Should you manage your own money?

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Introduction

If you’re reading this article, then you’re probably:

finding it hard to make ends meet and are thinking of appointing a financial advisor; or
not finding the time to manage your own money; or
disappointed with the dismal performance of the financial advisor you appointed and think that you can do it better yourself.

If I guessed any of the above, by the end of this post I hope to convince you to manage your finances yourself. If I fail to do so, we can still be friends :) In fact, I will provide you with some tips you may wish to consider before appointing a financial advisor.

You can also access a visual summary of the article here.

Should you manage your own money?

Information on how to manage your finances is widely available and easily accessible, so there is no reason not to manage your finances yourself. All you need is some time to understand certain basic principles, and the willingness to be disciplined in your spending, saving and investment decisions.

If you appoint a financial advisor to manage your money, you will incur hefty fees for unspectacular returns. Also, you will most likely forgo financial flexibility, because there may be restrictions on withdrawing the funds for a prespecified term. Besides, nobody is guaranteed to act in your best interest more than you. By appointing a financial advisor, there is risk that the financial advisor does not act in your best interest.

The rest of this article deeply explores the trade-off between self-management of your finances, or the outsourcing of your saving and investment decisions to others.

The source of the problem: lack of financial education

It is ironic how basic financial education is not taught in schools. Nobody ever teaches us how to invest, and debt is perceived as something we should avoid. As a result, most people grow up uneducated and/or misinformed about personal finance.

Then, at some stage in life - probably when they decide to make their first big purchase, or when they end up fed up at work, or when they approach retirement age and realize that the state pension is insufficient to maintain their pre-retirement lifestyle - people become aware that they lack financial knowledge, and end up trying to stuff their brains with the essentials of finance...

Bottleneck 1: Overwhelming 'complexity'

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Their first realization would probably be that there exists an abundance of financial jargon which may seem complex to those unfamiliar with the field. Their eyes ache when they attempt to read a balance sheet and income statement, they scratch their heads trying to understand why the money they hold in their bank is losing value, and they bust their minds trying to understand why tomorrow's money has lower value than the same amount today.

Well, financial terminology was purposely made complex to intimidate the average Joe and Jane, and encourage them to seek help with the management of their finances. However, behind the complex jargon are concepts which one can easily comprehend with some time and effort. And this is one of our several ambitions at Financial Fortify - in fact, one feature we stressed upon having during development of our website is the information icon

which defines any technical terms we refer to.

On to the next bottleneck - and this is a major one! People's "essentials of finance" web searches are likely to be recognised by Google's intelligent algorithm, and before they know it, pesky ads promoting "unique financial strategies" to “guarantee financial freedom” will start to haunt their browsing experience.

And money is linked to freedom, which is something we all care about - so when somebody recommends something we are more likely to pay attention. What pisses me off the most are those ads featuring individuals who made a quick buck because luck was in their favour recommending financial strategies which their followers should implement. But did it ever cross your mind that the so-called “influencers” who claim that they know the next best penny stock or alt-coin which “will make you rich” would be making themselves rich thanks to your views on their pointless posts?

As much as I admire him, even modern day Einstein frustrates me immensely when he irresponsibly tweets out his thoughts on certain investments and causes profound market movements. People should not have this much power.

Moreover, I worry when I meet friends who have no background in economics or finance and who have never invested before, who enthusiastically speculate on the prospects for the next Initial Coin Offering (ICO)

Unfortunately, social media lowered the entry barriers for several professions, including the personal finance space. Filtering good quality information has become increasingly challenging.

But let's say you are wise enough to disregard these distractions and ignore the noise. You try to understand the basic concepts of finance, but you end up bored, frustrated and lack the time or experience to apply what you've learned to your own finances. Following several attempts at understanding the basic concepts and trying to find genuine advice, frustration kicks in and you are tempted to engage a financial advisor....But waiiiitttt! Hang in there!

Why you should not appoint a financial advisor

Here are a few key reasons why you should not appoint a financial advisor:

1. The Moral Hazard Motive

Face it, no one values your possessions as much as you do.

In a property rental agreement, the tenant

is unlikely to take care of the property as much as the landlord would. An employee using the company car to drive to work is likely to drive more recklessly.

This typical behavioural of individuals is called moral hazard, which can be defined as the urge to engage in suboptimal behaviour once an agreement between two parties is made.

So, what does moral hazard have to do with the decision to appoint a financial advisor?

By giving up control of your money, you have no guarantee that your interests will be prioritized when the financial advisor makes decisions on your behalf.

Keep in mind that financial advisors (particularly those working for renowned asset management companies) are generally required to reach certain revenue targets to build their reputation or get promoted. But it is company revenue target they need to hit, not their clients' revenue.

Once you provide financial advisors access to your money, they have every incentive to put your money to work immediately instead of waiting for the opportune moment to invest your funds.

2. The Underperformance Motive

Financial advisors brag about the sophisticated models they use to generate an optimal diversified risk-return portfolio of investments.

While their efforts to model complex real world dynamics should not be degraded, statistics show that financial advisors tend to underperform the returns generated by the market index. Indeed, by simply buying the S&P500 index
A weighted stock market index tracking the 500 largest companies listed on the New York Stock Exchange
, performance should be statistically better than that of 80% of active managers over the long term.

From a 16-year study commissioned by S&P, after 10 years, 85% of large cap funds underperformed the S&P 500 index. After 15 years, 92% underperformed.

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What does this imply? It definitely does not mean that you should take the easy way out and buy the overall index. Returns are unlikely to be optimized if you outright buy the index and sleep on it for several years. But if you do so, then you're likely to outperform the PhDs, CFAs and CPAs

over the longer term.

While buying the index is indeed a viable strategy, if you put in the time and effort, then you could easily construct a portfolio of fundamentally sound investments which could easily beat it. By investments, I don't mean only equities - real estate, bonds, precious metals, crypto assets, and other items of value can also be part of your overall portfolio.

3. The Cost Motive

Even if they do happen to beat the market, financial advisors charge high fees for their services, irrespective of their performance. These fees will eat into your precious returns over time.

Fees are generally commission based (generally ranging from 1% to 2% a year), fixed fee based, hourly based or a mix of the three. The financial advisor always gets paid, irrespective of whether you make a return or not.

To illustrate, let us assume you engage a financial advisor to manage €10,000 worth for you. In the first year of asset management, the financial advisor makes a 7% return, meaning that your €10000 is now €10700. Your financial advisor gets paid a commission of 1.5% of assets under management at the beginning of the year, so €160.50 out of the total €700 returns you make go to the financial advisor. We shall assume that this €160.50 will not be forked out of your bank account and not from the €10700 assets you have invested.
Now in the second year, the market drops by 8% and your returns follow suit. Therefore, by the end of the second year, your asset balance will be: €10700 - (8\% \times €10,700) = €9844 . But the financial advisor still gets paid a commission of 1.5% of assets under management (€9844) which would tally to €147.66.
Despite your portfolio being down for the year, the asset manager still gets paid. By the end of the second year, you are actually €464.16 worse off than when you started. (€156 from market returns + €160.50 + €147.66 from financial advisor fees). However, the asset manager has made a total gain of €160.50 + €147.66 = €308.16.

A similar situation would have transpired had the financial advisor been paid on a fixed fee basis. Irrespective of the returns made, the financial advisor would still get paid.

Today, thanks to the web, all information is public and free. All you need is to find a trustworthy source for your education like Financial Fortify and dedicate a few hours a week to learn the basic concepts. The Master Class series is the perfect place to start!

4. The Flexibility Motive

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When appointing a financial advisor, you are likely to be presented with a booklet of endless terms and conditions which will probably end up as part of the furniture in your study. Somewhere in the booklet, there is likely to bound to be a clause outlining that if you decide to withdraw your principal prematurely, you will incur charges.

Consider the following scenario: 20-year old Tim appointed financial advisor Forbes to help him reach his goal of buying an expensive yacht by the time he turns 40. Tim and Forbes enter into a 20-year contract which stipulates that Forbes will help Tim achieve his goal. After 10 years of investing, Tim decides to propose to his sweetheart, Sally, and he needs the money urgently for their wedding. Although Tim has every right to access the capital before the full 20-year period elapsed, Forbes will inform Tim that he will be charged for breaching the agreement.
Moreover, imagine that when Tom urgently needs the money, the economy would be in the middle of a bear market which erased half of the gains he made from the previous 10 years. Tough luck Tom!

The main takeaway of the above example is that forgoing financial flexibility can be detrimental, especially during bear markets and when unforeseen calls on capital need to be made.

5. The Responsibility Motive

Imagine asking your friend to help you decide which horse to bet on in a horse racing event. Your friend rationally advises you to bet on the horse which secured the most victories in previous races. Competition day arrives and the horse you bet on didn’t fare as well. Your first instinct will be to blame your friend for calling the competition badly, but in truth, you should blame yourself, because it was you who asked your friend’s opinion.

The same analogy applies when you appoint somebody else to manage your finances. Investing in itself already carries an element of risk. By appointing a financial advisor, you create another risk - that the financial advisor performs suboptimally.

If however, you assume full control and responsibility of your finances, then you will enhance your accountability and also experience a greater sense of satisfaction.

Hopefully by now I managed to convince you to personally manage your finances! But if you are still skeptical, or you genuinely don’t have the time/willingness to learn, the following section provides some tips to guide you when appointing a financial advisor.

Checklist before appointing a financial advisor

You should still do your homework

Before seeking the services of a financial advisor, you should at least have some basic knowledge of certain concepts. This is because the job of financial advisors is to sell you their services.

Think of a house purchase as an analogy. The real estate agent has a financial incentive to urge you to purchase the property, because he/she earns commission on the sale. But the architect you appoint to give their opinion on a property acts like a fiduciary. Why? Because the architect will be personally liable should any structural impediment arise following the sale.

Thus, it is important to be informed on some basic financial concepts before your first meeting with an advisor. In this way, you will navigate through the meeting with greater ease and even be able to judge the competency of the financial advisor,

Compare financial advisors and what they offer

Check for professionally qualified individuals with reputable designations. Also, if possible, speak to a fiduciary. Unlike financial advisors, fiduciaries are legally obliged to put your interests before theirs.

Also, do some fact-checking, like exploring their websites or LinkedIn profiles, evaluate their work history, understand what areas they specialize in, and ask other people about them.

After shortlisting a few options, you should directly reach out to the top three you prefer to ask about what they offer. Why not inquire why you should appoint them instead of someone else? What better services are they offering?

Finally, you should always listen to your gut. If you feel intimidated or uncomfortable in the presence of the financial advisor, then don’t be afraid to politely back off.

Carefully read any contractual agreements before committing

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When you choose your financial advisor, be sure to make it clear what you are after.

If you feel that you already have some basic finance and investment knowledge and all you need is some further guidance or advice, you can always hire a financial advisor by the hour, without prolonged commitment.

An alternative strategy would be to self-manage part of your finances and then appoint a financial advisor to manage the rest. Otherwise, you can also consider using a robo-advisor

, which provides a cheaper alternative because it adopts an automated algorithmic based approach to investing.

But if you prefer to enter a longer term commitment, then read the terms and conditions of the contract carefully.

I had failed to do so myself when I was encouraged to apply for a Life Insurance policy after finishing college. Back then, I seldom paid attention to my finances and knew nothing about investing. Little did I know that I was signing an agreement to deposit an amount every quarter for 30 years. And to top it all off, the returns I made over the past decade or so are dismal. Not to mention the hidden fees I get charged with each quarterly payment made. When I started to interest myself in economics and investing, it dawned on me what a shitty contract I had signed. Frustrated with my younger self's negligence, I asked the insurance operator to close the fund, only to be informed that if I did so, I would lose the entire 12 years' worth of returns.

Well, this is the sort of "punishment" you get for not reading a contract and not being financially educated. Don’t be like my 18 year old dumb self.

Make sure that you ask your financial advisor for a copy of the contract, take it home, read it all in your own good time, highlight the points which are worth remembering, and ask about anything you aren't sure of. In doing so, you will make a more informed decision.

Watch out for hidden fees

Financial advisors generally get compensated by charging a fixed fee, a commission based on assets under management or a mix of both.

However, watch out for additional fees which are embedded into some of the financial products. For instance, active funds and exchange traded products have expense ratios which are incurred when adding them to a portfolio.

These additional fees substantially increase the cost of the financial advisor.

Also, watch out for the advisor's attempt to upsell you other products their firm offers. Don't be afraid to use the strongest word in the English vocabulary in this case - "No!".

Make sure you understand what you are signing up for

You should never invest in something which you are unsure of or do not understand. Consider your decision to appoint a financial advisor as an investment. Hence, you should not feel intimidated to ask questions or to clarify your understanding.

Remember that YOU are the client. You will be paying the financial advisor good money for their service.

Always remember that the information is publicly available and that the personal finance market is super competitive. Therefore, it is the financial advisor who actually needs YOU and not vice versa.

When a financial advisor may be helpful

Unless you are strongly unwilling to learn about finance or investing (although I doubt it, otherwise you won't be here ;) ), or you literally do not have the time do so, then appointing a financial advisor will be a better option than making rash investments or not saving sufficiently for your retirement.

A financial advisor can help you beyond simply managing your money. They can provide you with education, tax advice, inheritance and goal setting coherent with your age.

They can also help with portfolio rebalancing and help you to keep sane when there is a temporary correction in the market. If you do not have the stomach to endure the volatility that comes with investing, financial advisors are qualified to take some risk which you wouldn’t have considered, while ensuring that you have the cash flow necessary to meet any short term obligations which may arise.

In spite of these benefits, if you put in the time to assess your finances and understand certain financial terminology, you will assume full responsibility for your financial future and certainly feel a sense of accomplishment. A recent CNBC "Invest in you" savings survey showed that 75% of Americans manage their own finances and only 17% use the services of an advisor. If 246 million Americans can do it, then you can do it too. All you need is a couple of hours of to learn, and what better way to this than signing up to www.financialfortify.com to get notified everytime there is some new information for you to digest.