Financial Utopia Without Financial Advisers

In one version of Financial Utopia, financial advice is a public good. Advice is free. And it works. No one needs to worry about tax optimisation, or interest rates, or the best broker to use, because advisers take care of all that boring stuff for you. Learning about personal finance and investing is unnecessary.

Unfortunately, financial advice is about 427th on the list of things that it would be nice to be provided for “free” by the government. So barring some type of communist revolution, and even then – communists aren’t a huge fan of finance, this utopian scenario is out of the question.

We have to make do with what we have today, which is this: financial advice is not free and it’s not always good. This means that it’s better to manage your finances yourself. There are only a few niche scenarios in which this is not true.

Sorry Advisers

Pounds and pennies

The most obvious reason for this is the cost; professional financial advice received from an accredited adviser isn’t free. Whether this is in the form of a % of AUM or some fixed £££, advisers expect to be compensated for the job of managing your capital. This compensation is a drag on your returns. And because of the long time horizon over which we are playing, and the effects of compounding, this drag ends up having a significant impact on your portfolio balance.

The gang gives financial advice

And it’s not just up-front, in-your-face financial costs. Financial advisers are subject to the same group-think that all industries are guilty of. If you want to fit it, get hired, get ahead, it’s useful if your ideas mirror those of your contemporaries. This leads to industry-wide ways of thinking.

This thinking is often flawed.

Many recommend whatever the hot new thing is that will grow your portfolio; advisers want to implement new methods and use the latest academic research. Modern Portfolio Theory, Risk Tolerance, LifeCycle Funds, Risk Parity, etc. etc. etc. have all been in vogue at some point.

On the other hand, the financial advice you receive is also heavily dependent on who is distributing it. Advisers tend to recommend actions that are 1) reflective of their own personal attitudes to risk, asset classes, and life and 2) similar to recommendations given to other clients. These clients and these advisers may be in completely different financial situations to you. Advisers are restricted in what they can do, psychologically and otherwise, so what they recommend might not be right for you.

Incentives matter

“Show me the incentives, and I will show you the outcome.”

Charlie Munger

Advisers are incentivised to obtain and retain clients. One of the best ways to do that, particularly early on, is to increase returns. Imagine playing golf with your quasi-friend Harold as he persistently brags throughout holes 4-16 about how his adviser generated him 15% returns last year (and in the clubhouse, too). You will inevitably start questioning your choice in adviser. Advisers know this – as much as they explain their “long-term plan” to us, it’s difficult to ignore higher returns being enjoyed elsewhere. 

It’s not a problem for your adviser to try and generate returns. That’s their job. What is a problem is advisers taking on added risk to try and meet overly-ambitious goals or simply retain a client. They often end up chasing returns.

Advisers can also be incentivised to invest in specific funds. Although this isn’t a problem in the UK anymore, in other geographies advisers receive commission from funds they “recommend”. It should be obvious how this can result in “recommendations” that are not necessarily in the best interests of the client (AKA Y.O.U). And disclosures of this conflict of interest don’t seem to solve the problem.

Faking It

No desire

When most people start to see some GBP accumulate in their account, they don’t know what to do with it.

These people – it sounds like I’m sneering at them but I would like to take this opportunity to let the reader know that I don’t consider “these people” to be second-class citizens – have 0 interest in personal finance and investing. They apparently have better things to do with their respective lives. What could be better than thinking about tax efficiency and reading about bonds?! Lots of things, apparently.

These people cite the eye-watering dullness of finance as their reason for handing the financial batton to a professional. I get it. I get the fact that finance is boring. But what I don’t get is the eagerness to put your financial life in the hands of someone else. Blindly. Well, in some cases it’s not actually blind – you can use the eyes of others. Going to a trusted adviser, who has a successful track record, isn’t the most idiotic thing to do with your money.

But that would still make me feel a little uncomfortable. Maybe this is a psychological defect rearing its ugly head here, but I can’t quite bring myself to trust someone to that extent. To the extent at which I don’t know what they are doing with my finances. Where their incentives aren’t perfectly aligned with mine and they can’t possibly care as much as I do.

No time

This is why I think everyone needs to do research. And this is where the arguments presented by those who blindly trust advisers fall apart. Because the amount of research required to determine if your money is in good hands or not is roughly equivalent to the amount required to learn how to implement a good personal finance and investing strategy yourself.

To understand what’s going on, what the fuck your financial adviser is talking about, if what he (ok, calm down, or she) is proposing is a good strategy, you need to pretty much evoke all of basic personal finance and investing knowledge.

Example:

“So Harold, we’re going to allocate 10% of your portfolio to a global index tracker.”

What’s a global index tracker? A collection of stocks from around the world. What’s a stock? It represents equity in a business. Why would I own that? Dividends and capital gains. What…why…how…when…

This continues for a while. And this line of enquiry needs to be applied to each sentence that comes out of your adviser’s mouth. It’s hard to abstract many of the concepts without losing proper understanding.

And once you have this knowledge inside your brain, you may as well implement it yourself, to avoid the downsides of using an adviser listed above. So those who claim “I don’t have time to do my own personal finance, so I’ll just use a financial adviser.” aren’t thinking clearly. What they actually mean is that they don’t have time to do the required research for either selecting an adviser or doing it themselves. They accept the fact that their finances might be crap, because they quote “don’t have enough time”.

No control

Or they might claim that they need someone else to handle their finances because they have no control over them. This is a fair point. Some will simply spend all the money in their account or invest in every new fad in which others have been successful. I had an acquaintance at uni who would gamble the entirety of his student loan stipend the day it landed in his account.

These are evolutionary-trained actions (seeking instant gratification, short-termism, FOMO, etc.), which people try to avoid by relinquishing control of their finances.

My issue with this approach – outsourcing your finances to avoid disastrous spending – is that this leaves you exposed to the problems of advisers. Would it not be better to learn how to avoid these traps? To do the work required to mitigate these temptations? To self-impose limits and restrictions so that you can’t behave in such a way?

The Real Deal

The rule of 3

There are 3 scenarios in which you may need the help of a financial adviser:

  1. Approaching retirement/old age. This situation is very important to manage correctly, and can be confusing. You (should) also have sufficient capital to justify enlisting the help of a professional, especially when you start to make a plan for when you pass away.
  2. High net worth. Again, it is much easier to justify using a financial adviser when you have finances that need to be advised on. At a certain level of asset value and diversity, managing everything yourself becomes too difficult. You probably need help.
  3. Complex financial situation. Finance can get messy. There are times in which the situation is so messy that you need a professional to provide some clarity.

Advisers are good at details. They know how to minimise your taxes and which savings account will give the best interest rate at any given time. Hence, they can be useful when the situation is complicated and the details matter.

Utopia revisited

Does everyone need a financial adviser?

It’s like asking if everyone needs a personal trainer? Does everyone need a professional nutritionist? Does everyone need a professional to help with every part of their life?

Sort of.

Most people don’t have a fucking clue about most things. A good professional would certainly do better than your average uninformed civilian.

But the scenario in which everyone has this professional support is impossible. There are simply not enough good professionals to go around. We might be able to get kind of close due to the approximately 0 cost of distribution of information. The best whatever can now share their knowledge with everyone at very little cost. So we should theoretically arrive at a point in which the best teachers are teaching essentially everyone.

However, this teaching cannot be personalised. These teachers can give us principles, maybe even strategies, and some examples. What they can’t give is the care and attention and the specific implementation of this knowledge to our particular situation. Advice distributed in this way will never be sufficient.

A real, tangible, possible Utopia is one in which everyone has the basic level of financial education and desire required to manage their own finances. Because once you know what to do, the implementation is easy. It’s the what that’s hard.

But this what can be determined by research and thinking and data and life (and this blog). With this what in hand, well-informed, enthusiastic individuals managing their own finances will do as well as financial advisers.