate planning, tax planning, financial management, and the like, minus teaching you about investing, since that’s what they want you to think they can do better.
  2. The person who won’t manage your money and will do the entire gamut of financial planning, to include teaching you how to invest your own money. This is what I do, so I have an obvious bias, which I’ll explain shortly. In general, these people either don’t want to deal with the hassle of the regulatory requirements associated with having a broker-dealer relationship and investing your money for you (which is not insignificant) or they don’t feel like managing someone else’s money is in the best interest of their clients.

I fall into the latter of the latter categories. There are few of us out there (I feel like a wizard in Middle Earth – strange and rare) because, honestly, there’s just not a lot of money in it. An average engagement with me will cost around $2k (give or take), and even though I’m a lot cheaper than someone who’s charging a percentage of assets under management, due to cost deferral and the fact that Monkey Brain doesn’t have to ever stroke a check for the services, it’s easy to pretend that the costs aren’t there and that I’m actually more expensive than the investment advisor who’s charging you that percentage of your assets that he “manages.” Therefore, there are few people who a) have the strong convictions about what they do like I have, and b) have the financial wherewithal to have a comparatively low income from what they do (which I do, thanks to both my own prudence and to selling a company), since this route is not as lucrative as taking 1% of their client’s money every year. My goal is to teach my clients what they need to know, and then, unless they just want a check up, or their life circumstances change (“you mean Bill Gates was my illegitimate uncle and I’m inheriting everything from him?!?”), they shouldn’t need to come back.

Thus, the decision really comes down to a tradeoff of time for money. If someone REALLY wanted to, they could scour the Internet for every piece of relevant information that is out there, or take the CFP core courses, and get a pretty significant portion of the knowledge I possess. There are a ton of DIYers out there who spend a lot of time on Bogleheads and other similar forums and sites doing just that. Or, they can have the teaching tailored to their needs and pay for the education.

Now, back to why I think model #2 is superior.

  1. Conflict of interest. If I’m managing your assets, then I have an incentive to grow those assets as much as possible. Sounds good in theory, but in reality, it means that I’m encouraged to take inappropriate risks, which, more often than not (discussed below), wind up not working out the way that they were supposed to on paper, and you wind up with even less. Once you’re down some, I’m encouraged by prospect theory to try to win it all back – effectively a Martingale system for investment management.
  2. Nobody can systematically and consistently outperform the market in a replicable manner. Statistically speaking, investment performances are more and more a function of luck than skill (see my article “Do You Have to Be Lucky to Beat the Market?” for more). As a result, you’re paying what could wind up to be a significant portion of your potential net worth to someone to, from a probability standpoint, underperform the market.

Therefore, with regard to your question about the fees you paid, you have to ask yourself two questions:

  1. If I simply went with an appropriately allocated index strategy, what would my returns have been compared to the returns I received?
  2. What guarantees that I’ll continue to receive the same investment performance, relative to an appropriately allocated index strategy, year over year?

Unless you simply do not have the time because you’re pursuing activities which have a higher value to you than the few hours a year necessary to manage your own portfolio or you do not have the cognitive ability to do said management, I see no reason why you (or anyone) should be paying someone to invest your money for you and run a high probability risk of underperforming the market.

Furthermore, the level of effort to manage a $1 million portfolio is not twice as much as the level of effort to manage a $500,000 portfolio, so why do people who pay others to manage their money get charged twice as much?

By the way, I did not even include commission-based front-load mutual fund salespeople, because they’re not worth me wasting my breath on. Spend money with them and you’re lighting it on fire.

You’re darn right, I’m biased.

What do you think? Sound advice or am I blowing smoke? Tell us your thoughts in the comments below!

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Jason Hull, CFP®, was the co-founder of Broadtree Partners, a firm that acquires $1-5MM EBITDA companies. He also was the co-founder of open source search consultancy OpenSource Connections, a premier Solr and ElasticSearch firm. He and his wife FIREd (financial independence retire early) at 46 and 45, respectively. He has a BS from the United States Military Academy at West Point and a MBA from the University of Virginia Darden Graduate School of Business. You can read more about him in the About Page. If you live in Johnson County, Texas or the surrounding areas, he and his wife are cash buyers of Johnson County, Texas houses.

3 thoughts on “Personal Finance FAQ: What Are the Types of Financial Planners?

  1. This rocks. I must reference this. Unfortunately it is so similar to my outlook, and you articulated it so well, you may have grounds to accuse me of plagiarism when I publicly say how I feel about compensation.

    I have had the same conversation already. When I threw out a number in the $3,000-range my new acquaintance clearly balked at such an ‘extravagant’ sum. He hadn’t read your ‘car salesman’ post — it wasn’t written yet at the time, but … never mind.

    Then he referred me to another financial planner whose source of income is not apparent from his website — commissions? assets under management? Who knows.

    Thanks for carrying the flag!

    1. Thanks for the kind words, Rob! I don’t mind if other people have a similar outlook. It means that we’re all on the right side of the ledger. I have yet to see anyone make a cogent argument for why a client should pay extra money in commissions and for AUM when they can’t show with any type of statistical certainty that they can beat the markets. I’ve also yet to see a cogent argument for why it should take more than a few hours; therefore, there is no cogent argument for the enormous fees.

      Let’s take, as an example, someone who has $1 million in investable assets. Will that AUM manager, with a straight face, say “you can do just as well as I can, but if you don’t want to take the few hours a year to invest and rebalance, it’s going to cost you $10,000 every year. That’s about $2,000 an hour. You good with that? We’re on the same page, right?” If he can do that with a straight face and get someone to invest with him, more power to him. He’s fully and completely disclosed and received arm’s length agreement.

      Furthermore, at what point does an AUM advisor incorporate investment real estate? I find many cases where investment properties are an appropriate investment. What AUM advisor would do that? Oh, I’m sure they’ll provide a “service” which does not include a) finding, or b) managing those properties yet still charge some percentage of assets.

      I’d actually buy the notion of AUM for investment property or small business, because there’s a clear and definable alpha (oh wait…am I presaging a post later this week?) in an illiquid and irrational market, but I’d rather teach what I know and send my clients forth to make their own tweaks and use their own experiences and knowledge than relying on mine. Otherwise, they’d all be invested in the shiniest new tech startups! 😉

      BTW, I saw Bob’s article after I’d written this one. I usually write articles two to three months in advance.

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