Are you paying someone to rob you?

We keep our doors locked at night, chain up our bikes, and keep our valuables locked in our safe deposit boxes (or at least in a good hiding spot in a closet somewhere). It’s a painful thing to consider the possibility of being robbed. Few acts are so personally violating as having the bounty of your hard work taken by someone who did nothing to earn it. And yet for millions of Americans across the country they get bilked out of thousands of dollars every year, and they pay for the opportunity! Who are we inviting into our finances to do the burgling? Financial advisors.

Fleece Tactic #1: “Suitable” service

Imagine a scenario in which you or a loved one is ill. You seek help from a medical professional. Why? Because illness is a complex thing and often requires a trained expert who knows a lot about illnesses and their various treatments to solve. So you go off to the local doctor to seek medical treatment. Do you expect your doctor to provide you a solution for curing your illness, or simply a solution that may do what you need but suits the doctor’s needs more either for getting you out of the office quickly or earning them lots of money? The answer is obvious: you expect the best advice for the money you’re paying. It doesn’t work that way with financial advisors.

Right now in the United States, financial advisors are under no obligation to provide you good financial advice even when that is exactly what you’re paying them for.

It’s a little known rule that entitles financial advisors to provide “suitable products” for their clients to buy, but does not require them to serve in good faith in an effort to earn you the most amount of money with your capital. Instead it’s perfectly fine for them to look out for themselves and make the most money from your money by selling you products with low returns but high sales commissions so long as the product meets the nebulous “suitable” standard.

This problem has become so bad in America there is now an effort to end it. Under new regulations financial advisors would be legally obligated to act as a fiduciary for their clients forcing them to recommend the best financial products for the customer, not for the financial advisor. Imagine a single other industry in which you pay someone a fee so that they can sell you a product that nets them more money instead of selling you a product that nets you more money!

Fleece Tactic #2: Insurance

Death is the scary final adventure in life that so far humanity hasn’t been able to solve. So in light of the fact we’ll likely stop existing someday, it makes sense to plan ahead to prepare for our family’s needs when we’re gone. One way to do that is with insurance, but there are two primary types of life insurance: term and whole life insurance. So where’s the fleecing in preparing for your family’s financial well-being after you’re gone?

Term life insurance allows you to pay a small premium and if you die your family gets a large payout. Whole life insurance, on the other hand, is a quasi-retirement vehicle that is supposed to build up cash as an investment option. Its high cost and high commissions make it a prominent product financial advisors try to foist onto unsuspecting customers (it’s “suitable,” which is good enough). The reality is that the overwhelming majority of Americans are fine paying a small fee for term life insurance during their younger years where an unexpected life loss could significantly harm their family’s financial well-being. Whole life is much more expensive; instead, save those dollars and invest them following the 10 Step Plan and you’ll wind up further ahead financially over the long-term than you would if you paid the expensive costs of a whole life insurance policy, complete with fees and commissions for your financial advisor.

In the very rare circumstance in which you’re an incredibly high net worth individual a whole life insurance policy might be beneficial as a means of providing some tax advantages, but that’s a tiny percentage of Americans. The overwhelming majority of the time a whole life policy sales pitch is akin to an Amway presentation; you should run, and you shouldn’t feel bad about doing so.

Fleece Tactic #3: Assets Under Management Fees

Consider for a moment a world in which your faucet leaks. You call up a plumber to come fix the leak. She does a fine job getting things sealed off and your faucet is back in tip top shape. You ask how much you owe her and she replies, “You’re going to just pay me a percentage of the savings on your water bill from not having a leaky faucet for the rest of your life.” How likely would you be to continue purchasing services from that plumber? If you care about your money, not bloody likely.

Yet every year thousands of financial advisors get away with charging their clients using a fee-structure based on the assets under management. That means the amount you pay for their “financial planning” is tied as a percentage to the amount of money you have saved with them. Not the amount of work they’re doing for you, or the returns they get for you. Instead you save your money, they buy the mutual funds, and you pay them an entire percentage of your assets every year.

“But Bill,” you might be saying, “my finance guy charges me a paltry 1% for handling my money. That’s barely anything!”

Ah, 1% means far more than you think when you account for the most powerful force in the universe, compound interest. Consider this: on an annual return of 4%, investing $100,000 with a 1% assets under management fee could cost you nearly half your investment over 20 years! Across the span of two decades you’ll pay $28,000 in fees to your advisor, plus an extra $12,000 in lost interest from investing that $28,000. That’s a total of $40,000, nearly half of your initial investment! And that’s only on a fee structure of 1%!

Source: the SEC

Want to read more? Check out the SEC report I pulled that data from here.

One of the keys to your investment success will be minimizing your expenses over time. Stay away from advisors that charge fees using assets under management structures; even a fee as low as 1% can cost you tens of thousands of dollars over the lifetime of your investments. That’s your hard earned money going to someone else for minimal gain.

Fleece Tactic #4: Being bad at their jobs

Jack Bogle, the inventor of the index fund, is a kind of modern day Robin Hood. Nearly a half century ago he looked around and realized that most stock pickers were actually terrible at their jobs. If you picked a random sampling of stocks and compared your rate of return to “professional” picks from the top financial advisors you’d find success was essentially random. Bogle discovered that if you simply bought stocks that followed an index like the S&P 500, you could actually match the market year-over-year instead of trying to beat it. For an index like the S&P that means a rate of return of approximately 7% over the last century or so.

Bogle founded an extraordinary investment group called Vanguard Investments which focused on selling index funds to casual investors interested in retirement investing through their 401(k) or IRA. Because index funds don’t require humans picking stocks of funds for the customer Vanguard could charge much lower fees. Bogle’s plan was a hit and index funds to this day represent an increasingly amount of retirement account funds in the United States. (Full disclosure: I invest with Vanguard which technically makes me a part-owner in the company because of how their structure is set up, so consider that. However low-fee index funds are available from LOTS of firms now and I’d recommend any of them, not just Vanguard.)

It’s no wonder: for less money you get a better rate of return than you do from your fancy financial planner. “But Bill, my guy is great at picking stocks! He beats the market every year!” That might be true right now. But consider this famous example: take a room of 1,000 people, each with a quarter. Have all of them flip the quarters and record whether they flipped heads or tails. You and I know that the approximate chance of flipping a heads or tails on a quarter is 50/50. With 1,000 people flipping, however, some number of them will flip heads 10 times in a row. Does that mean those people are extraordinarily skilled at flipping heads? No, it’s simply random chance. Any given flip is a 50/50 shot of coming up heads, but random chance also provides the possibility that some number of people will hit heads ten times in a row. Given enough additional flips even your “skilled” quarter flips will get close to a 50/50 distribution of heads versus tails. But after 10 flips all randomly coming up heads it’s possible your quarter tossers will start to think they’re special snowflakes, not that their success is simply coming from chance.

Likewise, stock picks from your financial advisor function in the same way. They might be beating the market now, and they might beat the market for years at a time. Give that timeframe a long enough scale, however, and their luck will regress to the mean until they’re struggling to beat the market year in and year out. All of that and you have to consider the impact of the much higher fees you’re paying to that financial advisor and it’s simply a no brainer: stick with low fee investments through groups like Vanguard. In fact, you should already know what to buy when buying stocks.

For those of you that aren’t convinced, consider this: Warren Buffet, the greatest investor of all time, believes so strongly in the power of index funds that he actually bet against high powered hedge fund managers that a simple index fund could beat their best stock pickers in a head to head battle. Up against some of the most sophisticated hedge fund managers in the world, how do you think Warren is doing? He’s crushing them 3:1. His index fund has returned approximately 65% to their 21%, well out-pacing them plus he paid lower fees to make that investment! Stick with low-cost index funds instead of paying someone to make these picks for you.

When you still need an advisor

Money is a complex issue, I understand. It can be scary to try to manage the entirety of your finances, including your retirement funds. It’s possible that despite all the potential opportunities to fleece you, you still feel the need to hire a financial advisor. That’s okay. Here are some ways to ensure that you don’t fall for their traps.

Never say yes

Well, at least, never agree to a service or payment in the office of your financial advisor. Be willing to take any type of documentation or prospectus to review home but under no circumstance buy under pressure! You need to know what you’re buying before you make a leap, and that means reviewing things thoroughly outside the earshot of a person with a financial stake in what you select to purchase. Take reading materials home, go over them with your partner(s), and make sure you understand all the fees associated with the products you’re looking at!

If you decide you don’t want to purchase something and you’re afraid of conflict, let your advisor down via email or text message. This isn’t the dating world; this is someone you’re paying. If you want to dump them over the phone you have the right to do that. And if they pressure or whine about it? Fire them and find a better advisor.

Stick with fee-only advisors

Advisors who charge assets under management fees or otherwise look for a percentage of your assets are trouble. They’ll cost you tens of thousands of dollars long-term and they’re not worth it! Remember, you wouldn’t pay a plumber a percentage of your money forever for fixing your sink; why should you pay an advisor a percentage of your income for helping you save it? Look for financial advisors that charge a set fee for their assistance and don’t try to bilk you out of your assets. That fee structure means you know what you’re getting. Providing you a service and charging by the task or hourly allows you to know exactly what you’re paying and what you’re getting for it. Paying more over a longer period of time simply isn’t necessary; avoid it at all costs.

Hire a fiduciary

An advisor who will provide you “suitable” service isn’t an advisor you want. Instead be willing to demand that your financial advisor act as a fiduciary, meaning they put your financial interest above their own. In fact, here’s a handy contract you can demand that they sign. If a potential advisor won’t sign the document and pledge to act as a fiduciary? Run. Run as quickly as you can. Get out while you still have most of your money, because if you don’t they’ll wind up with it.

Don’t fear conflict

At the end of the day we’re talking about not just your money but your wealth, all the money you’ll accumulate until the end of your life. And that’s worth fighting for! It may be uncomfortable to demand your advisor act as a fiduciary. It may be uncomfortable to demand that your long-term friend who has been your advisor for years stop pushing bullshit insurance policies on you and instead just sell you low cost index funds. You may have to have some tough conversations with someone who wants more of your money than you want to give them. When push comes to shove, however, we’re talking about hundreds of thousands of dollars of your wealth on the line. That’s worth fighting for and getting outside of your comfort zone. And really, if someone who is supposed to be handling something as critical as your finances makes you that uncomfortable, do you really need their services? Don’t let them rob you of your hard-earned dollars just because you’re afraid to tell them no.