Clark Jeffries
May 3, 2023
Financial advice can have significant long term benefits.
Compound Your Wealth with Time and Advice: The Enduring Benefits of Financial Guidance
The landscape of financial advice is broad and diverse. Ranging from friends and family to professional advisors, consumers have their choice of the litter when it comes to financial advice. There has been an explosion of new technology firms aimed to provide financial advice along with household, legacy names that have provided advice for decades for consumers to choose from.
According to a study from 2022 by YouGov, roughly two-thirds of American adults have personal financial goals. That same study found that American adults turn to financial advisors 22% of the time for financial advice. Interestingly, respondents noted that they would turn to people they were close to (partner, parents, family, close friends, coworkers, and acquittances) 83% of the time[i]. Meaning, while some people will turn to their financial advisor and people they are close with, more often people will only turn to people they are close with than a financial advisor.
Now, financial advice from friends and family could be as good as advice from a professional (key word being, could). Importantly, your friends and family will likely not be under any conflict of interest in the advice they give you. They may give you outdated, incomplete, or bad financial advice, but at the very least they’re probably not trying to make money off you or giving you advice to benefit themselves in some way.
A Schwab survey found that 65% of people with a written financial plan say they feel financially stable, while only 40% of those without a plan feel the same level of comfort. Fifty-four percent of planners felt "very confident" they would reach their financial goals, compared with only 18% of non-planners[ii].
Having a written financial plan gives you a measurable goal to work toward. Because you can track your progress, you can reduce doubt or uncertainty about your decisions and make adjustments to help overcome obstacles that could derail you.
Types of Advisors
Professional financial advisors are that: Professionals. Meaning, they earn a fee for providing advice. As defined by the SEC, an investment adviser is a
- firm or person
- that, for compensation, engages
o in the business of providing investment advice to others about the value of or about investing in securities – stocks, bonds, mutual funds, exchange traded funds (ETFs), and certain other investment products
and/or
- in issuing reports or analyses regarding securities, as part of a regular business.
Firms or persons who are required to be registered with the SEC or a state-security entity (like the Securities Division of the Georgia Secretary of State’s Office). Importantly, Broker-dealers and broker-dealer reps may be exempt from this requirement based on a list of criteria.
Investment advisers, as defined above, are required to act in a client’s best interest and disclose any potential conflict of interest. For example, if an investment adviser recommends rolling over an old 401(k) into an IRA that they manage, that adviser would have to disclose the additional fees the rollover would incur and the monetary/financial benefit/consequences of rolling that 401(k) over into an IRA.
There are exceptions where other professionals are allowed to give certain types of financial advice without broaching the registration requirements. Accountants, Lawyers, Teachers, and Engineers are specifically listed as exempt so long as the advice is general in nature, and they don’t promote themselves as investment advisers (among other requirements). Meaning, your CPA may tell you to fund an IRA to lower your taxable income. That advice may or may not fit your entire financial picture, but the accountant would be allowed to do so.
To add complexity, some investment advisers will be dually registered as registered investment advisers (or investment adviser representatives) as well as broker-dealers (or broker-dealer representatives). Meaning, depending on the transaction, client, and situation they can flow between two different set of rules and regulations to deliver financial advice. Typically, financial advisers may enact transactions (like life insurance sales) as a broker-dealer representative, but deliver ongoing investment advise through their registered investment adviser firm (as an investment adviser representative). Meaning, you could be paying 1.5% of your assets to your adviser for them to manage your investments, but also have paid them through sales commissions for an expensive life-insurance policy. Some advisors also recieve money from investment management companies for investing clients in particular mutual funds.
Simply put, when you’re interviewing an investment advisor/financial advisor, it’s critical to ask:
- Are you a fiduciary, 100% of the time?
- How do you charge/get paid?
- What services are included in that fee?
Bad financial advise can be significantly harmful over the long-term and lead to significant underperformance compared to your financial peers as well as a lower-likelihood of achieving your financial goals.
How to know if a recommendation is right for you?
Even for professional advisers, it can sometimes be difficult to parse through jargon and understand a new product, a new tax strategy, a new investment philosophy, and its benefits/risks. For the average person, that can be a very difficult task.
Coming from a family of engineers, I was raised on the KISS philosophy. Keep it simple, stupid. If something sounds too good to be true, or if it’s so complex you couldn’t easily explain it to a 5-year-old, it might not be a good product/strategy for you.
Too often financial salespeople pray upon someone’s lack of financial literacy to order to enact a transaction that pays them a large commission. Risk and fear are powerful emotions that can be easily harnessed by skilled salespeople. Typically, we would call this phenomenon loss aversion. Loss aversion is the tendency to avoid losses overachieving equivalent gains. Broadly speaking, people feel pain from losses much more acutely than they feel pleasure from gains of the same size.
To affect more transactions, life insurance salespeople may pray on your fear of loss (loss of life, loss of income, a family left to struggle without your income) to sell life insurance.
These insurance policies can be the foundation of your financial plan (term life insurance is a great product for those in need of life insurance). However, life insurance is often combined with an investment component (look out for “whole life insurance”) to give people “the best of both worlds.” However, by comingling these two distinct items, companies can hide fees through significant complexities.
If you’re struggling to know if advice is good for you, ask for a professional second opinion. Or take the advice through a litmus test:
- Does the advice align with my most important goals and values?
- Does the advice get me closer to achieving my goals?
- Is the advisor a fiduciary?
- Could I explain the advice/product/process toa 5-year old?
How good and bad advice can have long term implications
Advice today can have significant long-term consequences or benefits. A 2012 study by Claude Montmarquette, Nathalie Viennot-Briot titled, “Econometric Models on the Value of Advice of a Financial Advisor” found that on average, participants retaining the service of a financial advisor for more than 15 years have about 173% more financial assets (in other words, 2.73x the level of assets) than non-advised respondents, ceteris paribus (or said another way, 2.73 times the level of assets of “comparable” non-advised respondents).
The impact of advice on financial assets (cash, GICs, term deposits, stocks, bonds, ETFs, investment funds and other investment vehicles) increases with the tenure of advice. The difference in financial assets is explained most significantly by higher household savings rates and greater allocation into non-cash investments. The presence of a financial advisor increases the confidence of having enough money to retire comfortably.[iii]
Other studies have suggested that portfolio performance can be improved by anywhere from 1.6% to as much as 4.2% per year through working with a financial advisor who implement wholistic financial advice[iv].
Importantly, it’s not likely that those additional returns will manifest themselves every single year. More likely, a good financial adviser providing wholistic advise will provide advice at certain periods of time that have significant long-term impacts. That could be preventing panic setting, increasing investment rates, choosing the right insurance product, providing proper estate planning analysis, helping with private stock options in a tax-efficient way.
For a real-life example, let’s examine a decision on life insurance.
As mentioned before, a broker-dealer representative or life insurance salesperson may recommend a life insurance product that’s suitable for your needs, but might not be in your best interest. In simple terms, your best interest is to buy a cheaper insurance policy and invest the excess, but the salesperson wants to enact a larger transaction that earns them a higher commission/bonus.
For example, in reviewing a Guardian Whole Life Insurance policy we have the below investment/insurance hybrid:
- Monthly Premium: $833.33
- Death Benefit: $886,303
- Term: Whole-Life Insurance Paid-Up at Age 99
- Cash Value in 20 years: $162,840.45
- Cash Value in 73 years: $886,303
Or, someone could buy a 20-year term policy every 20 years, starting at age 30, until age 90. For the initial period you would see:
- Monthly Premium: $26.25
- Death Benefit: $1,000,000
- Term: 20 Years
If you were to take the money saved from not buying the complex product, you would have $807.08 per month to invest.
If you were to deposit that into an investment account that earned a non-guaranteed amount per the table below, you would typically end up with significantly more money in 20 years:
*Investments carry the risk of loss. No return is guaranteed.
It’s also important to note that investments are not guaranteed. However, the ability for these insurance companies to pay future claims is not either! These companies are subject to their own business and market risks. If the company you bought insurance through went bankrupt and wasn’t able to pay claims you may be SOL.
Now, premiums will increase over time as you get older. For example, per NerdWallet and Quotacy, applicants in the super preferred health class, would face the below premiums[v]:
With proper estate planning, you could pass on your investment assets to your partner, tax-free, while they benefit from a $1,000,000 death benefit that is also, generally, tax-free.
How to know when it’s time to work with an advisor
For many young people, the idea of working with a financial advisor may seem daunting. The reputation of financial advisors, for a variety of reasons, is not very high. Especially with younger investors. A survey conducted by Vericast found that 34% of Gen Z Consumers seek advice from Tik Tok whereas only 24% seek advice from financial advisors[vi].
Many young people saw their family struggle through the 2008-09 financial crisis. Many young people saw that as the fault of Wall Street and saw large financial institutions get bailed out by the government while their family struggled.
We so often hear the bad stories more than the good. However, by arming yourself with general financial knowledge and the ability to ask important questions for a financial advisor, you can have comfort in being able to determine if an advisor is a good fit for you.
However, that doesn’t answer the question of, “When should I work with an advisor,” or, “Do I have enough money to work with an advisor?” The answer of course is it depends.
The same 2012 study by Claude Montmarquette, Nathalie Viennot-Briot referenced above found that most households (71%) who worked with an adviser first sought out advice when they had less than $50,000 in assets (the median was $11,000 in assets for their initial investment).[vii]
Most individuals and families over inflate the amount of money they need to benefit or receive financial advice. There’s been a proliferation of pricing models and services for a variety of financial situations and goals.
Typically, I look at the complexity of a person’s financial situation, the complexity of their entire life, and their attitude towards investing. Are they working 50+ hours a week and unable to mentally handle managing their own finances? Do they have a complex financial situation that requires a professional (private stock options, business owner, etc.). Do they have attitudes/tendencies that prevent them from making proper financial decisions?
Like most anything else in life, it doesn’t hurt to ask. Reach out to local financial institutions and gauge their interest in working with you along with pricing model, typical clients, etc. At the very least, many firms will give you a consultation and the ability to ask them questions that might help you along your financial journey.
[i] https://www.marketingcharts.com/industries/financial-services-227177
[ii] https://www.schwab.com/learn/story/5-ways-financial-planning-can-help
[iii] https://cirano.qc.ca/files/publications/2012RP-17.pdf
[iv] https://behaviorquant.com/wp-content/uploads/2021/05/Merril-Lynch-2016-The-Value-of-Personal-Fiancial-Advice.pdf
[v] https://www.nerdwallet.com/a/insurance/life-insurance
[vi] https://www.vericast.com/press-release/consumers-seek-financial-guidance-and-comfort-from-non-traditional-sources-like-tiktok-vericast-survey-finds/