Books and common sense
Saturday, March 17, 2007
I’m changing my mind about hiring a financial advisor. Dave and I met with him on Wednesday for a couple hours for him to present our personalized financial plan, along with his recommendations. The data part was interesting, especially finding out that together we have a negative net worth.
But when it came to the “recommendations,” I started getting suspicious. He had picked several products in order for us to divert our monthly disposable/discretionary income and put it to better use. I agree that we need to invest whatever extra income we have, but as soon as I saw the front-end load fee of 5.75 percent on the mutual fund he was suggesting, a red light went off in my mind (thanks to Kevin for warning me). That didn’t even include the maintenance fee of 2 percent charged annually by the mutual fund company, and I’m sure there are hidden costs too.
Moreover, he was recommending whole life insurance. Luckily I had read a book that explained the difference between term insurance and permanent insurance. Whole life insurance is about five times more expensive than term because you’re buying both insurance and a savings account (basically money market which earns 3-5 percent returns). He said term insurance is bad because, while cheap, it gets exponentially more expensive when you hit age 60 or so. With permanent insurance, you lock in whatever price applies to you at the age you sign up. In our case, our premiums would be around $150 each since we’re young and healthy. “You’re not getting any younger,” he said.
But all the books I’ve read say don’t get permanent insurance because you shouldn’t mix insurance and investing. And I had dinner with a very financially minded friend who owns term insurance. She said when you’re close to retirement age, you can either afford the higher term premium or you won’t need life insurance at all. Our advisor never said you might not need life insurance if you’re financially independent and have your financial affairs in order. So that is one big strike against him.
We spent a while at the meeting grilling him about the commission-based nature of all the products he was recommending. “How do we know you don’t have a conflict of interest?” we asked. His answer was that he wants a long term relationship with us and he doesn’t work for free. Well, there are other pricing structures such as an hourly rate or annual percentage of our portfolio, but he didn’t mention that.
We almost signed up for his recommendations because we felt overwhelmed by all the planning we have yet to do, and we want an expert to handle it so we have more time to do other things. We should not spend too much time researching and obsessing over our finances. But something in my conscience or whatever made me hesitate, so we ended up asking the financial advisor for more time. He set us for an appointment next weekend. (Smart.)
I am so glad we didn’t sign up, because we would have been doing so out of fear and convenience, and because I started reading (devouring, really) The Bogleheads’ Guide to Investing (thanks to Kevin again for that one). This book is excellent. It’s written by people who don’t work for the financial industry and don’t have a vested interest in taking your money. The biggest lesson I’ve learned so far is that the life principles that generally hold true do not apply to investing. E.g. in life, you get what you pay for, it’s good to listen to an expert, go with your gut… but the complete opposite is what will ensure success in investing. Another lesson is that the financial industry doesn’t want the public to know the truth about investing – that it is really simple, and that nobody can beat the stock market.
This weekend my goal is to look into buying Vanguard index funds and figuring out how much we can afford to put in per month. I think there’s a $3000 minimum, so we might have to save up for that.
So much to learn!!!!!!!!!!
Congratulations on stepping away from the financial advisor. It’s something a lot of people can’t muster up the strength to do. I was in the same position as you (my parents didn’t teach me much about finance either) and I know that it’s difficult to not take the easy way out. Actually, it was kind of painful reading about you going to a financial planner.
And, just as a reassurance, from what I’ve read here your financial advisor was trying to swindle you and you did the right thing by telling him to take a hike. You’ll do much better managing your money yourself simply by matching the market with a diversified portfolio of index funds. Best of all, you’ll only end up paying a meager 0.2 to 0.3% per year without any absurd front-end / back-end loads, high expense ratios, and annual fees that most financial advisors will put you in and still beat out 80% of the mutual funds year after year. Investing for your future isn’t difficult, the people on Wall Street simply want you to believe so. So again, congrats. Walking away from that thief will be one of the best decisions you’ll ever make.
Btw, go to http://www.diehardsforum.org. You can talk to the authors of the Boglehead’s Guide to Investing as well as a bunch of other very intelligent individuals who can help you with any questions you may have.
P.S. For low balances, go with the target retirement funds. They’ll divserify your portfolio by giving you a piece of the total U.S., international, and bond markets without having to put in a ton of money. Just make sure you keep it in a tax sheltered account since the distributions from the bond portions are taxed if you keep them in a taxable account.
Hey. Good choice not making a decision in the heat of emotion. I honestly think that everything you’re researching really sets you up to figure things out yourself in the long run—including making your own investments. Sucks it takes so much time to do right? There are things that are more important than spending time on money… like LIVING!
But in a perverse way I do like investing… my 401(k) before I cashed it all out was making like 13% a year, I think above the regular rate. I know everyone says to forget you have that money and never touch it but it was totally worth cashing out.
Kevin – Thanks for the encouragement! What mutual funds do you and/or Linda have? All Vanguard? I need to read up more about non-tax-sheltered mutual funds (which is anything but a 401(k), right?) so I can figure out which ones to invest in. If they’re supposed to be long term, I’m guessing there are penalties for withdrawing etc.
M – Well, the things that are really worth it in life always take hard work, right? =P Didn’t you have to pay a penalty for cashing out your 401(k) early?
We use all Vanguard just to keep it simple. Basically a mix of total stock market, total international, and total bond based on our age. Tax sheltered accounts include IRAs, Roth IRAs, 401(K), college savings plans, etc. Once you finish the book, go to the diehards forum and post any other questions you have. You’ll get much better responses than I can offer. And yes, there are usually penalties for withdrawing money from a tax sheltered account. There are exceptions (1st time house payment, higher education, etc) though. Make sure you get all your quesitons answered before you invest. Otherwise you may end up commited to a tax unfriendly fund in a non-tax sheltered account.
Yeah, I paid a penalty of sorts, but it balanced out because my stock picks were pretty good (I picked the risky ones that made good bucks and cashed out while it was high), and the penalty was a bit less than the interest I had made; so it was like I had a savings account with some interest.
Honestly, the hardest work in life is relationships for me and keeping consistently in touch because that is the <span class="caps">EASIEST</span> thing to lose track of. Thank goodness for blogs, right?
The other hardest work is finding personal time for leisure and hobbies when employment gets in the way and maintaining a free spirit which quotidien job annoyances and the workload can so easily crush.
Having a financial planner is good because that’s less work you may have to do. If you go with one, I hope you find the right one… I get the sense this guy isn’t it.
“Having a financial planner is good because that’s less work you may have to do.”
I have to disagree here. Having a financial planner is almost never worth it. Unless your portfolio is extremely complicated (e.g. you own lots of real estate, corporations, etc) you should avoid these leeches at all cost. Simply put: the vast majority of them will happily suck you dry and spit you out without blinking an eye. That’s simply the nature of their business. The money they make off of your success is negligable compared to the money they receive from the active mutual funds they’re paid to unload on uneducated, scared, lazy investors. Bottom line: they’re not in the industry to help you, they make their money by scamming you. They’re not necessarily evil people, but the simple fact of the matter is that financial advisors have families to feed too and if their well being depends on your loss , you can bet the house that they’ll do it.
As for financial planners making your life easier? Investing is as easy or as complicated as you want to make it for yourself. If you want to wheel and deal, shorting stocks and actively trading with the big boys on Wall Street, then yes, you’re going to need commit a <span class="caps">LOT</span> of your time. However, if you’re like most knowledgeable investors that don’t work on Wall Street and go with a simple index-fund based strategy, you’ll probably spend maybe 30 minutes each year on your portfolio (end of the year rebalancing so your asset allocation doesn’t get out of whack). And what do you get for your trouble? You don’t have to put your money in the hands of someone taking 5-10% of your hard-earned money for his, and the mutual fund industry’s, pocket. Compound the difference in return over the course of 30 years and you’re talking a difference of hundreds of thousands of dollars which you can use to retire earlier, more comfortably, and most importantly contribute back to society.
Learning about finances may be the single most important thing you do in your post-college career. It boggles my mind why people are so nonchalant about it when money is such an integral part of how we live our lives. Money doesn’t buy you happiness, but it takes a huge burden off of you so you can worry about living your life instead of how to pay your bills. There’s a reason why you see some people retired at 50 free to travel the world, watch their grandchildren grow, and contributing back to society while others are stuck working 9-5 for the next 20 years.
M – I don’t know anything about you or your financial situation so if I’m wrong about my assumptions you can throw this comment about the window: taking the penalty on the 401(k) is almost never worth it. Your 401(k) is a vehicle for your retirement. It’s not a savings account for normal expenditures, it’s there so that you don’t have to work for the rest of your life. If you want a savings account, get a savings accounts or a money market fund. From the way you put it, it sounds like you guessed on your 401(k) picks, stuck with them for a couple years, happened to get lucky and cashed out. My guess is that you probably invested somewhere around 2002 at the bottom of the bear market and happened to go with a small-cap fund that did well. The penalty you paid on the 401(k) early distribution was 10%, which basically meant all those years netted you a gain of 3%, which is actually lower than the interest rate on a savings account. Not only that, but you did so with a drastically increased risk (you could have lost 13% just as easily, whereas a savings account at most financial institutions is either <span class="caps">FDIC</span> insured or backed by treasuries) and cashed out money that can never be put back again. There are caps on how much you can invest each given year into a tax-sheltered account like a 401(k). Now that those years are gone and the money is out of the 401(k), you can’t go back and put the money in. I say all this with all due respect because I know how daunting the investing world can be. But I highly suggest you read up on some introductory investing books before you jeopardize your future financial welfare. Even if you’re filthy rich it’s still never a good idea to throw money out the window. It’s a one-time cost and it will benefit you for the rest of your life.
<span class="caps">FYI</span>, with the money I cashed out, I did volunteer work in Thailand and backpacked mainland Southeast Asia, Thailand, Laos, Cambodia, and Vietnam over six months in 2005.
I gained a deep appreciation of Southeast Asian cultures, saw some of the most amazing cultural heritage sites in the world, ate some damn good food, including the best French baguettes and steaks in Vietnam. I suffered some culture shocks but my cultural knowledge and openness to differences has deepened and I like to think I have a more nuanced understanding human nature in general as a result of that. I’ve also seen some of the worst poverty that exists in this world, and from that I am motivated to continue working in the field of human rights and international relations.
I’ve been doing French immersion in Montpellier France for the last six months. Besides gaining a language, I’ve made friends from Sweden, Spain, and Japan and French is the common language for us. Who would have known that that my soul-sister is Swedish if I hadn’t ventured from the States? I think that is absolutely amazing.
There are intangible spiritual and personal benefits from all of my experiences that I will carry with me throughout my life. I went through a change in values in some ways (in re money and work) and affirmed some of my fundamental values. My head cleared up a bit in stepping out of the United States and its quotidien banalities, workplace wear, and money obsession.
So don’t worry, I didn’t throw the money away, I invested in myself instead. I’m pretty optimistic about my financial future not because I come from a rich family but because I know the mechanical things need to be done for financial security. What I got out of it was more immediate and worth more than the $6k I cashed out.
btw, this is why I extremely dislike U.S. capitalism and the system of social support (or lack thereof). Since we’re caged in American social structures, it’s necessary to be as obsessive as we are about finances and it’s fatiguing.
Personally I think personal finances and investing are fun (I’ve read and even suggested to Chan the book she’s reading on Couples Finishing Rich and I was a Motley Fool fan at some point) and saving is a good exercise in discipline. But I decided to do something deliberate (or reckless as some might characterize it) as a way of reacting against this money mentality which is special to the United States and hypercapitalistic countries. It was an exercise in anti-discipline.
So what do you think of people who give up their riches to do good for the world like the Mother Theresas? Do you lack respect for them because they’re reckless or do you appreciate more that they can privilege values that come from the human spirit more than the material world?
I maintain I had a great financial advisor. He only charged me when he did my taxes and he saved me thousands of dollars the first year I was out of college. He also gave me advice for my plans of world travel before I went out. He said that it was not the best thing to do to cash out my 401k but he paused and thought about all of his senior friends who keep saying they keep meaning to do something with their lives and they drown in their misery of unfulfillment and regret. He thought world travel was an all right idea in the end.
That advice was free. I see the pay off now, too.
M – You’ve always been an unconventional person and fiercely independent, which I admire. I remember in high school when you gave me the 1995 Idiot’s Guide to Managing Money (which I still have but never read =P). That’s great that you weighed the cost and benefit and decided to go for your trip abroad. It definitely sounds like a life-altering and life-enriching experience.
I do think, at this point, that the majority of financial advisors are self-interested. Perhaps you got lucky with your advisor or just knew what questions to ask when deciding which advisor to go with. That’s awesome that he didn’t charge you (not even in commissions, I gather) and I wish that were the norm.
Also, I don’t think anyone who has commented on this blog is money-obsessed… The point of putting in some overhead hours learning what we should have been taught in school about finances is so that we don’t have to obsessed. I think that’s actually a realistic non-capitalistic approach to an inescapable problem.
M – We all have a social responsibility to give back to the world and I’m glad to see that you feel the same way. However, a financially risky and unsound decision made in order to fund a good cause is, unfortunately, still a financially risky and unsound decision. If you wanted to fund a volunteer trip to Southeast Asia, that’s great, but I would have recommended putting the money for the trip somewhere other than a high risk investment that automatically loses 10% when you withdraw it. This isn’t about being obsessed over money, it’s about being responsible enough so that you can actually see your goals through. If your 401(k) had dropped substantially during that time instead of going up (very likely given the fact that it was a high risk investment and a short time span) you might not have been able to fund your trip. You may not like the fact that so much of our lives revolve around our financial circumstances, but that doesn’t justify ignoring it and it certainly doesn’t justify encouraging others to ignore it. Simply put, most of us need money in order to accomplish the things we want to accomplish. This may not be the way we want it to be, but it’s the way it currently is.
As for the question regarding Mother Theresa, I’ll respond with one of my own: What do you think of the people who focus on their finances so that they can give back to the world? Do you lack respect for them because they’re unwilling to live a nomadic, impoverished life or do you appreciate them more because they can see that they will have a far greater impact on the world this way than they would otherwise?
I have a friend at Wharton and I completely think he’s awesome. He’s into business because he gets to use the skills he possesses well, and he’s concerned with taking care of his loved ones and can do a lot of good with what he donates. I’m just saying that we all have our different values and ways of living and it seemed like you had a mind set extremely one way.
I never thought I’d cash out my 401(k) in fact while I was working since I know what the “rule” is: pretend that money doesn’t exist until you’re retired blah blah. 25% of my investment was in a high risk account, 50% was in moderate to high risk accounts, and 25% was in “safe” accounts. I picked those options out myself by looking at balances sheets and charts of each account, rather than letting some quiz pick for me. I did pretty well putting in 20% of my income into the account every month for about two years. I’m happy, and have no regrets for retiring the account. Even as I am fully aware of what I lost.
Thanks for your deep concern; but please, don’t worry about my financial future. I’m content and my financial plan will be set in the next month as I figure out law schools, etc. Maybe we should get in touch again at 65 to see how we’re doing eh? I don’t think I’ll be retired by then, but it’s because I’ll be in a job I love and wont want to leave. Take care of yourself.
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