Should You Hire A Financial Advisor?

If you have twenty minutes to set aside, I highly recommend you read this. It very well might be the best article I have ever read on The Motley Fool website. Molly McCluskey, John Reeves, and IIan Moscovitz wrote one of the best investigative pieces on the potentially unethical relationship that can exist when financial advisors team up with mutual funds to siphon your wealth.

The article about some of the business practices at Edward Jones. The article originally caught my attention because the headquarters for Edward Jones is about fifteen minutes from where I grew up in St. Louis, and the investment advisory probably has the best reputation out of all the providers in the industry despite a string of settlements in the past ten years in which they failed to disclose to people like you the nature of the kickback relationships with their mutual fund providers.

The most illuminating passage I found in the article was this:

“It’s instructive to take a closer look at a typical fund that might be sold to an Edward Jones customer. According to company filings, it received 19% of its 2011 revenue from just one mutual  fund partner: American Funds. The biggest fund from American Funds is the Growth Fund of America, so it’s very likely that Edward Jones clients have had this fund recommended to them.

The Growth Fund of America’s Class A shares come with a 5.75% front-end load, along with total ongoing fund expenses of 0.71%.”

And then, they draw up a hypothetical scenario outlining what would have happened if you followed the Edward Jones instruction to buy “The Growth Fund of America” in 2001 and held through 2011.   From 2001 to 2011, the Growth Fund of America compounded at 3.62% annually. Before adjusting for fees, that would have turned a $10,000 investment into $12,528. However, after paying Edward Jones and the American Funds their fees, you would have $1,349 in fees, meaning you’d only see $10,000 turn into $11,179 over the course of ten years. And it would be less than that if you held the shares in a taxable brokerage account and had to pay 15% or so on the dividends along the way.

By the way, none of this is meant to necessarily be a shot at the Growth Fund of America. From 1982 through the end of 2012, the fund would have grown $10,000 into a little over $277,000. Owning stakes in a S&P 500 index fund would have turned your $10,000 into $217,000. During my freshman year in college, one of the guys on my hall was the son of a manager for the American Funds. And although I don’t care much for the fees charged in connection with the fund, I do respect the high-quality underlying assets that make up the fund’s holdings.

Instead, my problem is that I don’t like the prospect of paying $1,349 in fees over ten years on a $10,000 investment. It’s hard to get rich when you are letting financial advisors and mutual fund companies siphon off 13% of your investment amount over a ten-year period. The growth fund owns somethings like Google, Philip Morris International, and Nike. I am capable of picking out companies like that myself without letting someone else have an override on my assets.

There is always going to be something of a fundamental tension between your ability to create wealth and someone whose ability to create wealth hinges on taking as much money from you as possible.

There’s a financial incentive for financial advisors to recommend mutual funds to you. If they choose individual stocks, then the only money that comes your way is the fees they charge you directly. But, if financial advisors introduce mutual funds into the picture, they get another bite at the apple that is your hard-earned money. With mutual funds, everyone wins but you. The mutual fund company adds you to their assets under management, and they charge you a fee. The financial advisor will often get a kickback from the mutual fund company (as was the case in this Edward Jones example), so they earn more money from you than if they put your money into stocks outright. Some honest advisors do put their clients first and rise above this, and some are quite good at creating wealth for their customers, but the industry is littered with some financial incentives for taking advantage of you.

By the way, I do not think the easy solution is to hire a fee-only advisor. A lot of times, advisors are fee-only because they are desperate clients. At the very least, every financial advisor whom I respect charges an asset override of around 1% annually or so. It makes sense—if you’re good at picking stocks, you’re not going to want to take $300,000 from someone and only receive compensation for a dozen or so hours worth of billed labor. That’s why my solution to the problem is to try to learn about investing myself. That way, if I lose money, there will be no finger pointing: the blame will rest with me. And when it comes to trying to make money, I’m already at a tremendous advantage by only paying $9 here and there, rather than shooting myself in the foot from the get-go by giving someone else a certain percentage of everything I own each year into perpetuity.