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I have already mentioned financial advisors on this blog and my dislike of them. But I have not yet delved into the subject. It is essential to realize the dangers of financial advisors.
Most financial advisors do not have your interest at heart, but theirs! This is the main issue with financial advisors. Most are biased. And this bias can cost you a lot of money in the long term.
And there are other issues with financial advisors as well. So, in this article, we will delve into the problems with financial advisors.
What does a financial advisor do?
There are different levels of involvement for financial advisors. But the idea remains the same: help you with your money. But they will generally focus on the investing side of things (it is more lucrative for them to focus on that point).
A financial advisor will start with the current status of your finances. From there and from your financial goals, they will help you plan what you have to do to reach your goals.
And then, they will help you implement your financial plan. For this, advisors will generally propose to invest your money. In most cases, they will manage your money directly. In other instances, they will only advise you, and they will let you invest your money according to their recommendations.
They can also help with estate planning, severance packages, and even divorce issues.
There are two kinds of financial advisors:
- The advisors in a bank or financial institution.
- The independent advisors.
We will talk about financial advisors in general in this article.
Financial advisors are often biased
The biggest issue with financial advisors is that they are often biased. And they are biased in several ways.
If you are talking with a financial advisor from a bank, insurance, or a mutual fund provider, they will entirely biased towards selling you the products from this financial institution. So, even though these products may not be the best for you, they will only sell you these products. This limitation is a red flag since they are not serving you. Instead, they are serving the financial institution.
A more significant issue is when they get a commission for the products they sell you. For instance, if they are making you buy into a mutual fund, they may get a part of the management fees you are paying to the mutual fund. The issue is that the advisor will only recommend the products he gets the highest commission from. So, they have their own interest at heart, not yours!
These two points are big red flags. If you use a financial advisor, it is to improve your financial status. But this only works if the financial advisor has your own interest at heart. But if they have their own interest at heart or they care more about the financial institution than about you, they will not serve you properly. This defeats their purpose entirely.
Financial advisors can be very expensive
The second important issue with financial advisors is that they can be very expensive!
There are several ways a financial advisor can be paid.
- He can get a flat fee. This could be a fee per month or year or a one-time fee.
- He can get an hourly fee based on the time he spent financial planning for you.
- He can get a fee based on your assets.
- He can get commissions based on the products he sells you.
The first two models are acceptable. They may not be cheap, but in the long-term, they will be much better than the last two.
Getting a fee based on your assets is adding a hefty management fee to your assets. It means that you will lose money to the fees. And considering that financial advisors will not deliver higher returns than average, this will cost you a lot. So you need to remember that investing fees are important.
And being paid by commissions is an indirect way to make you lose money. They will generally make more money when selling expensive products (high management fees). So, even though they may not charge you much, you will lose in fees because of the bad products they are making you are investing in.
So, making you invest in expensive products is another way that financial advisors are expensive. Sure, this is indirect, but whether you pay money to the fund or the advisor directly does not matter. What matters is the total fees you pay to invest your money.
Finally, keep in mind that you will pay the fees regardless of the performance of the portfolio. So, if the advisor is doing a great job, you may not mind paying the fees. But you will also pay the fees if the advisor underperforms the market. And you will pay the fees when the market is going down for everybody.
You most likely do not need a financial advisor
Most people do not need a financial advisor. This fact is something that big financial institutions do not want you to know. Financial advice is a very lucrative business, so they want your money.
The main reason people use financial advisors is that they think investing is too complicated for them. But investing is not nearly as complex as advisors make it looks. You need very few financial instruments to invest your money. And with passive investing, it has become easier than ever. So if you want to get started yourself, I would encourage you to read my guide and start investing in the stock market.
Another thing that people believe (and that advisors want you to believe) is that a financial advisor will give you higher returns. But this is not true for several reasons. First, even if they could generate higher returns, the fees would reduce the returns to subpar returns.
Then, it is improbable for anybody to beat the market in the long term. This difficulty to beat the market is why it makes sense to focus on index investing. If your financial advisor recommends (or invests for you in) index funds, you will get the same returns as anybody investing like this. But you will have to pay the advisor’s fees, and that will reduce your returns.
Finally, if you think you cannot (or do not want) invest yourself, there is an alternative to a financial advisor: Robo-Advisors. A Robo-advisor is a digital advisor that will help you invest your money. Their fees will be lower than a human financial advisor. However, their returns are likely to be the same. Most Robo-Advisors are very simple and focus on index investing (it is a good thing!).
With a Robo-advisor, you will save fees compared to an advisor, and it will be very simple. Of course, it is still more expensive than investing by yourself, but it is a great middle ground for many people. Of course, a Robo-advisor will not cover anything like estate planning or severance packages, but for investing, they are a great solution.
For more information, I have a guide about Robo-advisors.
How to choose a financial advisor?
What if you want to have a personal finance advisor? Here are a few points you should check before choosing a financial advisor.
First, I would only recommend an independent financial advisor. An advisor that is a part of a bank (or any other financial institution) will be strongly biased towards their products. And he will generally be limited to the products the bank or the institution provides. And these products are unlikely to be the best for you.
Second, I would make sure that the advisor is not financially interested in the products he is proposing to you. Even if he is independent of a financial institution, he may still touch a commission (possibly a large one) if you opt for some products. And once again, this will bias him to offer your products for which he will get more money rather than products that will serve you best.
Third, I would only use a financial advisor that lets me invest myself. I would think that this point is optional because not everybody wants that. But I would not trust my money to a financial advisor.
Fourth, if the advisor invests for you, you should ensure that all the accounts are in your name. The advisor should be set as an advisor, not as the owner of the account. If his name is shown as owner, he can withdraw the money. And I would also refuse to give an advisor power of attorney.
Finally, I would only use a financial that charges a flat fee or hourly fee for its services. I would never use a financial advisor that charges a fee based on your assets. In the long-term, this would eat too much of your savings.
It is challenging to find a financial advisor with such criteria. However, I think it exists. And the fact that these criteria are challenging shows that you must be very careful about all financial advisors.
Tips for dealing with financial advisors
If you are dealing with financial advisors, here are a few tips to avoid some issues.
First, you should always think before signing anything. I would recommend reading what the advisor proposes to you entirely. And I would especially recommend waiting at least one day before signing. If the financial advisor becomes pushy, I would recommend leaving and not sign anything he would propose to you.
Then, I would recommend asking all the questions you have. Even if you think a question is dumb, ask it. If the financial advisor cannot answer all your questions or become irritated with them, it is a good sign that you should not deal with this advisor.
Finally, you should always be ready to say no. If the advisor proposes something you do not want, say no. And if the advisor does not respond well to your refusal, once again, do not deal with him. You should be comfortable with a good financial advisor. If you do not feel comfortable, just quit!
You should now realize that there are many issues with financial advisors. The two most significant problems are that advisors are expensive and do not have your best interest at heart.
So, you have to be very careful when dealing with one financial advisor. If you want a financial advisor, you need to make sure that you choose one that will serve you (and not serve itself or another financial institution). And you may also want to consider a Robo-advisor instead.
And you may probably not need a financial advisor at all. Investing by yourself is not as complicated as people think. You can forget much of the noise and focus on a few financial instruments and reap 99% of the benefits of investing. And DIY investing does not take that much time.
Have you ever had a good or bad experience with a financial advisor?