Seeking out a financial advisor can be the right move for some investors. The financial markets and the American tax system can be complicated to navigate, and it makes sense that not everyone wants the liability or time commitment involved in self-managing their financial lives.
However, when it comes to basic investing, it can really pay off to learn how to manage your own portfolio. By avoiding the fees you'll pay for a professional manager, you could end up $360,000 richer in retirement. A simple exploration of the math will make the argument on its own.
The assumptions
Let's assume you max out your 401(k) every year by contributing $19,500 annually (for simplicity, let's say the annual maximum never increases from now until you retire). Also, let's imagine you're 30 years old and will retire when you're 60, and you can earn an 8% annualized return on your investments over a 30-year working horizon. You pick a total market index fund offered by the 401(k) plan to earn your 8% return. This scenario would leave you with a final 401(k) value of about $2.2 million at retirement.
Let's say, in an alternate world, you decided to pay a financial advisor a 1% annual fee to manage your invested retirement assets. Understanding the benefits of index funds, the advisor directs your money to the same total market fund mentioned in the above example, and the investment earns the same 8% return. In this case, your investment portfolio in retirement would leave you with $1.84 million -- a nice haul by itself, but not the $2.2 million you would have earned had you managed your own portfolio. How is this possible?
The truth is, a 1% fee has a deleterious effect on an investment portfolio, and an eerily quiet one at that. It sounds harmless, but the reality is that a 1% (or higher!) fee will act as a major drag on your returns over time. This is especially true from an administrative standpoint, because you don't have to physically write a check each time the fee is charged. It's tacitly deducted in the background. So even if you end up retiring with just over $1.8 million -- no doubt, a reason to be happy -- you'll have missed out on $360,000 that you would have earned had you lived exactly the same life over your working career but chosen not to pay the advisor's 1% fee.
As it turns out, long-term investing is surprisingly quite simple. It's very easy to imagine that the financial markets are too complicated to understand, or there's too much risk in managing your own money. The research would show otherwise, and the math is there to prove it. A well-diversified portfolio of passively managed index funds is in all likelihood the best way for an ordinary individual to invest for the long term. It's also extremely easy to ignore the effect of a recurring fee when you don't see the balance that could have been. Instead, you see the balance that you have.
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I've decided to go it alone. Now what?
The benefits of index funds are well-established: They provide diversification, come at extremely low cost, and require little time to manage. Index funds are also highly accessible -- you don't need a fancy advisor, name brand bank, or sophisticated financial software to become a lifelong ETF investor. You do need, on the other hand, a good basic understanding of index fund investing and why this strategy is likely to work over the long run. It's extremely unlikely that an active manager -- someone who strategically picks stocks on your behalf -- is going to consistently outperform broad market index funds. With that backdrop, it's best to avoid the recurring fees of the financial industry and become the captain of your own ship.
There is however, space for financial advice -- in the right context. Fee-only financial planners who charge by the hour or on a fixed-fee basis tend to be more aligned with the needs of a retail investor. A fee-only planner can help guide you in the right direction without charging asset-based fees, and should provide advice that adheres to a fiduciary standard. In other words, a fee-only advisor is there to provide recommendations that are in your best interest -- not to sell you a product or separate you from your retirement money.
What to do with this information
One of the most effective things you can do for your financial health is to gain a basic understanding of investing through free resources. A 1% fee might not sound like a big deal, but the numbers clearly tell a different story. For those seeking objective advice, the best route is to find an experienced, fee-only, fiduciary advisor that will charge based on the service provided as opposed to the amount of money you have. Heeding this simple advice will allow you to keep the returns you rightfully deserve.
