This is one of our most common questions. In a nutshell, it really comes down to overall costs and who is doing the work – The Advisor or the client. Some will argue that money is so complex, that it is well worth it to leave it to professionals, pay the cost for the service and leave it to them to manage. Fair enough.
Is money complicated? Well, it depends. It can be as easy or as complicated as you want it to be. We’re biased obviously, but we know that all it takes is 5th grade level math and someone motivated to learn with a good attitude. That’s a pretty low standard.
If you are looking for a totally hands off experience and want to leave the heavy lifting to someone else to get you to retirement, then you are looking for a Financial Advisor. On the other hand, if you are the hands on, independent type, want to do the work yourself and maximize your investments to earn the most money you can possibly earn, then you need a Financial Coach.
In this post I’m going to discuss the education/certification, pros and cons of using a Financial Advisor versus a Financial Coach.
EDUCATION & CERTIFICATIONS
The finance industry is extremely regulated. In order to be a Certified Financial Advisor, you can rest assured that these professionals must go through extensive training and schooling in order to earn the title of a Certified Financial Advisor. Since Financial Advisors are essentially doing the investing for you and advising you on where to put your money, they must hold numerous certifications to be able to do so. Due to all the regulations surrounding the management of your money, only Certified Financial Advisors are qualified to put their hands on your money.
The Financial Coach is a relatively new industry and doesn’t have a lot of the same education and certification requirements as that of Financial Advisors. As a matter of fact, financial coaches don’t require any type of certification to become one. There are various coaching certifications such as the International Coaching Federation (ICF) or the Accredited Financial Coach (AFC) that many coaches pursue, but they are not a requirement to be a coach. Financial Coaches cannot tell you what to invest your money in and they cannot manage assets for you. In fact, it is illegal. Financial Coaches specialize in the education aspect of finance management and capitalize on that. It is up to the client to take that education and put it into action to achieve the financial goals they want to achieve or not.
PROS
With Financial Advisors, it’s very hands off for the client. Basically, you come in to show the advisor your current financial picture, assess your goals for retirement, create a plan to get there and they execute it for you. They point you in the direction of investments, open up the accounts for you, you transfer over the money and they make all the investments for you aligning with your goals. You come in every year or so to get an update on how your portfolio is looking or call in and give updates to your life situation or give direction in which way you want to go. If that means you need to liquidate some of your assets to buy a house, pay off a debt or buy a boat – you tell them and they should execute.
With Financial Coaches, there’s typically an educational aspect to their services followed by hands on work for the client. Different finance coaches have varying aspects of finance they focus on. For example, some will focus on debt management, while others will focus on budgeting or a specific type of investing. At Fudog Finance, our focus is on the BASICS of money management (Doing a financial inventory, debt management, assessing where your money is held, building an intentional spending plan, investing and executing the plan). Think of a typical basketball coach at a basketball camp. They will do a block of instruction on dribbling the basketball, demonstrate it and then run you through drills to do it while supervising and cheering you on. Finance Coaches will do the same. The overall difference with the Financial Advisor and Coach is that the CLIENT will be doing most of the work versus the advisor.
CONS
Financial Advisors cost A LOT. Because they are doing the work for you, their first priority has to be to get compensated for their services. Many big firms will require the client to have at least $100,000 in assets in order to take you on.typical fees for a Financial Advisor can look like the following:
- Hourly Rates – $100-$300 per hour
- Creating a personalized Financial Plan – $1000-$3000
- Annual Retainer Fees – $2000-$7000 a year
- Fees for Assets under management – ~1%
If you were to talk with a cheap Financial Advisor for an hour to build you a financial plan, open retirement accounts and check in with you every 6 months, your costs would look like this. Hourly rate for one session and follow up session 6 months later = $200 + Creating a personalized Financial Plan = $1000 + Annual Retainer Fee = $1000 = $2200 right off the bat. This is on the low end of the scale. You haven’t even started investing yet.
But this isn’t all of the costs. If you’re just starting up, the Financial Advisor and its firm will push you to get started by setting up as many basic services as possible – ie. Checking and savings accounts, retirement brokerage accounts, debt management services (if needed), budgeting services (if needed), annuities, life insurance and mutual funds. Once you put in your initial investments to each of these services, there will be load fees and commission fees for the advisor. Again, this is all BEFORE you’ve started to truly invest to make that money grow.
When you do get started pushing money to invest, the fees continue. Each time you buy or sell an investment, Advisors can charge fees per transaction. “Churning” is a term used for the frequent buying and selling of assets in your portfolio for the benefit of the Account Managers. It is illegal, but sometimes have been disguised as “rebalancing your portfolio”. Actively managed mutual funds and annuities require professionals to manage so their expense ratios (over all cost) will be high. They are statistically doomed to underperform the performance of low cost index funds you can buy on your own.
If you’re following the costs above, the most costly one is the 1% of Assets Under Management. Not only do you get charged fees for every transaction made in your accounts, but the overall cost for everything the firm manages for you. This may be annuities, life insurance, a ROTH IRA, Checking, Savings Accounts, Mutual Funds, etc. 1% doesn’t sound like a lot until you begin to see how those fees compounded over time can hurt your retirement. Here’s an excerpt from an article at Nerd Wallet showing the effects of 1% in fees on a retirement portfolio:
“To examine the effect of fees on a millennial investor, we looked at different investing scenarios for a 25 year old who has $25,000 in a retirement account, adds $10,000 to the account every year, earns a 7% average annual return and plans to retire in 40 years.
- In one of the scenarios analyzed, paying just 1% in fees would cost a millennial more than $590,000 in sacrificed returns over 40 years of saving.
- A millennial with the option of investing in either of two commonly held funds can save $215,000 in fees – and, through the magic of compounding, retire nearly $533,000 richer – by choosing the one with fees that are .93% lower.
- By assembling a low-cost exchange-traded fund or ETF portfolio on his own and rebalancing it once a year, a millennial can retire $345,000 richer than if he uses a target-date mutual fund.
- Outsourcing portfolio management to a robo-advisor could be a less work intensive alternative to self-managing and less costly than a target-date mutual fund. In our scenario, using a robot-advisor would cost $232,000 in fees over 40 years, about half the $454,000 a target-date mutual fund would cost.”
Let’s put this in perspective. Based off the 4% rule for retirement withdrawals, 1% in fees can be a quarter of living expenses. Here’s how. If you saved $1 million for retirement, you should be able to withdraw $40,000 per year or $3,333 per month to last you. This is 4% of your portfolio. If you lose 1% on that in fees, your retirement would now equate to $30,000 per year or $2,499.75 per month. Do you still think 1% in fees isn’t a lot now?
Another con with Financial Advisor is the basis of their overall compensation structure. Financial Advisors are supposed to be fiduciaries. This means that they must act in line with the needs of their clients first. This means, that it is in everyone’s interest to continually grow their money. I will argue that this encourages the Financial Advisor to keep the client as a customer and invested so that the Advisor and the firm and continually suck money out of the client for as long as possible. If a client wants to liquidate $100,000 in a mutual fund to pay off their house in order to free up more cash flow and benefit them, the Financial Advisor and firm would no longer be able to charge fees to pay themselves. They are dependent on the clients to continually invest in order to get compensated.
Cons with a Financial Coach aren’t as costly. As previously mentioned, the Financial Coaching industry is relatively new and unregulated. As a result, there are numerous coaches out there from those just starting with very little background to those with ICF and ACF certifications. Coaches can vary greatly in their specialties from everyday budgeting, investing or helping to manage the psychological aspects of how one spends their money. With so many coaches and so many specialties, narrowing a specific niche applicable to your needs can be daunting.
Because of the lack of regulation, there are many people claiming to be coaches who are actually nothing more than salesman or middle men to selling clients other products similar to Financial Advisors. These “coaches” make contact with clients and point them to various services such as debt management, budgeting, life insurance, annuities, and mutual fund investments. They connect the clients to each of these programs, earning commissions on each product they sell as well as passive commissions on investments. All under the disguise of being a Financial Coach. I know, because I almost got hired by one.
Because the Financial Coaching realm is so open right now, it gives the client the opportunity to really think about what you are looking for in a coach and search for the particular one that suits your needs. If you’ve determined that you are the DIY, independent type and need a coach versus an advisor, that’s the first step. Now its just a matter of doing your due diligence and searching for who’s the right fit for you.