Not a day of the week ending in Y goes by without someone standing up on a soapbox somewhere and decrying the financial planning profession. We’re little more to be trusted than used car salesmen, we can’t generate investment alpha, and the fees will eat your returns! Or so the soapbox man says.
One rather famous financial influencer has even taken money for paid endorsements for a financial planning firm that charges fixed fees rather than the industry’s traditional “assets under management” fee. Never mind that said firm’s fees are so high, and the influencer’s courses are so expensive that they’ve been shown empirically to cost more over a lifetime than the business models they decry as being overpriced.
A particularly popular example goes something like this: “Did you know that if you pay a 1% advisory fee, you’re giving up 28% of your nest egg?” This specific example assumes a 43-year investment of $1,000 per month at an 8% rate of return, versus the same assumptions but with a 6.93% rate of return (which would be the fee-adjusted rate of return).
Never mind the base assumption that an untrained consumer is going to create the exact same portfolio a professional would and thus obtain the same gross return.
Never mind the base assumption that the consumer is going to stick to their guns for 43 years straight and never once skip a savings contribution, waver or falter in their confidence in the markets, or yield to the temptation to tinker with their portfolio in a sub-optimal way.
Never mind the base assumption that the consumer’s income will be consistent over time, that all of these savings are being made legitimately in some sort of Roth retirement account where the taxes don’t matter, or that they will never overspend or find themselves in any sort of financial distress whatsoever.
Never mind the base assumption that this consumer is adequately insured and that all risks in their lives are well-managed as to never impact their financial future.
Never mind any of that noise. In fact, let’s grant all of that. Let us grant the core assumption that gross returns are better than gross returns minus fees. Let us grant that any particular reader of this example is uniquely superhuman, and that they will manage their finances as well as a professional who does this all full time. Granted across the board, you might say. But just for the sake of curiosity, let’s examine what non-hypothetical people do and have done in the real world, and see if those granted assumptions hold true, or whether a financial planner is ever worth the expense.
Granted – You’d Never Overtrade Your Account
You would never overtrade your account. You would never day trade or chase performance. That’s what amateurs do, and you’re not an amateur! But when we look at the behavior of real investors over the years, it turns out there are a lot of amateurs out there.
A seminal study on this particular issue was done by Terrance Odean in 1999, peer-reviewed, and published in the American Economic Review. “Do Investors Trade Too Much?” The study found that for those DIY investors using a discount brokerage (think Charles Schwab, Vanguard, Fidelity retail platforms) that investors were typically underperforming themselves by 3.32% annually, showing that across a sample of almost 100,000 investors, their inclination to sell something and buy something else led them to lag the performance of their previous holding by 1.36% over the next few months, 3.31% over the next year, and 3.32% over the year following. The effect was more pronounced over those who traded the most (the top 10% most active investors) with a 2 year lag of 3.5%, but even those who traded the least (the other 90%) lagged themselves by 3.26%.
Oh, and all of this? This was trading behavior measured from 1987-1993, aka, before the internet made it easier to trade and before commissions and transaction fees were effectively made $0 based on competition between the brokerages. So not only were the results of the study conclusive that investors regularly betray their own interests by self-managing their investments, but that was back in a time when you knew you’d have to pay for each trade, and didn’t have constant psychological pressure and manipulation pouring financial media and nudges to buy this or experience fear of missing out in your face all day long.
So let’s take the granted example of the superhuman hypothetical and the foolish client of the financial advisor. While the superhuman is enjoying a $4,474,943 nest egg and the advisor’s client paying 1% a year is missing out with a terrible $3,207,231.87 on hand, our less-than-superhuman real people granted the same assumptions and even that they’re in the lower trading group, only have $1,613,286.77. So they’re missing out on 63.95% of the superhuman return, or 49.69% of the advisor’s “terrible” return. And again, this is using data from a group of people living in a time before commission-free trading, apps beeping constantly at them to buy before they miss out, and a million and one finfluencers convincing them that they can be the next Warren Buffett.
Big bet to assume you’re in the superhuman camp, right? Of course…
Granted – The Solution is to Chill
A simple solution to the problem: Don’t trade! Easy! Just buy index funds, and don’t trade your account. Wham, bam, you’re a genius. After all, keeping your head during market volatility or big scary events is super easy, right? Well, maybe. No, actually.
Let’s look at a particularly memorable and recent big scary event: The COVID Crash. During the early months of the COVID-19 pandemic, the stock market as measured by the S&P 500 crashed over 30% in a period of weeks. Now, granted as we’ve said, the solution is to just chill and do nothing. But not everyone heeds that wisdom, even those who might otherwise think of themselves as the superhuman stronger stuff.
In a study performed at Morningstar by Dr. David Blanchett (“Keep Your Distance,” 2020), examining the real behavior of 635,116 participants across 509 different 401(k) plans during the initial months of the COVID pandemic, it was found that those plan participants with the largest and most aggressive plan balances (e.g., those with $250k-$1 million in their 401(k) plan and those who were already 90%+ equity in their allocation) reacted the most viscerally to the pandemic, cutting their equity exposure on average by 18.94%, while those with more than a million cut their equity exposure on average by 18.91%. This is colloquially known as “buying high and selling low.”
You might then scoff and say once again that you’re superhuman and you’d never make such a mistake. But compare this behavior to that of 401(k) participants in the same dataset who had their money managed by professionals. While 10.8% of the participants in 401(k) plans who were self-managing made changes like the aforementioned example, only 1.3% of those in managed portfolios did. In other words, there was about a nine times greater likelihood that the DIY participants in retirement plans were going to make a classic investment mistake than those who had delegated their investments to a professional.
Worse yet? Months later when the study had been updated with more behavior as the market made a miraculous recovery (netting over a 20%+ return by the end of 2020 as measured by the S&P 500 index), hardly any of the participants who’d cut their equity positions at the wrong time during the downturn had gotten back in the saddle. So not only did they sell when they were down, but they failed to catch a good chunk of the recovery.
So let’s take our granted example once again. You’re superhuman, but let’s say you make this mistake when you’re twenty-six years into your journey when you’ve saved $1,042,411.04, and you cut your allocation from 100% equity (with that lovely assumed 8% average rate of return) by 18.91% into some bonds yielding 4%. Now your asset-weighted average rate of return going forward is 7.24%. Good news, it’s still better than the advisor’s fee-adjusted rate of return of 6.48% annually. At the end of the journey you’ll end up with $3,957,983.95, or 11.55% less than if you’d just remained superhuman. But hey, it’s only one mistake at one point in time. You’d never make a mistake that cost you 11.55% of your future savings twice, right? Fool me once and all that?
You’d only ever make a mistake one time, and that one mistake would only cost you 11.55% of your lifetime wealth. Granted. You’re superhuman, after all.
Granted – Financial Planners Don’t Do Anything But Investments
Of course not. All financial planners and advisors do is gather assets and manage investments. Badly at that, as we’ve already granted. Or at least, no better than you’d do for yourself. And charging 1% on top of it!
That’s why the CFP® Professional curriculum is only 17% investment planning and 83% professional conduct, general principles of financial planning, risk management and insurance planning, tax planning, retirement savings and income planning, estate planning, and the psychology of financial planning. That’s why of the 70 principal knowledge topics, a measly 61 of them have nothing to do with investments
That’s why when the Nerds Eye View blog published “101 things advisors actually do to add value (beyond just allocating a portfolio)”, the list is actually just empty. Seriously! It definitely says nothing about comparing purchase versus rental choices, student loan analysis, reverse mortgage analysis, tax efficient distribution strategies, risk management and advice about every type of insurance, equity compensation, or charitable gifting and family legacy planning. Oh, sorry, I read that backward. It talks about all of those things, and 93 other things to boot.
Of course, it’s not like anyone has done empirical studies about the value financial planners add (whether it be about investments or not). Envestnet definitely didn’t calculate it as being 2.93% annually, of which only 1.43% was investment-related. Morningstar certainly didn’t conclude that financial planners improve retirement outcome certainty by 22.6% or annualized return improvements of 1.59%. Russell never calculated that planning was providing a 4.83% annual improvement to finances, which 3.58% had nothing to do with investments and 1.22% above that was purely tax efficiency. Heck, even the patron church of low cost DIY passive index investing, Vanguard, ballpark’s a financial planner’s value at around 3% annually.
But don’t take those educational programs and studies’ words for it. After all, education is simply education. 7 graduate courses, a tough exam, and 6,000 hours of professional experience are meaningless. A list of all the things planners do that aren’t captured in a portfolio return mean nothing compared to the portfolio return. And granted, four separate empirical studies simply go to show that the value is all over the place. Is it 1.59% or is it 4.83%, huh? Clearly it’s all non-sense, now matter how positive they all suggest that it is.
Let’s perhaps take the word of those who are self-managing or using DIY tools versus those who actually work with a financial planner. Ignoring that the DIYers think they’re going to get 21% annualized rates of return on their own (sorry, they’re not, and no one is), the customers of the human financial planners value the advice they get at a whopping 5% annually. That’s right: the sole perception of actual financial planning clients is that they are 5%, or in the scale of the study, 50% better off by working with a financial planner. Granted, we already said that the advisor was worth 1% or more less than our benchmark superhuman, but isn’t it remarkable that clients of financial planners think they’re worth 5x more than it’s assumed they’re charging?
Granted – You’re Superhuman
It doesn’t matter. None of it matters! The math is simple:
Gross Rate of Return > Gross Rate of Return – Fees
There is no room for value in that equation. What you get is what your returns are, and what you don’t get is what you pay for. Ipso facto, ergo, hereto and therefore: Financial planning isn’t worth it. This is granted, you are granted, nay, endowed with superhuman capabilities. Every financial pundit selling a newsletter, every hack with a course to hock, is right: there is no value in financial planning.
Granted, of course, that unlike the hundreds of thousands of people in the studies we’ve cited in this piece as examples of those who are not superhuman, you are, in fact, superhuman.