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Do you need a financial advisor?

Do you need a financial advisor? Market graph.
Do you need a financial advisor to invest successfully?

Do you need a financial advisor to invest your money successfully? The people in the industry certainly want you to believe that you do. Of course, that’s how they make their money – they are not in a position to give you an unbiased opinion. I, however, firmly believe they are no more than unnecessary middlemen, at best. More often, they are directly counterproductive to making money investing (I will show you how later). The financial advisors are more than happy to place themselves in the middle and take some of your money, without really offering much except for a facade of expertise.

I say facade because they are too unreliable at their job – beating the average market return. Don’t let the fancy jargon they use trick you into thinking they know what they are doing; they don’t. They might even be smart people, but not that smart.

How do I know? I have outlined the reasoning below. Once you have read through it once, you won’t be fooled by them again. The logic is quite simple to follow; most people have just not spent the time to inform themselves. In 15 minutes or so, you’ll be happy that you did!

Setting a baseline – The Market Average

When you invest your money, the goal is to earn as much return as possible. Now, you might be thinking that you have no idea how to accomplish this. The financial markets are complex and hard to navigate, so I don’t blame you for feeling a bit lost. In fact, people who are confident their abilities to pick “the winners” are likely in a worse position than you. Sure, they may have got lucky once or twice in the past, but they are not telling you about their failures. More likely than not, they have or will make costly mistakes that tarnish their overall average returns.

Financial advisors supposedly have the skills to invest your money in a manner that beats what you can achieve on your own. Confidence can get you a long way and they use theirs to deceive you into thinking your money would be better off in their hands. Yet, this is not the truth.

Let me explain.

First, we need a baseline of what level of return you could achieve on your own. “I don’t know that I could get any positive return through investing on my own,” you might think. Here’s why you are wrong: Anyone can earn average market returns by investing in an index fund, such as the S&P 500*.

If I’m going to pay someone to invest for me, they better get better returns than I can by investing in an index fund. If they cannot do that for me, why would I pay them?

Can financial advisors beat the market average?

So, can your financial advisor consistently beat the market average?

It is highly unlikely that they can. Most of the US stock market trading is done by people who are at least as qualified as your financial advisor. In fact, the bigger firms have far more resources dedicated to this pursuit and should, therefore, be expected to do better than individuals with limited capacity. Even, in a level playing field, only half of the people investing can ever be above average. To make matters worse, there is almost no correlation between the performance one year and the next. This means that the financial advisor with the best returns this year may very well have the worst returns next year.

What if they do beat the average consistently?

As a matter of fact, even if your advisor beats the market every year, they may not make you more money than if you invested in the S&P. That seems odd, right?

This is, of course, due to the fees they charge, which can be as high as 2.5%. How does this affect your return?

Let’s say you invest $100,000 and the average market return that year is 9%. Your financial advisor, however, boasts 10% returns. How much would your investment be worth through each investment strategy?

Index fund:

($100,000 * 109%) = $109,000

Financial advisor:

($100,000 * 110%) = $110,000
Fees = ($110,000 * 2%) (2,200)
$107,800

As you can see, once the fee is factored in, the financial advisor still earns you less money than the market average. The after-fee return above for the financial advisor is actually 7.8% instead of 10%.

With this in mind, financial advisors don’t just have to beat the market average to be beneficial to you; they have to beat it by a lot, and very few do that consistently**.

Conclusion

Financial advisors that are worth what they charge are few and far between. To make matters worse, there is no way of telling if you found one that is, until after the fact, making it a gamble. In most cases, financial advisors are actually hurting your returns by taking a sizeable chunk of your money in fees every year.

Let me be clear, I don’t hate the people who decide to be financial advisors. I know some who are nice people and I have heard of several more. But it’s a bit like paying for a friend at that point. If that is what you are after, a financial advisor might be the thing for you. But from a financial standpoint: Do you need a financial advisor?

No, you do not need a financial advisor.


Notes

* The S&P 500 tracks the performance of the 500 largest listed companies in the US and is, therefore, a good proxy for the US stock market.

** Remember that financial advisors still charge you fees when you have had a bad year and lost money. As such, the fees are consistently impairing your ability to capitalize on the effects of compounding, which is key to good growth over time.

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