Financial Advisers? Discuss
It is widely accepted practice in the FIRE community that Financial Advisers are largely a no no. The main driver for the theory is that:
Over the long term, actively managed investments will deliver less or equal to an "Invest and Forget" passive investment strategy.
If that theory is true, then why would you pay a fee to someone to advise you or manage an investment that will ultimately give you the same return as a broad based index tracking ETF with substantially lower fees? isn't that just borrowing your watch to tell you the time?
Bless me father, for I have sinned. It has been 44 years since my last confession.
This week I appointed an independent financial adviser. Let's call him Pete (names have been changed to protect the innocent), he's a thoroughly nice chap and as far as I've seen so far, he doesn't own a crystal ball, have a super power and he hasn't showed me the meaning of life, how to turn flax into gold or developed an elixir for eternal youth.
And yes, he's charging me a fee.
So why Mr H? Why? I hear you cry.
You could say my hobby is finance, well one of my hobbies, I also like cooking (and drinking). I consume large amounts of financial content every day starting with my first hour awake where I read the financial news, review the previous days stock market performance, see what's going on in local and global politics etc. Then I get up and make coffee for Mrs H and I and then analyse our financial performance across all of my investments and track everything in a super complicated spreadsheet. All of that takes anything from 1 to 3 hours every day. I don't have to do it, we won't become homeless if I don't do it, I like doing it. I enjoy watching my money grow organically and I like to understand the cause and effect of global events on my future.
I'm a geek, and I'm proud.
As a result of performing this daily ritual for the past three years I am well on my way to the 10,000 hours that apparently makes you an expert at anything. Despite having almost no education (I sort of completed high school and left with a few qualifications that with the exception of Math, English and perhaps Science, have been almost of no use to me throughout my career) I am now able to hold my own amongst other financial geeks and professionals and I'm doing OK on the investing front. I can let my numbers speak for themselves.
So why would I decide to take on a financial adviser?
So we spend all of our money before we die and we don't give more of it away than I should. Oh, and to make sure I stay out of prison!
Having moved to a new country as part of our FIRE journey, pretty much all of our knowledge on tax e.g. Income Tax, Capital Gains tax, Inheritance Tax, Property Tax and every other bloody tax is reset, you have to learn the game all over again and it's complicated and confusing. Most of all, as far as the tax man is concerned, ignorance is no excuse and it is possible in South Africa that if you make a mistake, no matter how unknowingly, you get dealt with in the most severe way to set an example to the rest of the country.
I'm too good looking to go to jail people!
So that is reason 1. Reason 2 is business. When I went into Pre-retirement and quit my full time job I started to get approached for paid freelance work and consulting. This was a nice little side hustle but it started to get a little more complicated than me just doing a day or two's work and sending an invoice. I was buying things and incurring costs like software costs and travel expenses and buying equipment and stuff. Quite soon it became clear I needed to separate my side hustle from our personal wealth or there could be a situation where I put our future at risk (for instance if I got sued for making a mistake that cost one of my clients money). So $50 later I made myself a CEO (read about that here) and became the owner of a business. Once again this is completely different from the UK so I had another massive learning curve to make sure I don't accidentally end up bankrupt or in jail or both. This part got more complicated this month as my turnover (not profit) just went over R1,000,000 / $60,000 / £50,000 which means I now have 21 days to become VAT registered. I have literally no idea how VAT works other than I now have to charge my customers 15% extra for the work I do (I'm sure they'll be ecstatic) and pay that money to the government. Sounds like another opportunity for me to screw up and end up in the slammer.
The third justification for breaking the FIRE 101 rulebook is not spending enough money. That probably seems odd but one of the side-effects of hitting your Fi number is you become as tight as a drum if you're not careful and end up being so afraid to spend money you defeat the purpose of early retirement. I've been going through that emotion, probably because I went into post retirement (out of full time employment and working for a boss) earlier than planned due to ill health so we're still not technically at our Fi number. I feel like I need an independent adjudicator to track our spending and give me a kick in the pants when I inevitably err on the side of caution too much and give me a call to simply say "Mr H, please spend some more money, you have too much"! What an awesome thing to happen to a person, I can't wait for that day.
Number 4 is what I'm going to call structuring. Between Mrs H and I, we now find ourselves with a complicated set of finances. She is still working, but at some point in the next couple of years will want to quit, we have a bunch of investments, some in my name, some in hers. We have investments in South Africa, the US, the UK and Gibraltar that are probably spread across about 20 different investment companies, We have a property that's bought and paid for that we might consider selling or downsizing at some point, I now have a small side-hustle business that makes a little cash and we have 2 elderly parents, 3 kids and a granddaughter in the UK that we need to be able to see and have visit and, I suppose, leave a few shekels to when we pop it. All of that ball of spaghetti needs to be understood, managed and planned for, and whilst right now I do most of that work, as you can see from above, I'm possibly not the safest pair of hands for making sure all of that hangs together in the most efficient way possible. I would like someone to take a non-emotional, helicopter view that can structure it in a way that we don't have any cash leaks on the boat and I pay my dues and stay out of the big house.
Finally, I have absolutely no ego-driven desire to leave millions in the bank when I die. I never took a dime in help from anyone in my journey to where we are today and I fully intend to enjoy every last cent whilst I'm living. Yes we'll leave a little cash for the offspring, that's a given (ish), but I intend to live life to the fullest and it is going to be a stressful and complex balancing trick to make sure we spend everything before we snuff it without running out of cash too early. That job alone doesn't sound like much fun so outsourcing the task means I can spend more time living and less time planning.
So I present my case to the court.
I know enough about my readers to know the logical next question is: How much? Ok, let's get to the good part.
So first, let me clarify what I mean by "I've appointed a financial adviser" You will notice above, that nowhere do I mention that I'm taking any investment advice. That is a critical point of this story. I do subscribe to the theory that actively managed investments cannot outperform low cost passive investing over the long term. I plan to die on my 100th birthday so I have 54 years, I class that as long term. I also wrote last week about where I intend to put the bulk of our money (read about that here) over that long term. So whilst I have appointed a financial adviser, I will not be taking financial advice in the short term. I will probably get to a point where I hand over the reigns completely so I don't have to do anything but that's some way off in my head.
So the advice I'm paying for is all of that stuff I don't understand, could accidentally put me in jail, or could end up inadvertently costing me money without me even knowing it. I could learn all of the knowledge I need to do it myself but frankly, I don't want to! I can buy in that expertise and have the benefit of learning as it happens. It also happens today instead of a year from now while I attend YouTube university to get the knowledge. That time saved will probably offset the first couple of years of costs from my new adviser.
Before we get into the numbers, let me explain how the "Normal" approach to financial advisorying (not a word) works in South Africa.
You appoint an adviser and essentially handover the day to day management of your wealth. They take care of everything from investments to insurance, tax, accounting, inheritance planning, medical aid, the whole kit and caboodle. They then charge you what is called an AUM (Assets Under Management) fee.
The A in AUM is your money. Your Adviser is the M. The AUM in South Africa is generally around 0.85% + VAT which makes it just shy of 1% flat. As our current A (excluding the house as it's not a manageable asset) is around 14,500,000 / $850,000 / £700,000 that would equate to a fee of [drum roll]...
R145,000 / $8,500 / £7,000 per year or R12,000 / $700 / £570 per month.
Now that already feels like a chunk of change to me but let me give you 2 reasons why it's only the tip of the iceberg:
Your AUM fees go up as the value of your assets go up because the M keeps taking 1% of your cash based on it's value today, not the value you invested with them. This is where the smoke and mirrors come in. We already know that the stock market produces average returns over 10% over the long term so your adviser increases their fee every year by 10% for delivering absolutely nada.
You pay them even if they fail. If they monumentally screw it up and you only get say 5% return, essentially costing you money not adding it, you still pay them the full 1% and they increase their fee by 5%
What the AF! I can't think of one other industry that can get away with increasing its prices by 10% every year for doing nothing, increase prices even more when they do a good job and still charge in full when they do a bad one.
OK, so let's subscribe for just a minute to the possibility that active management can outperform the market consistently. Let's say over 10 years, Acme Investing inc. can give you a 12% return instead of a 10% one. Even with their 1% fees, they're giving you an extra 1% and you don't need to do anything other than sign a few forms and grab a coffee with them twice a year, right?
Over that 10 years, our 14,500,000 / $850,000 / £700,000 growing by 12% a year with a 1% AUM fee, our end pot would be; R40,700,000 / 2,400,000 / £1,840,000.
If I don't appoint an adviser and I don't pay any AUM but I only get 10% return from the market, I end up with R37,600,000 / $2,200,000 / £1,700,000
So the difference in your pocket is a tidy R3,100,000 / $180,000 / £140,000. Not a bad day at the office.
But let's say your Financial Adviser isn't able to deliver the extra 2% and after 10 years, you end up with a 10% average return. You then end up with R34,500,000 / $2,020,000 / £1,560,000. A loss of R3,100,000 / $180,000 / £140,000.
Now let's say M is not the brightest bulb in the box and actually underperforms the market and give you just 8% (believe me that this is a very real possibility) your closing pot is now R28,300,000 / $1,660,000 / $1,280,000.A whopping loss of R9,300,000 / $550,000 / £420,000.
And M gets paid in full in every scenario!
In every scenario where your adviser is not able to beat the market by 1% every year without fail, you will lose money.
Now let me really drive this point home for you:
The latest S&P Global report to June 30th 2020 showed that 67% of active managers underperform their benchmark indexes. Now, considering that the best active managers in the world work for much more than 1% and are earning millions working for the biggest investment banks in the world, what is the chance that your financial adviser from the company down the street is one of the 33% that beat the market for one year?
I think we both know the answer to that. I rest my case.
So with that rant over, let me explain the hybrid deal I have struck with Pete. He does everything a holistic financial adviser does except tell me what to invest in, he's going to make sure I spend enough, am tax efficient, structured properly, make sure the offspring get a cheque after the fat lady sings, keep me out of Alcatraz and generally make sure as much of our cash stays ours for as long as possible. For all of that goodness and knowledge he is charging me R3,000 / £175 / £135 per month. He puts his fee's up by half of the rate of inflation each year which means I effectively pay him less each year (what a guy!), I get a free coffee when I go to see him and a good night's sleep. I've given him a 12 month contract and told him as long as he saves me more than he costs, we'll be lifelong pals.
So what's in it for Pete?
Despite the fact he's not charging me an AUM fee he does get to include my fairly chunky A in his book of client assets.
Why is that good for him?
Buying power. The way financial advisers can make more money (or make themselves more competitive) is to negotiate lower fees with their providers. Their are retail and wholesale fees for financial products, for example, if you or I buy an actively managed Unit Trust, we may pay a fee of around 1.5% a year. The wholesale prices are staggered, so a small financial advisory firm might pay 1%, a large one 0.5% and a massive one 0.2% that helps the firm either lower it's fees to beat it's competition or make it easier to beat the market.
So Pete grew his Assets Under Management by 14,500,000 / $850,000 / £700,000 by having me as a client. If he gets a lot more clients like me, he can get a better deal with his providers and everybody wins. Pete is a smart cookie and has seen that the old approach of charging 1% AUM is dying out as people become more savvy so is offering this bespoke model to appeal to people like me who want financial planning without the advice.
So there it is, I think I've managed to get a financial adviser without being a FIRE community outcast. I'll post about the value I get out of it over our first 12 months together to truly answer the question of whether Pete is able to save me more money than he costs.
Hopefully this has been insightful, if it was, and you haven't yet, don't forget to subscribe.
Next time, We'll be looking back over my first 6 months of retirement. One of my readers reached out and asked me to include a table of how my net worth has changed over the last 6 months, which I think is a great idea and I'm more than happy to oblige. If there's anything you'd like to know that I haven't covered yet, stick a comment below and I'll do my best to come up with the goods.
Until then, keep living,.