Never Hire a Financial Advisor Says Richest Investor

If you’re struggling to generate the returns you hope for and considering a financial advisor, we’ve got some news for you. The world’s smartest investor has discussed many times in the past the dangers of hiring so-called professionals to manage money.

But why is he so against paying a small percentage to a licensed professional? After all, if you needed help with a legal contract you wouldn’t think twice about hiring a lawyer, why is paying for the services of a financial professional so different?

Key Points

• The math of money management doesn’t add up for clients but it makes a lot of sense for financial advisors.
• While annual fees are deceptively small on any given year, they add up to a massive number over the long-term.
• Instead of paying a fortune in costs, whether management fees or expense ratios, consider a low-cost approach as Buffett recommends.

The Math Doesn’t Add Up

Simply put, the math of money management doesn’t add up. And when we say it doesn’t add up, we mean for clients. For money managers it makes a lot of sense.

Take a portfolio that is subjected to 2% fees annually and extrapolate over 40 years, it doesn’t take a genius to crunch the numbers and conclude that 80% of the originally invested principal will be swept away in fees.

But is 2% reasonable? Or is a smaller number more realistic?

When the ordinary Jane Investor walks into a financial advisor’s office they usually won’t be quoted a fee of 2%, but rather a smaller management fee to the advisor of maybe 1%. So how do we arrive at the 2% figure quoted above?

What isn’t so obvious is that when money is invested another fee is charged, the one by the mutual fund, the frequently preferred investment vehicle of advisors. These mutual funds often have higher fees than those charged by exchange-traded funds and can be around 1% too.

So the client incurs two fees, a financial advisor fee and a fund fee for a total cost of around 2%. On any given year these numbers don’t seem too large but over a long period of time they can stack up to erode portfolio value in a very material way.

What Does Buffett Recommend?

Buffett’s gripe with financial advisors is that they pitch a service which they cannot deliver, that being superior market performance.  He understands that the S&P 500 is a little bit like a competition where only the fittest survive. If the laggards stop performing, they are tossed out and other enterprises that are more robust get added.

Portfolio managers in aggregate are compensated and incentivized to beat the market but history shows most fail. So if the professionals can’t beat the average, Buffett suggests simply riding its coattails. Or in other words, if you can’t beat it, join it.

And among the best vehicles to do so is the Vanguard S&P 500 exchange-traded fund with ticker symbol VOO because it has a tiny expense ratio of just 0.03%.

As the weak companies get pruned, the index does all the work for the investor by replacing them with stronger companies. So ordinary investors don’t have to the homework of finding stocks and weeding out the poor ones. Or in Buffett’s words, paradoxically when the “dumb” investor realizes they are “dumb” they become smart by remaining passive and riding the coattails of the broader index.

The bottom line is, according to the most successful investor of all time, if a passive approach to investing appeals to you then instead of paying financial advisors consider simply investing in a low-cost S&P 500 exchange traded fund.