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1) Traditional Financial Analysts Do NOT Tell You TO Diversify Out Of Paper Assets
If you have had a meeting with a financial analyst, I am sure that you have heard that “diversification is key.” You might find it shocking to find out that almost no financial analyst practices what they preach. You may hear them say they will achieve diversification through mutual funds, stocks, bonds, and CDs. If they are really “cutting edge” they might even mention emerging markets, foreign currencies, and some commodity ETFs. Too bad all of these investment vehicles are centered on one asset class: paper assets.
When you only invest in paper assets you are giving up many of the great benefits of investing.
- Cash Flow – Stocks only provide small quarterly dividends. With real estate, it is possible to receive double-digit cash flow that is paid monthly, which is much more convenient for financial planning.
- Leverage – When you invest outside of paper assets, the bank will provide financing for your investments with as little at 3% down. Take some time to think about why this might be the case…
- Insurance – When you invest in physical assets, your investment can be insured up to 100% of replacement cost. This isn’t possible with stocks.
- Tax Incentives – When you only have paper assets, you miss out on depreciation, one of the most important reasons to consider investing in physical assets like real estate. Instead of being removed from your portfolio, the money that you aren’t losing to Uncle Sam can be reinvested and compounded
- Control – You have no control over large companies that you own stock in. Further, even if you want to, you cannot add value to your investment or decide in what direction the company moves.
2) A Personal Financial Analysts Will NOT Even Try To Beat The Market
Financial analysts are not trying to beat the market; they are incentivized to track along with it. Excluding hedge funds, which have unlimited risk, almost all financial analysts’ goals are to keep up with the major indexes. They won’t tell you this when they are pitching you their services, but think about their incentives…
If you use a financial advisor and for 5 years the market realizes a 10% return, but your financial advisor only returns you 6%, what do you do? You would fire them. However, when the market returns 10% and you receive a 10% return, you would be confident that your financial advisor is competent and that you are in good hands. If they ever do something “creative” and end up costing you money, you probably won’t give them a second chance, but if they simply keep up with the market, they will be assured long-term job security.
You don’t have to be a rocket scientist to understand why financial advisors’ business is to basically go along with the herd.
Financial advisors are not paid to think outside the box. In fact, they are paid to be so conservative that you will never beat the market over the long term. After all, the speech they gave you when you first contacted them was centered on “protection of capital.”
If you think your personal financial analyst is different, please ask yourself when was the last time he told you to short the market.
Here is the real interesting part… If you insist on being invested in stocks, there is a relatively new investing tool that tracks major indexes on a 1:1 ratio. This tool is called an Exchange Traded Fund, or ETF, and it is in the process of eliminating the financial advisor profession. By owning an ETF, you get the diversification of the entire index without the fees associated with a financial analyst.
If you are like me, you want to receive reliable returns regardless of the over all market’s performance. Reliability is one of the main arguments I have with stocks and financial advisors that invest in stocks. I want to have control over my own finances, not allow the uncontrollable and volatile market, to dictate my future.
3) Financial Advisors’ Mutual Fund Fees Make Investing A No-Win Scenario
Most financial advisors are paid according to three different fee structures: assets under management, hourly fees, and commissions. None of these fees are directly related to the performance of your portfolio.
Assets under management is the most common way financial advisors are paid, so let’s look at the incentives on this model.
Unless you have a very large portfolio, you are probably charged an annual fee of 2% of your portfolio’s size. This fee can all but eliminate any gains the general stock market produces.
From 2001 to 2011, the S&P500 has yielded 3.25% annualized. If you include just the annual fees for assets under management, this cuts your yield by more than half, down to only 1.25%.
From 2006 2011, the S&P500 only yielded a 1.96% annual return. If you have had money invested with a 2% assets under management fee, you have an average return of -.04% annualized. The math simply doesn’t work.
If that doesn’t convince you that the numbers don’t work, think of this…
4) Financial Analyst Firms Don’t Spend Time Analyzing Stocks, They Spend Time Marketing
Financial advisors aren’t stupid. They know they can’t control the market, and they want to make money whether the market goes up or down. They might try to tell you that their “assets under management” fee encourages them to make more money. As in: If your stocks perform well, you will have more money, and therefore, their assets under management fee will increase.
I want to show the glaring fallacy of this philosophy…
Let’s say you have invested $250,000 with your financial advisor who is paid an annual 2% of assets under management fee.
Normally, your advisor gets you an 8% return. For the sake of argument, let’s say your financial advisor now concentrates all his energy on picking the best stocks, rather than marketing. He spends his entire work year, 2000 hours, on picking you (and his other clients) the best stocks. I personally don’t believe this hard work would pay off at all, but let’s say his work results in you getting a 25% increase in your return, bringing your total return from 8% to 10%.
The net difference to your portfolio would be $5,000. This increase has changed your assets under management fee by 2% of $5,000 bringing the net result to the financial advisor to a staggering $100.
This is laugh out loud funny that they try to pitch this as a “mutually beneficial relationship.”
Because the math doesn’t work out, they don’t spend time analyzing the markets; they spend time marketing for new clients. Billboards, magazines, and commercials are where financial advisors spend their time and money, not on hard laborious stock picking that may or may not pay off.
It is time to take your financial future into your own hands. Furthermore, using a financial analyst that will only mimic a readily available ETF will only cost you precious percentage points.
Going forward, consider cash flow, rather than appreciation (in stocks or real estate) to produce reliable gains.