On average, you’re not going to beat the market. By definition, the average investor will get average results. Some will be lucky and do better. Others, who are less fortunate, will not do as well. Do you want your investment strategy to be based on luck? If so, buy lottery tickets.
There are surely financial advisors who are able to consistently beat the market, but are these people to whom you have access? Someone who is smart enough to consistently beat the market is also smart enough to be very well paid for his or her skills. That leaves two possibilities.
One, he or she will work for very large investors (for example, the Harvard endowment). Unless your investable assets rival those of Warren Buffett or Bill Gates, this isn’t you.
Alternatively, he or she could work for a large number of smaller investors (provide advice to a large brokerage such as Edward Jones or Raymond James). Every large brokerage firm has its “experts.” Some will win, some will lose. How do you choose one that will win? Again, we’d argue that luck plays a large role.
By the way, you’ll often hear mutual fund families claim things such as “80 percent of our funds beat their Lipper averages over the past five years.” Of course they did, most of those that didn’t beat the Lipper averages were shut down. Don’t be fooled by the fun with numbers in which many investment houses engage.
However, win or lose, you’ll pay for the advice. It can be difficult to know how much and, while most financial advisors won’t lie, many will obfuscate to keep you from finding out how much you are paying. It’s not difficult – there are a plethora of different types of fees: frontend loads, contingent deferred sales commissions, 12B-1 fees, mutual fund management fees and operating expenses, asset-based fees, the list goes on.
Unless you are aware of these fees and negotiate very well, you’ll likely end up paying north of 200 basis points (bps) of your assets annually.
That’s not so bad, you may be thinking – 200 bps for financial advice seems fair. That’s not a large percentage. But let’s put this in context. The Dow over many years has managed to gain an average of 8 eight percent per year. Therefore, if you are paying 200 bps annually for the privilege of having someone advise you regarding which shares to own, you’ll have to beat the Dow by 25 percent to break even. Essentially, no financial advisor can do that.
So what are your options to paying expensive fees? You could go to a discount broker (for example, Vanguard) and purchase low-cost, index Exchange Traded Funds (ETFs). With a diversified set of index ETFs (U.S. Large Cap, U.S. Mid Cap, U.S. Small Cap, Europe, Asia, and Emerging markets) you’ll mirror the returns in world markets. Choose the percentage of your assets you want invested in each fund and rebalance annually.
When world markets go up, you’ll make money. When world markets go down, you’ll lose money. But, with this type of buy-and-hold strategy, your return will be about the same as world markets, not 25 percent below world markets because you are paying expensive brokerage fees.
Wait a minute, some of you are saying, even low-cost, index ETFs have fees. It costs you something to own these funds. That’s true. The last time we calculated the weighted average cost of owning our ETFs, it was 13 bps. That’s less than 7 percent of the cost of the expensive financial representatives we had used in the past when we were trying to beat the market.
Financial advisors can be worth their weight in gold, if they get you to save and invest when you otherwise wouldn’t. However, if, like many entrepreneurs, you are a go-it-yourself kind of person and if you have the discipline to save and invest on you own, you can make a lot more money in the long run by skipping the expensive experts.
How much more? Consider a woman who starts investing $200 per month at the age of 25. By the time she is ready to retire at age 65, she would have invested $96,000. If this investment earned an 8 percent annual return (the average return of the Dow over time) and she paid 15 bps to own low-cost, index ETFs, she would have approximately $621,000.
On the other hand, if she earned the same 8 percent, but also paid 200 bps in fees to a high-end money manager, she would have only $383,000. The difference is nearly a quarter of a million dollars.
Wow – we know which we would choose.