Or Why My Financial Advisor Didn’t Like Me
You need to understand, I’m a Real Estate guy and this site talks about landlording, Real Estate and Real Estate investing . That’s why my retirement planning is based around property, not mutual funds or stocks.
Due to that, due to some of my experiences and due to some knowledge picked up along the way, I may have a slightly biased view towards financial planners, but it wasn’t always like this.
When I was much much younger I really bought into the mantra of setting aside money each month to put into mutual funds. I even modelled what successful people do (or at least what I thought successful people did) and found a financial manager to help me along the path.
To make sure I was doing it right I set up automatic withdrawals each month so funds were withdrawn from my savings account and transferred over to buy more mutual funds. Here I was just like one of the grownups!
I was ecstatic that the power of dollar cost averaging along with along term plan securely set up the future was bright…
Does this sound familiar to anyone?
You know, invest in your retirement now, start early, dollar cost averaging, plan your financial future and more? All the hugely successful investment firm and big banks were all talking the same game, so it had to be right, right?
Well, unfortunately it seemed the more I read about all these great mutual funds and the more I chased the mythical returns they made in previous years the more disappointed I became. For some reason these funds that made 10% one year, suddenly only made 3% when I bought in…
What was going on? Or more importantly, what was I doing wrong?
Over time my visions of yearly 10% returns the books talked about started to fade. Doubts started to creep up, was I doing it wrong? Did I need to set more money aside? Maybe I needed a longer time frame and things would balance out, or maybe, just maybe there was something else going on?
Could it be possible that this promised land of steady returns wasn’t actually true?
I was starting to suspect that perhaps the rules weren’t quite what they seemed and maybe much like Las Vegas, the odds were not in my favor, but rather they were stacked in the favor of the house.
To make sure I understood everything clearly, I did more digging and found out some interesting facts.
The Rules Are In Favor Of The Fund Managers
If you’re not already familiar with how mutual funds work, here’s a quick recap, or at least the part we hear about. (This is the simplified and slightly sarcastic viewpoint btw).
Some brilliant financial guy analyzes the various financial markets finds solid stocks and investment vehicles that he believes show great opportunity to grow and become more valuable over time. Then through marketing and sales they get investment capital to finance these purchases so everyone can grow their investments.
In my case, this investment capital was in the form of my automatic withdrawals, but it’s also through large institutions like pension funds who buy into these funds and many other individuals and groups buying into the game of investing.
The idea being as the fund grows in value from the carefully analyzed data the value of each fund grows, or in some cases a dividend may be paid out which the investor typically uses it to reinvest back into the fund.
As more and more money is poured into this fund it grows and gives the brilliant financial guy even more of other people’s money to play with. All with the intent to provide everyone with a nice return.
Now, here’s the part they don’t talk about.
As for the funds themselves you need to realize their goal is to make money for the institution, not just to help investors in the funds retire…
To make that money, it used to be very common to have what were called front end loaded funds where you paid a percentage up front to get into the fund. This put you behind right away, but made sure the fund itself made money right away.
To counter the paying to play setup of front loaded funds there were also back end loaded funds where you had to keep your money in for a set period and if you took it out early you were penalized on a sliding scale.
This worked out slightly better for investors, unless you were in a losing fund or needed to get the money out early. In the case of a losing fund you then got dinged twice.
Once by the loss of the funds value and then by paying a percentage of your original investment for having them lose your money.
Of course there are also no-load funds, but they have a different set of rules which I talk about further on.
The problem is, all the rules are designed by the funds for the funds to make sure they make money and not necessarily for the fund investors. Basically they are playing a stacked deck where they are guaranteed to win and if you win, well that’s just a bonus.
Best of all though, at least for the investment companies behind the funds, whether they make or lose money, you’re still paying them for the privilege of having your money in their hands.
Which is one part of the other two problems with mutual funds, including no-load funds.
The Two Problems With Mutual Funds
Problem one, even if the fund loses money, the fund itself still gets paid a management fee. This management fee is often 2% or more and often up to 3% and guess where that gets paid from?
If you guessed your money you’re absolutely correct.
Think about that.
If you invested $1,000, the fund went down by 2% your $1,000 has become $980 plus you get hit with another 2% management fee for managing your losses. Now you’re down 4% or more depending on how they calculate their fees (is it based on the original investment or the amount after losses, you might need to read the fine print to be sure).
Or say you win and it went up 4%. suddenly your $1,000 is now $1,040 yay. Oh wait a minute, you still have to pay 2% for their management!
They win either way! With your money. With you taking all the risk, how awesome is that? At least for them…
But I haven’t talked about problem two yet….
Problem two is the majority of fund managers under perform the market. I’ll give that a minute to sink in…
Let me know when you’re ready…
Is that enough time for you to digest that the majority of funds or institutions that you’re paying 2% or possibly higher fees too, is unable to outperform the average growth of the market?
You’d be better off investing yourself in something like the S&P 500 which is an index of the top 500 stocks in the US markets rather than paying your fund manager to manage your money.
Here are some of the numbers to back that up.
Over a 20 year window from December 31, 1993 to December 31st 2013 the S&P 500 returned an annual return of 9.28%. Yet the average investor made just 2.54% according to Dalbar, one of the leading industry research firms.
According to financial industry expert Robert Arnott, the founder of Research Affiliates, from 1984 to 1998 (a 15 year span), 192 out of the 200 top active fund managers did worse than the Vanguard 500 index (an index fund similar to the S&P 500).
Anyone feeling confident about their mutual funds yet?
But Wait, The NaySayers Are coming!
By now the naysayers reading this will be getting ramped up with their counter arguments.
“There are lots of funds with lower management fees!”
“You’re forgetting about compound interest and long term growth.”
“My Financial Advisor is different….”
I’m sure all of this is true, as are my numbers and info.
Many of these lower management charging funds are not actively managed and hence have a lower management fee, but they are also lower risk and also come with lower returns.
Compound interest is incredibly important, but 2.54% average growth over 20 years even compounded is still crap.
And it’s very likely your financial advisor is not different. Unless of course you’re already a multimillionaire and then I question why you’re even here reading this.
That leads me to problem three, which is an industry problem and an internal bias your advisor may have and not even realize.
What’s Best For Your Financial Advisor,
Isn’t Always Best For You
There’s a built in bias to the entire system and to be fair I’ll admit, it’s not just restricted to the financial industry.
Whether it’s a Realtor directing clients to a property he gets paid more for (properties listed through full brokerages versus discount brokerages), a mortgage broker pushing you to a lender he gets paid a higher commission through or a Financial Advisor pushing you to trade your mutual funds to get into a new, higher paying fund.
I understand I’m painting with a broad brush here, but it’s a brush that deserves to be painted broadly.
When I updated my Financial Advisor about our plans to buy and invest in multiple properties I was warned vehemently about how risky Real Estate was.
He was extremely anti-Real Estate due to the risk involved, or that’s how it was framed anyway. Never mind this was only recently removed from the days of Enron, the dot-com crash and multiple high flying stocks that were heavily bought into that virtually disappeared over night leaving investors with nothing.
Now you can call me biased, but perhaps the aspect of losing out on future capital that he could invest for me was the real risk? Or was he sincerely concerned about my long term financial wealth? I’m not sold on number two in this case.
Over the years I’ve learned even more about the financial systems through various books and articles and it’s becoming an even harder sell to trust an industry that has become “to big to fail”.
Circling back to Real Estate, the same individuals behind the mutual fund and investment world were also involved in the financial crisis of the late 2000’s.
And it seems like far more of the little people who lost their homes or their finances ended up hurt than any of the big players who received bailouts and huge bonus’s for their spectacular work…
Now all of this seems to be strange for a land lording guy to be talking about, but learning more about the financial world is what made Real Estate that much more attractive to me.
Real Estate Gave ME Some Form of Control
So here we are, full circle back to Real Estate. When I invest in stocks or mutual funds I’m often affected by decisions about austerity made by politicians in Greece, about oil price decisions made by ministers in OPEC and by real or perceived threats of invasion or retaliation by hostile countries. All factors that affect potential values for stocks and funds and all beyond my control.
Even more frightening is the potential for a stock to devaluate from x price to not being worth the virtual paper it’s printed on simply because of the previous factors.
With Real Estate investing I still have a certain lack of control, not all banks will deal with me, I can’t have all the properties I want, zoning rules can be problems and landlord tenant laws also factor me. Overall though, I do get to choose where I want to buy, who I want for tenants and I have a steady long term plan to carry me through.
Perhaps most importantly though, I’ve also never seen property devalue from x price all the way to zero. Even if it’s destroyed and you had no insurance (don’t tell me you’re not properly insured!) you still have the value of the land!
Ultimately I simply felt I had more control and there are still ups and downs, but that’s why we also had a long term view.
Long Term Financial Planning With
Real Estate Investing
With traditional investment planning once you reach retirement age you have to covert your IRA’s or RRSP’s or other retirement vehicles (USA, versus Canada versus other places) into investment vehicles where you withdraw money until it’s all gone or you die.
It’s a race to the finish with no real winner.
If there’s too much left, the government takes a chunk of it as part of the two inevitabilities of life, death and taxes. If there’s not enough left, well that’s not a pretty picture either.
With Real Estate, what if you have three or four or maybe ten properties that you held not just up to retirement, but well past that point?
If you generate around $1,000 per month cash flow after all your expenses, that gives you $3,000 per month of income with three properties, $4,000 with four and $10,000 per month with ten properties.
What if you generated $2,000 per month per property after expenses?
Remember in 25 years your mortgage is done, so all you’re paying is taxes, insurance, maybe a property manager and setting some aside for maintenance and vacancy funds, so it’s not that unreasonable if you buy smart!
Tell Me Your Thoughts!
Does Real Estate investing as a long term plan start to look even better? Why don’t you tell me your thoughts by leaving a comment below!
If you’re a Real Estate person, tell me if you’re like minded, if you’re a stock person (and I know they’re out there) tell me why I’m crazy! And if you’re a Real Estate person with stock minded friends, share this with them 8’]