[Editor's Note: This is a guest post from Chris who has a blog titled Eat The Financial Elephant. He and his wife blog about do-it-yourself wealth building, financial planning, and investing with a focus on achieving financial independence and retiring at an early age simply by eliminating waste and living efficiently to create a high savings rate, in their case over 50%. I bet he doesn't buy $11K tables or waste money on expensive boats! We have no financial relationship. Enjoy!]
I am very grateful to have this opportunity to guest post on The White Coat Investor. While our blog has a slightly different focus from WCI, we have a clear common mission of creating educated consumers who will not be victimized by the financial industry. I have read WCI's motivation for starting The White Coat Investor after having poor experiences with the financial industry and it was all too familiar to our own experience. When I think about what motivated each of us to become part of the blogging world, I can’t help but think of the great quote from the movie “Rounders” about the world of high stakes poker: “If you can’t spot the sucker in your first half hour at the table, then you ARE the sucker.” As a high income young professional entering the world of investing, you would be wise to enter into any meeting with a financial professional thinking they are looking at you that way. Your only defense is self-education. DO NOT BE THE SUCKER!
When beginning to invest, we elected to use a financial advisor for two reasons. First, investing seemed very intimidating and complicated. There was definitely an element of fear to go it alone and make mistakes. We felt that we needed a professional to guide us in our investing decisions to assure the best outcomes. Second, it just seemed like it would be easier to pay someone else to do these things for us than to learn to do it ourselves. We were busy young professionals and it was worth our time to outsource these duties. I think our thought process was very representative of most young professionals.
DIY Investing is Cheaper and Easier
Since taking a DIY approach to our financial planning and investing, we realize we could not have been more wrong on either front. We are all but guaranteed to do better on our own precisely because of the extreme savings on expenses and the tax advantages we’ve been able to give ourselves by getting rid of our advisor. By decreasing our tax burdens and eliminating expensive financial advice that brought no value, we have dramatically improved our financial situation without any sacrifice or taking on any excess risk. More importantly, after an initial investment of time to develop our financial plan and investing strategy, it is actually easier and less time consuming to simply do things ourselves than to have to deal with an advisor. We hope to demonstrate this to you with an example.
Let’s create two hypothetical married couples that would be typical young readers of this blog. Each couple earns a combined salary of $200,000. Everyone is 30 years old and beginning to save for retirement starting with $0 savings. [If only most doctors could start investing that young AND with a net worth of $0, but the example still works fine-ed] Both couples plan to retire at age 60 giving 30-year investment time frames. They each have equal risk tolerance. They both will commit to saving $30,000 (15%) of their pre-tax income, to invest. They both will invest in the stock market. We’ll assume market returns of 10% annually.
Finally, we are going to attempt to keep the example simplified. First, we’ll eliminate the effect of inflation by discussing everything in terms of 2015 dollars. Therefore we will reduce the market returns to 7%, attributing 3% of the return to inflation annually. We will keep the absolute amounts of everything else (salary, amount invested, etc.) in the examples constant for the 30 years. We are also going to eliminate the effect of all income taxes except for federal, to not overcomplicate the points being made.
The only difference is that one couple uses a financial advisor and is given the same advice we received as young professionals. Let's call them FA. The other couple chooses to educate themselves prior to committing their first dollar to the investments. They employ the strategies we currently employ since managing our own investments. Let’s call them DIY. Can it really be easier for one couple to have far greater results as we claim without taking any greater risk with investments or saving any more money? Let’s run the numbers.
Missing Out On Tax Deferral
The FA couple is advised to invest in products sold by their advisor. This would be the standard advice for anyone starting out without a high net worth, because the primary ways for most advisors to be paid is through the sale of investment products and having assets under their management. Couple DIY knows that for high wage earners, there are great benefits associated with deferring taxes so they invest their full $30,000/year in their employer-sponsored 401(k) plans. Therefore, they are actually investing $30,000 each year while the FA couple is investing only $21,600/year after paying 28% federal income tax on those dollars.
Paying High Expenses
The FA couple would then be subject to expenses charged by the advisor. We have showed in our case that we paid expenses equal to approximately 2% of our assets per year in fees to our advisor. When starting out, one would likely pay more than that, but let’s use 2% fees to be conservative. After accounting for fees, the FA couple would actually earn a return of only 5% annually. The DIY couple would be subject to fees also. We are very focused on limiting fees with our own investments, using Vanguard index funds that average about .1% annually. However, since our DIY couple is using a 401(k) account they may not have access to these exact funds. Let’s assume they have a poor plan to be fair and have to pay 5X the rate of the Vanguard funds, .5% annually. This reduces their annual rate of return to 6.5%.
Tax Drag
Because the FA group did not utilize their tax-advantaged accounts, their investments are subject to additional taxation each year on dividends, interest and distribution of capital gains. They would also be taxed on the sale of any investments that went up in value if rebalancing accounts. We showed in this example how this ends up decreasing investment returns by approximately an additional 1% per year, decreasing their annual rate of return to 4%. The DIY couple’s investments would not be subject to taxation annually, because they utilized the tax sheltered accounts, allowing them to keep more money working for them longer.
Therefore, the DIY couple would contribute $30,000 per year at an inflation-adjusted, after-expense return of 6.5% annually. At the end of 30 years they would accumulate $2,759,677. The FA couple would invest only $21,600 per year and their annual return would be 4% annually. They would accumulate $1,259,892. Assuming you could safely withdrawal 4% of your investments annually in retirement, the DIY couple would be able to draw $110,387/year to live in retirement. The FA couple could draw $50,396/ year in retirement. Remember all amounts are in 2015 dollars.
Taxes Upon Withdrawal
To be fair, the DIY couple has only deferred earnings on their accounts and so they would pay approximately $20,000/year in retirement in federal income tax lowering their take home amount to about $90,000/year versus about $50,000/year in retirement for the FA group. Still not too shabby to nearly double your retirement income without taking extra risk by simply minimizing your taxes and investment expenses.
[Editor's Note: Chris actually overstates the tax bill Actual federal income tax on $110K taxable income (not yet taking SS) for a couple with $20K in exemptions/deductions (basically standard deduction/exemptions) is:
- First $20K= $0
- Next $18,450= $1,845
- Next $56,450= $8,468
- Last $15,487= $3,872
- Total = $14,184
Plus, it's not like there is no tax cost for that taxable account. Some of it is basis, of course, but even if just half of that $50K represents earnings and dividends, that's still $3,780 in taxes. So after-tax, the difference would be $96,203 vs $46,616.]
Are Advisors Really This Bad?
-Can you really assume that a DIY investor could obtain equal returns to someone using a financial advisor? It just so happens that the low cost index funds we choose for our investments have a greater than 80% chance of outperforming an actively managed mutual fund investing in the same sector. Knowing that, I think a more accurate way to ask the question would be this: Could someone using a financial advisor, who has every incentive to sell the more expensive funds, possibly assume to be able to equal the returns of a knowledgeable DIYer? I would personally think not.
– Would a financial advisor really sell you investments and advice that costs you 2% or more of your portfolio annually when there are better investment vehicles costing .1% or less? Absolutely. It is how they are paid. This is why if you choose to use an advisor, you should never choose one who is paid through the sale of products or the amount of your assets under management unless you fully understand the conflicts of interest this produces and you are comfortable with accepting these conflicts.
-Would an advisor really advise you to pass on the obvious and tremendous tax advantages shown above? Ours did! This is the second layer to the conflict of interest. Most advisors are paid by selling you products and/or having your assets under their management. Because the greatest tax advantage available to most workers is to use work-related accounts, advisors have a great incentive to steer you away from these accounts and to products they can earn fees on. [I see this more frequently with cash value life insurance-ed.]
I again want to thank WCI for the opportunity to write this post on The White Coat Investor. I would imagine that there are 3 categories of readers on this site reading this post.
Which Type of Reader Are You?
To the first, this post is simply preaching to the choir and primarily reinforces things you already know. Congratulations if you fall into this category. I hope you keep learning and growing your wealth.
For the second, I hope I’ve piqued some interest in the financial independence/early retirement idea where we look at little inefficiencies in the system that allow you to develop a high savings rate and build wealth very quickly with minimal to no sacrifice of things of value. For you, I hope you’ll stop by our blog to read a bit further about our ideas.
Finally, I’m sure there is a third group of WCI readers that despite reading this guest post still feels that you need to hire a financial advisor because investing is too complicated, too scary or takes too much time. You are high wage earners with disposable income that you are willing to put at risk without even knowing the rules of the game you’re playing. To those in this last group, I’d love if you would reach out to me personally. I’m organizing a poker game and you’re exactly the type of person I’d love to invite!
[Editor's Note: Fee-only advisors reading this will correctly point out that Chris has set up a bit of a straw man here that makes advisors look particularly bad. He's taken the worst type of “advisor” (I usually just call them mutual fund or insurance salesmen) and pointed out how detrimental to your portfolio they can be. Of course, to Chris's credit, the vast majority of those who call themselves “financial advisors” are exactly as he describes and many of us have shared his experience in interacting with them. Even when working with a competent, low-cost advisor (and it's amazing how hard it is to find that combination) the effect of advisory costs on your returns is very real when compared to you investing the exact same way on your own. However, in order to gain that advantage, you must be capable of investing the exact same way on your own. If you are not, due to lack of education or temperament, you either need to rapidly become so through Continuing Financial Education, or hire a competent, low-cost, fee-only advisor.]
What do you think? Have you felt like a sucker when interacting with a financial professional? Have you been sold loaded, high ER mutual funds or inappropriate cash value life insurance? Is Chris too hard or too soft on advisors? Comment below!
FYI, I 100% agree that there are some outstanding low cost, fee only advisors out there. However, the fee only advisors will give sticker shock when you see what you are actually paying for advice instead of paying hidden fees that are overlooked. This includes actively managed funds with high expense ratios which include 12b-1 fees (kickbacks), variable annuities, whole life products, etc.
This is why fee-only advisors are the exception rather than the rule in the industry and must be sought out carefully. It is a much tougher business model for them to make a living selling advice at face value rather than selling products with hidden fees to unsuspecting consumers.
You also still must educate yourself as fee-only doesn’t guarantee a good advisor who is a fit for your needs. Once you start learning, you may realize (as we did) that it is as hard or harder to find a good advisor than it is to do it yourself.
It’s especially tough if you’re doing it on an hourly basis instead of AUM basis. People are simply willing to pay more when they don’t actually total up what they’re paying, whether it’s commissions or AUM fees.
Started off nicely but then went downhill from there. Your sample scenario illustrates you don’t really understand the “typical young readers of this blog”. Overall, meh.
Group 1, not inspired to visit your blog.
No worries. Different strokes for different folks.
I admit I am not a “typical” reader of WCI in that we never cracked $200K/year earned income combined. I may have missed my mark on my assumptions of average income of readers in the post (and also debt.). I however am a regular reader and while some posts are not relevant to me and I skip after seeing the title or the first few lines I have learned a lot here from other posts and reading the comments.
Likewise, I would think there is much to be learned by most here from my blog on how to live a satisfying life while building wealth quickly, especially since we’ve been able to do it with much less income.
Cheers!
Chris
Chris don’t listen to this guy. I thought your concept was right on, even if the numbers may be off for some folks. Thanks for your post.
We can relate to this post and sentiment against FA’s. Our “fee-only, DFA fund touting” advisor (who we thankfully fired before we even got started), wanted us to pay him a minimum of 2.5K a quarter (10K a year) when all we had in savings were a combined total of 150K, including our work 403b accounts. He advised against using the 403B but to instead put the money in a taxable account managed by him. Luckily for us we had starting reading the WCI at the same time (found the WCI blog accidentally when looking for ways for doctors to reduce taxes on the web). This led us to fire our FP once we realized the trash he was peddling us and we could not be happier becoming DIYers and have Jim and his blog for literally saving our lives…
Oh come on. I save lives occasionally, but I only saved you $10K a year….compounded at 5% real for 60 years. That’s only $3.7M, hardly a life. 🙂
Jim, now that you are not that “frugal” 3.5 Mil is chump change! 🙂 (which btw is my goal for the next 15 years)
In all seriousness, you did!! We were in the “consumer-sucks lifestyle” and grew into our income so quickly because as a physician family – that is what you do! In 3 years we tripled our income (attending incomes) and yet we were living paycheck to paycheck, saddled with consumer debt (all self inflicted), car loans and such… In February last year, we had had enough and I couldn’t make sense of it… I just kept thinking – oh god, I need to earn more money. My health suffered My Wife and me were arguing/fighting about money all the time and I barely recognized who I was. We got saddled with a tax bill of 20K (for 2013) and I am ashamed to say that I had a panic attack because I had no money in the bank to pay it…
I then went online to figure out how doctors can reduce their taxes and stumbled on the WCI blog – at first I though that Jim was a “Wall Street” Financial advisor selling some sort of investments to doctors… And then over the months I started reading, bought the book and slowly developed the confidence to make a budget and stick to it, paid off all our loans (except for the mortgage), starting writing up and implementing our own investment plan (Jim even reviewed it for us!) and life just seems so mush better nowadays.
I am not worried nearly as much, am excited to see my net worth (which was negative last year) grow, feel so much more satisfied with how our lives have improved and my health is getting better again. So it not an exaggeration that you did play a huge part in literally saving our lives! We cannot thank you enough.
Life is just so much better!
You bring a tear to my eye. Or maybe it’s the methed out lady down the hall fighting the security guard.
🙂
Well said and preaching to the choir I have promoted this for yrs to my colleagues at DENTALTOWN, where the dental community meets, probably 200k members worldwide.
THE KEY IS SELF EDUCATION. A fifth grader can learn to invest in stocks and bonds as well as any doc.
Even if you use a fee based honest advisor, you need to know the FACTS
GREAT POST!!!!!!!!!!!!!!!
Great post. Having been the sucker, I think it is also helpful to emphasize the feeling of satisfaction when you take control of your own finances. Most physicians are control freaks at heart, and while this can, in some respects, make it harder to be a passive investor, it is also tremendously gratifying.
the comparison is not right in that he is comparing a ret plan account to a personal account-BIG DIFFERENCE
Most would pay state income taxes as well on their ret plan distributions
It is hard to cover every contingency such as differences in state income taxes, whether the person is receiving SS or other income, etc in a general example as I was trying to build. I tried to be as conservative as possible in my estimates on taxes as WCI pointed out b/c I don’t want to embelish a case that I feel is damning enough. I also underestimated the impact of investing in active funds in taxable accounts. John Bogle would estimate that at closer to 2%/year.
Depending on the argument you are trying to make you could say that I am building a “straw man” or you you could say that I am being TOO conservative. Regardles, the take home point is that you have to educate yourself and to not do so would be a very expensive mistake. I think that is fairly indisputable.
Nice article. I am a DIY and agree with the overall sentiment of the article, but I am glad that WCI pointed out the straw man he set up as that was going through my head the entire time I was reading. While advisors like that are an unfortunate reality for many, I think there are some good advisors out there too. But it is important to be aware of the impact that even a 1% fee to a fee only advisor can have over an investing lifetime. I feel like I have a good handle on maintaining a high savings rate, maximizing tax advantaged accounts, and building a diversified, low cost portfolio so having that fee siphoned off of my net worth year after year just doesn’t make sense for me. I do anticipate sitting down with an advisor on a fee for service or hourly basis once I am into my 50’s to get a clear idea of the best ways to transition into an early retirement, if that’s still my goal at that point. I will be more than happy to pay up for good advice when that time comes.
transition into retirement=research marginal utility of wealth
I think the WCI got suckered into providing free publicity for this guy’s unvisited blog–check out the scads of posts with 0 comments.
I think everyone agrees that advisers that would steer one away from tax-deferred investments to high fee taxable accounts are worthless. No contention there.
Lots of blogs have zero comments on most articles. Most don’t have 350,000 people stopping by every month. Free publicity? Of course. That’s what most guest posters want. My hope is that they provide readers some useful content at the same time as they get the free publicity. If the content isn’t useful, I’m confident I’ll hear about it right here in the comments section! (Thanks for the feedback!)
Sorry, no suckering involved.
I am new to blogging and submitted to Jim b/c I am a regular reader to his blog and felt I had something to share.
I openly admit I submitted the post to get some publicity and drive some traffic to my blog. I openly thanked Jim in the post for the opportunity to do so. He had nothing to gain by featuring me, and quite frankly I have nothing to gain other than personal satisfaction of helping others. If you checked my blog, you may notice that I do nothing to monetize except have an Amazon affiliate link earning about $.25/book for sales driven by my reviews. It’s not exactly a get rich quick scheme!
I did enjoy reading your blog today – have a few cousins that live/lived the dirtbag lifestyle and it brought back some good memories of our trips to Banff! Don’t worry about all the negativity… For a lot of beginners, your blog is a great resource.
Thanks for the positive feedback!
I know my lifestyle which by some is considered “extreme frugality” is not for everyone. If I can inspire even a few people to educate themselves on the basics of personal finance and escape the mainstream thinking sold to us by advertisers, I would find it very satisfying. If they want to become “dirtbags” in the process, well I could always use people to ski and climb with during the week. Everyone else is working;)
I hope you’re not buying those expensive SLCDs, dirtbag. No cams for you.
Bogle compares portfolios with a 2% difference over 40 yrs and calls it the TYRANNY OF COMPOUNDING
It’s shocking when you see the results. Read his books
Excellent post. Makes me wonder why more in the financial advisor realm reading this post hasn’t tried to hang their own shingle by marketing solely to physicians with an emphasis on:
– high value term life
– disability (thank you Lawrence Keller!)
– assistance in doctor mortgages and perhaps even auto/homeowners products for drs (who I bet are safer insuree’s)
– 401K and/or IRA’s using vanguard or similar funds.
Different licenses to do insurance, mortgages, and investment advice.
I want to hear about your boat! I am with you on that one.
I’m sure it’ll show up in some pics this summer!
My wife’s school let them meet with “financial advisers” who work for Northwestern Mutual (NM). They said they were “free” during residency. Tried to sell my wife individual disability policy only from NM without shopping rates. My wife told them she wanted Term Life and they tried to sell her Whole Life. The worst part of it… the financial aid office received your book a few months ago and still allowed NM to pitch to students using school email blast. Ugh. Also heard of a resident in a military program looking to buy a 500k house because “that’s the cheapest available in the area”. Ugh. This will only get worse, won’t it?
don’t hate on this dude so much, it’s a very reasonable post with some gems.
the top gem to me is that i really don’t think you have your armor fully on as a young professional high earner unless you realize just how unscrupulous some of these financial planners can be.
they all have the same spiel, come to your house, make things sound confusing, tell you about your “3 buckets.”
the other thing to know about going it alone is that you have to be careful talking to your colleagues about it. i’ve found that many of my older partners are pretty aggressive sometimes nearly insisting i talk to their “guy” (always a guy isn’t it?). when i say something like “oh thanks but i sort of manage my own stuff” i’ve had 2 fellow docs really climb my tree, basically insinuating that i was a young (true) arrogant (probably true) pup (not true) who didn’t know what he was doing (not true).
This is so similar to how my senior collegues have been treating me – “go meet my banker” “go see my guy”
And I always politely decline and they think that I am so foolish…
You are insulting their masculinity or something like that when you refuse their advice, or worse yet imply that they are suckers or your advisor/yourself is better than what they use.
My experience has been mixed. One hand has been Edward Jones guy who sold me a huge life insurance policy, on the other hand has been a better firm that mainly does index investing for 1.25% AUM of my portfolio. Finally WCI gave me enough courage to just do everything on my own and start believing in myself and start questioning FAs or as they call themselves wealth advisers.
I’ve got a post coming up about my two least favorite ways to pay advisers. None of it will be new to you.
As investment professionals, I believe it is our responsibility to give sound investment advice at all times. Yes a lot of “professionals” do not do what is in their clients’ best interest. They may not even know, nor are they qualified to be Financial Advisers. It is however disingenuous of you to create such a silly and extreme example that is not reflective of what mostly happens in real life to make your case. While your scenario is possible, it is improbable. You may be providing a good service, but when you use these improbable scenarios it takes away from your credibility. A lot of professionals are committed to transparency and educating their clients. They also expect to be paid for providing professional services, just like Doctors, Lawyers, Engineers, Pharmacists, etc. We are not for everyone, nor are we interested in everyone, BUT, EXPERTISE MATTERS, EXPERIENCE MATTERS. I see a lot of DIYers who do it totally wrong and we end up saving them from themselves. I also see A LOT of people who have “Financial Advisers” who are abused and taken advantage of, and given BAD ADVICE. I advocate and am committed to EDUCATION, TRANSPARENCY AND BEST PRACTICES – Putting the client first. I believe as Zig Ziggler said, that “You can get anything in life that you want, as long as you help enough other people get what they want”. There are definitely more good advisers out there than bad. My caution is “Trust But Verify”, get more than one opinion, if you talk to more than one adviser, their counsel should be reasonably consistent if given the same scenario. Disqualify anyone whose solution is 100% Insurance products -Fixed Index Annuities, or who recommends some form of Life Insurance product as the solution for all scenarios. They are most likely unqualified. While these products have their place in giving sound advice, they should typically be part of a comprehensive financial, risk management solution and plan. We have seen people use life insurance for College Planning for their kids, WOW! REALLY? Qualifications matter, experience matters. Good luck readers, don’t be “Penny Wise and Pound Foolish”, but don’t be a sucker either. Trust your instincts, get some education and use common sense. We work with a lot of Doctors and others, my wife is a Doctor, we take their trust and confidence very seriously. Lets all win.
You sound like one of the good guys. I disagree that the “good guys” make up a majority in your field. I wish my observations were otherwise. The sort of experience outlined in this guest post is very similar to situations I hear about by email and comment multiple times a week. In my experience, it is the norm. I also wish it was otherwise. If it were, there would be no need for this website.
Blast from the past… Rereading this today I wanted to note a charming adviser we ran into early in our career, prior to reading WCI. (Was WCI even born yet then? Certainly not in med school yet!) He advised we sell all our current mutual funds and Keo (401K) type funds and put it into his company. He’d charge us only 1% per year. I was looking over the math as I sorted out how to turn our third million$ or so into 4 million over the next many years with his help, when I realised he hadn’t even counted on all the taxes we would immediately deduct from our 1/3 million to transfer it into his care. Aside from thinking the fee was too high, I discussed with husband that he is less competent than me alone since he had neglected to consider that immediate $30-60K drop in the amount we’d have to invest with him. We were just lucky not to have made that mistake. Also we bypassed whole life insurance thanks to Andrew Tobias’s little book The Only Investment Guide You’ll Ever Need. If only we’d known to go into EM or some other speialty paying >> FP…
Fee-only is certainly better but isn’t a panacea, unfortunately. AUM can be fee-only. Too large monthly/quarterly fee payments as well. Trying to find someone to be a second pair of eyes to ensure you’re not messing up deferred comp, draw downs, SS, insurance (including LTC), and RMDs is ridiculously expensive. With hourly rates in the $200 – $300 range, even for CFPs with less than 15 years of experience (lot of nerve), DIY is the way to go. Find someone you can pay for a couple of hours every year to validate your planning and do it yourself. Also consider doing what I’m going to do and pay to take a CFP course. Will be 1/10 the cost of what these AUM clowns would charge me for 1 year of fees.
This industry reminds me of the legal field where the only ones who win lawsuits are the lawyers.