I'm regularly asked about money and investing, often by people who know little about it. Since I like to run my mouth, I've decided to write a bit about creating and maintaining wealth.
I usually answer them by asking another question: How do you think you get rich? Usually, their answer involves making a lot of money. While making money no doubt helps, it's only half of the equation. Moreover, it's the more difficult part: Contrary to what others would have you believe, there are few easy ways to make money quickly and the "regular" ways of getting ahead (promotions, degrees, etc.) are usually time-consuming, laborious and highly contested.
Instead of focusing on these mined-out areas, I focus on the other side of the earn/spend battle by encouraging people to focus on improving personal economy (i.e., how much and/or on what you spend).
In case you're worried I'm about to spew a bunch of shit about canceling cable and not eating out, let me assure you that I am not the kind of person who compromises their quality of life by scrimping. Last year I took two international trips (real ones - Japan and Scandanavia) while supporting expensive photography and running habits. I eat out far more than is healthy and live in a big inefficient condo with both cable AND netflix. The difference between me and most people is that I did all these things while spending a shade less than $28K for the entire year.
I'm going to show you how to do this too, by focusing on only the best form of frugality: changes that make absolutely no difference in your day-to-day life.
There are a few of these, and I'll get to them in time, but I'd like to begin with the questionable utility of financial advisors.
No, that's not worded strongly enough. Let's try it this way: I would rather have an open postule on my testicle (right on the spot that always gets chafed by running shorts, no less) which oozes a glowing green substance that doctors can't identify than have a financial advisor.
Whenever I enumerate the quantitative disadvantages to advisors, people generally nod thoughtfully and then ignore my advice. So I'm going to try something new. Here are a few stories of my direct and observed interactions with these sharks.
I'm twelve years old and I want to invest some money I'd saved. I have maybe $2,000 and, having recently been alerted to the existence of the stock market, am interested in buying some shares of stock. It's the early nineties and the internet effectively did not exist to offer guidance in this arena. In those days, we called up my parents' financial advisor, asked his advice, and then made an order. None of us were exactly sure how he made money off us, but he worked for Charles Schwab so we figured he must be above-board.
At the time I was EXTREMELY unsophisticated when it came to investment strategy. My plan was to invest in Checkers (the hamburger chain, not the board game). My reasoning was (1) I liked the food and (2) it was trading around $3.87 a share and I wanted to buy the largest quantity of shares possible. Not great reasons, but I barely had hair on my balls.
My father took my idea to our financial advisor, who promptly poo-poo'ed the idea. He confidently predicted that Checkers was close to bankruptcy and was poised to fall. Instead, he recommended I split my money into four mutual funds in something called the American Funds offered by the Capital Group. What are American Funds? This website explains it pretty well: In short, their funds usually track major indices but charge much higher fees, guaranteeing that they'll underperform benchmark averages. Part of these fees are kicked back to the advisor as compensation for steering idiots like us into such a shitty investment. In effect, it's collusion to enact a shitty scam on the unsuspecting.
The extra commission from steering a twelve-year-old into a ripoff investment wasn't enough for our financial advisor, however: Rather than selecting a single American Fund, he split my entire fortune (two whole grand!) into FOUR diversified mutual funds. Why? Four times the commission, that's why! (Note: Four separate mutual fund purchases is actually TWENTY-FIVE times more expensive as purchasing a single stock on Ameritrade's platform)
I'm ashamed to say I allowed this poor investment to go on for well over a decade before finally selling and transferring the money to a low cost index fund (run by Vanguard, which is the only company you should ever work with). As for Checkers declaring bankruptcy, it never happened. I drove by one of their over 800 locations yesterday. It was acquired by a private equity group several years ago.
My parents wanted help planning how to pay for the cost of college for me (so nice of them, right?). They again went to their financial guy to help them formulate a plan. What did he come up with? He suggested they buy four zero-coupon bonds that would mature at the beginning of each academic year.
Normally this would not be a bad approach: Unlike now, the early nineties were an OK time to buy government bonds (about an 8% return on ten-year goernment debt, guaranteed). While this did trail the annualized stock market return by about 13%, a conservative approach could be easily forgiven under these circumstances. However, my parents were steered into ZERO-COUPON bonds (the coupon is the part of the bond that generates interest; in effect, my parents were robbed of a decent guaranteed return in exchange for a modest discount on the purchase price of the bond). This fact, combined with the general illiquidity of the investment, made the whole affair a total facepalm (at least in retrospect).
I'll give you one guess who gets a huge kickback for selling zero coupon bonds in a high-interest environment.
A totally different advisory group was somehow introduced to the mental health practice my father co-owned. They attempted to convince the business partners that it was a good idea to put a whole life policy on themselves and their family members, including their children. Insuring your healthy teenager is such an asinine idea that advisors should be ashamed to even bring it up, but these guys weren't bothered by inconsequential details like that.
As I mentioned earlier, kickback fees to advisors are generally proportional to the shittiness of the investment (really think about that for a moment: the worse investment they can steer you into, the more they profit). I later learned that placing a client into a whole life insurance policy is one of the most lucrative scores in the financial service industry, a fact I found wholly unsurprising given the behavior I'd witnessed.
My father fortunately declined the offer, but remembers other partners taking them up on the proposition.
Not a scam per se, but an example of massive incompetence and/or negligence. A family member was coached (by a presumably different financial advisor) into taking a MASSIVE position (about $40K) in Worldcom/MCI. Buying single stocks is a risky game of musical chairs, which this relative learned when the company went his entire investment went up in smoke when the company subsequently declared bankruptcy (as happens relatively regularly with utilities, see Nortel and Enron). While there should be a degree of personal responsibility in any investment, ignoring basic concepts like diversification immediately disqualifies and advisor from any pretense of intelligence and/or common sense.
Occurred fairly recently. A different relative mentioned that they still use a financial advisor, whom they claimed managed to achieve a greater return than they could have achieved on their own. Knowing what I do now, I issued her a simple challenge to determine the real value of their advisor: I implored her to ask them for a record of their annual returns for the past ten years (after the advisor's 1% management fee was taken out) and compare them to the average market return over the same period.
Guess who failed the test? When I saw the response, I knew the result before even seeing the numbers. The cover letter was long and full of equivocations as to why their results lagged. It was as if the simple, direct question (Why am I paying you?) had cut a swath through all the normal bullshit.
And I'm Spent
I'm sure there are other examples, but I'm getting tired of angry typing. I've never worked with an advisor as an adult, but I get calls and emails from them frequently. Whenever one calls, they get the same offer (one I picked up from the excellent book The Millionaire Next Door) I give anyone seeking to manage my money: Send me your last ten years of tax returns and show me that you've beaten the average market return every year. If you have, my money's yours to run. I've made the offer maybe thirty times and no one's taken me up on it.
If there's any interest, I can write a post on simple DIY investing that minimizes expenses (partly by eliminating human parasites from your account expense line).
Noah's Inner Monologue
Scribblings of a man who can barely operate an idiotproof website.