The commission trap

So you’re an investor, and you’ve got seemingly unlimited options for your money. Some seem awesome, some look a little suspect, and for the most part, you’re not really sure what’s going to work and what to stay away from. Typically, you’d talk to some type of financial advisor. Or you’d succumb to your own hubris and decide to get online and do this whole investing thing yourself until it becomes clear that you’ve made a huge mistake, then you’d talk to some sort of financial advisor. But now instead of trying to figure out how and where to invest money, you’re trying to figure out how to pick a trustworthy advisor who can help you with the investing part. Well, I’ve got one piece of advice: watch out for the commission trap.

There are several different ways that financial professionals are paid, the two most common are through fees and through commissions. Some advisors only charge one way or the other, some do both.

A fee-based advisor means that if you’ve got money invested, the advisor collects a fee (usually a small percentage) from your investments every year. It’s a pretty simple, pretty common model, and it makes sense because the advisor is invested in your success. It definitely doesn’t mean that the advisor is trustworthy, but you can at least take comfort in the fact that it’s a sensical payment model.
On the other side is the commission trap. There are a few bad things about commissions:

  • It means you’re buying a financial product. Advisors who collect commissions only get paid when a client buys something. Financial products, while veiled as beneficial to the customer, are generally not the best option. They prey on people’s desire for security and charge a hefty premium for it (annuity). What a financial product offers can almost always be had for a fraction of the cost with a much higher ceiling for growth by simply investing in the market. Not every product is always bad, but you definitely shouldn’t be buying lots of financial products.
  • It means the advisor is collecting a large commission. These products, specifically annuities, will pay out massive sums to advisors who can peddle them. Commissions between 5% and 10%, and sometimes even more, are common. That means if you take your $500,000 investment account and buy an annuity, the advisor could be collecting between $25,000 and $50,000. That’s a lot, suspiciously a lot. Brokers will pay advisors these kinds of fees is because the product is extremely lucrative for brokers, which means it’s probably not super beneficial for customers. 
  • It means there’s a conflict of interest for the advisor. They’re stuck with the tough decision (or maybe not so tough) of educating and caring for their client and promoting their best interests or putting food on their own table for their own kids, or taking a super nice vacation, or whatever else you could get excited about buying for $50,000. Unfortunately, the advisor’s interest will likely lean toward the $50k. Better not to put yourself, or the advisor, in a conflicting situation like that. 
  • It means that you’re probably not getting coached. Advisors who sell products aren’t evil (mostly), but they have to function more like salespeople than advisors or coaches in order to survive. Best case, the salespeople are catering to clients, giving them what they want without trying to rip them off. Worst case, the salespeople are manipulating or aggressively pushing bad products to people. Either way, coaching doesn’t enter the equation. There is no correlation between a customer’s desire for or the suitability of a product and the long term success of a client. So instead of coaching and educating clients, financial salespeople end up helping clients orchestrate their own financial purgatory, never making progress towards their goals. 

So keep an eye out for the commission trap when you’re evaluating an advisor.

The Investor Behavior Question

So we looked at the problems with stock picking, market timing and track-record investing. The evidence strongly suggests we should avoid these investing pitfalls. So why do people still engage with them? Many people aren’t familiar with the research, which is an indictment on the investing industry, but the problem goes deeper than that. Even people who understand the research, even people who understand and assent to the research, still don’t consistently comply. Why is this? The industry calls it investor behavior, and it’s big business. I hear a lot about bad investor behavior, but I don’t hear much about why investor behavior is bad, or how to think helpfully about it. Here are a few reasons why I think it’s tough to be a good investor today:

1) The practice of buying low and selling high is ingrained in us. We’re deal shoppers. We see a good deal, something that’s worth more than its sale price, and we can feel great about the purchase. We’ve got TV shows that show us how to buy cheap houses and storage units in order to flip them for a profit. The booming fantasy football business teaches us to perform hours of research before drafting players (no? only me?) in order to find the underpriced guys who will overperform. We’ve got side hustles flipping cars, furniture, clothes, electronics, you name it. We’ve got sale adds spilling out of our mailboxes. That’s just how our world works, we shop for deals, things that are underpriced. Another way to say it, we’re always on the lookout for inefficiencies. But the stock market in not inefficient (see Are you stock picking?). It’s the one place we shop where there are no sales or discounts. It makes sense that we would apply our standard buying principles to investing, but unfortunately, our instincts aren’t helpful here.

2) Active investing feels right. Trading in a portfolio is exciting, especially if you think you’re good at it. A big win in the stock market makes for a really nice adrenaline hit. It’s similar to gambling. You can do it from your favorite chair in your living room, or a bustling coffee shop; it feels meaningful; it provides a perfect excuse to be constantly checking the news; you get to use your favorite tech gadgets (that’s what gets me). And even if you’re not the one making the trades, it just seems responsible to watch the news and track your returns every day. It seems right to talk predictively about the market, to decide on an investing strategy for the upcoming year. We’re not lazy people, we do our due diligence; unfortunately, with investing, we diligently do the wrong things.

3) We’re inundated with encouragement to engage in active investing. Financial news networks and websites were not created to educate their viewership, they exist to drive traffic. Since patience, diversification, minimal trading, (aka the staples of a good investment strategy) are really boring, news outlets lean heavily towards the predictive and active trading slant. Specific stock recommendations and bold market predictions fuel our instinct to do something with our investments. Again, it feels right to try to figure out where the market is going and how to profit from it. The news only tickles that itch.

Investing is counterintuitive and human behavior is often the trickiest part in investing. Sometimes we simply lack the knowledge required to be a good investor, but more often it feels like we should be doing more. When something needs fixing, we put our heads down and figure out how to fix it. Before we decide to buy something we do our research. But the way we make buying decisions in our every-day lives doesn’t work in the stock market. While we constantly look for inefficiencies, sales, discounts, deals, etc., the stock market is efficiently moving along on its unpredictable upwards trend. Instead of working to beat it, let’s ride it.

How To Fix Your Finances

If you’re super stressed about your money situation, which, according to CNBC is pretty common, you’ve got two options:

Option 1: tighten your budget and stick to it at all costs. This option is not a lot of fun, but it’s still very important. The basic principle of personal finances is to live within your means. This means that if you don’t have money for something, you don’t purchase it, instead, you save some money over time until you can afford it. It’s common sense, but it’s not commonly practiced. SNL is an authority on the topic: Don’t Buy Stuff You Cannot Afford. Though this definitely isn’t the fun option, it might be the more important option. Sticking to a good budget and living within your means teaches you to think differently about money. If you’re a subscriber to the ‘I want it and my credit card isn’t maxed out yet’ line of thinking, this budget thing won’t be easy, but it will change your life.

Option 2: make more money. This is much more fun. Instead of holding back, you’re increasing. You can be creative, start a side-hustle, work towards a promotion. The options aren’t exactly endless, but they’re pretty broad. Do something that is exciting, something that you love, or something with a loved one! The only rule is that your idea has to make some money (and also stay within the bounds of federal law).

Here’s the twist, you don’t have to pick just one option. Ideally, you’ll work on both simultaneously. If you only tightened the budget, you would confine yourself to a workable, but boring financial existence. If you only earned more money, you would spend it as soon as you earn it since you would never have learned the discipline and benefits of saving. Neither option, by itself, is likely to get you where you’re hoping to go. But together, these two strategies can create a real and lasting fix to your finances.

Finances by age

We’ve all heard of general financial guidelines which wisdom would suggest we follow. Dave Ramsey talks about them, financial planners use them, we all interact with them on some level. As you move through life the guidelines also move a little bit, some things you didn’t have to deal with in your 20’s become pressing in your 40’s, and vice versa. This is a breakdown of these financial guidelines by age, things that you should be thinking about based on your stage of life. This does not mean that you’ve failed if you’re working on some 20’s things in your 30’s or 40’s, or even 50’s. But these guidelines are a helpful measuring stick to see how you’re doing currently, and they provide a good pathway for lifetime financial success. Let’s dig in.

Teen years:

  • The number one thing you can do in your teens is to start developing good financial habits.
  • Stay away from consumer debt. These debts are often subject to high interest rates (credit cards), tied to depreciating assets (cars), and often end up funding things that are unnecessary. They encourage bad spending habits and can cost years to catch up from.
  • Learn to save money. Instead of unnecessary spending, practice going the other way, save up money for things you want. 
  • Learn to work hard. Financial guidelines will certainly help you succeed, but you won’t get far if you can’t earn money. 
  • Get through college with minimal student loans.


20’s:

  • Now you’re out of college and real life is set in. The number one thing you can do is create a zero-sum budget and stick to it as if your life depends on it. Give yourself some spending money, make sure to budget your savings, and again, avoid consumer debt. The budget is not a forecast of your future spending, and it’s not just for tracking your spending either, it’s for planning your spending. You intentionally decide what you’re going to spend money on and how much, and you don’t spend beyond that. 
  • Start a financial plan. Meet with an advisor, learn about how the market works, and start putting together a loose plan for retirement. Things will obviously change, but the plan will ensure that you’re pointed in the right direction.
  • Create an emergency fund. Dave Ramsey says save $1,000, that’s a good place to start. Eventually, you might work up to a month or two worth of expenses. This is how you will pay for life’s curveballs instead of using your credit card.
  • If your company offers a 401k plan, start putting some money away. The money you invest in your 20’s will work the hardest for you over the long haul. If your company’s 401k plan offers some sort of match, try to contribute whatever is required to take full advantage of the match. The free money is hard to pass up.
  • Be aggressive about paying off student loans (and any other consumer debts).
  • Start saving for a house.


30’s & 40’s:

  • Now that you’ve set the stage in your 20’s, you’re ready to start executing in your 30’s and 40’s. Keep meeting with your advisor and updating the plan, keep learning, and keep on the straight and narrow.
  • Become debt free (aside from a potential mortgage loan). If you have any consumer debt or student loans, be aggressive about paying them off.
  • Think about buying a house. Your financial plan will show you that buying a house is the most cost-effective way to provide housing, a home is a good asset. Save up a large down payment and ensure the payment fits nicely in the budget, there are few things more financially stressful than being ‘house-poor.’
  • Make a plan to pay off the house, ideally in 15 years or less. Owning a home free and clear is one of the most impactful things you can do for your retirement. It’s also a great way to help kids through college if that’s a goal of yours.
  • Increase retirement savings. You’ve been contributing enough to take advantage of the match, but there’s no need to stop there. Bump up your 401k percentage or put some extra money away in an IRA. 15% of your income is a good goal.
  • Buy some term life insurance, especially if you have children. A 20-year policy is often sufficient, the goal is to ensure that your family will be well-off in the event of a tragedy.
  • Put together a will, again, especially if you have children. It’s another way to ensure the family will be well-off in the event of a tragedy.
  • Increase the emergency fund to cover 3-6 months (or whatever number feels most comfortable) worth of expenses. Think about this money as insurance. It’s not going to earn much if anything, but that’s not what it’s for. The investments will earn money for retirement, the insurance is to shield you from unforeseen events.

50’s:

  • Talk to your advisor about your investment allocations. As you move closer to retirement, you’ll want to ensure the retirement funds will be available for you, which means you’ll probably scale back the risk factor in your portfolio, or at least have a plan in place to do so. This means owning a higher percentage of bonds and fixed income type assets and fewer equities (stocks). A good advisor will engage with you on this subject pro-actively.
  • Adjust investment contributions. It could be a good time to increase savings again to maximize what will be available in retirement. It’s the home stretch!
  • Pay off your home. I mentioned this earlier, but paying off your home is one of the most significant things you can do for your retirement. From a cash-flow perspective, it makes a ton of sense. If you owe $100,000 on your mortgage, and your payment is $750 per month, you’ll gain $9,000 in spendable cash-flow per year for spending by paying the $100,000. If you instead saved that $100,000, you would be able to pull about 5-6% per year ($5,000-$6,000) and you’d still be making the mortgage payment. A mortgage-free budget will also be much more flexible. Many people end up working in retirement mainly because they still have to cover the mortgage.
  • Look at your social security estimate. This is available online (https://www.ssa.gov/benefits/retirement/estimator.html) and will be helpful as you get more detailed in your retirement plan.


60’s+:

  • Finalize your retirement plan. Determine when you’ll retire, what your new income sources will look like, how your advisor will manage the retirement funds, when to take social security, all the exciting stuff. These are important details to nail down as you move into retirement.
  • Revisit your budget. Income, expenses, taxes, and cash-flow all change significantly in retirement. A good comparative cash-flow analysis from your advisor could prove very helpful. Usually, retirees can achieve a similar or better cash-flow with significantly less income because of how the taxes and expenses shape up (especially if that mortgage is gone!).
  • Decide what you’d like to accomplish in retirement, maybe even set some goals. The great benefit of retirement is not the ability to stop doing anything, it’s the opportunity to focus on the things you want to do. A part-time job or some sort of enjoyable work, more family time, travel with loved ones, important hobbies, these all can be part of a richly fulfilling retirement; but don’t let them simply happen to you, do them on purpose.

Introduction

Hello, my name is Josh VanDyke, and I am an investment advisor. I think ‘investment advisor’ probably means many different things to many different people, so I want to let you know what I do. In the interest of keep things simple: I help people understand investments, and I offer people advice surrounding their finances.

I help people understand investments. This is the technical part of the job (which I get nerdy about), and it can be complicated, but the principles are simple. I help people understand where returns come from, how the market works, what diversification means, and a host of other important things. There’s a right way to invest and a lot to lose if you’re not invested well. I love to help people understand the principles that make for a successful investor.

I offer people advise surrounding their finances. There are many things that go into this, things like determining when and how you would like to retire, what your goals and aspirations are, even talking about how your budget is (or isn’t) doing. I like to ask the question, ‘if you continue doing what you’re doing today (budgeting, saving, investing, etc.) where will you end up?’ If we can determine where your current path leads, you can start making intentional decisions about how to get where you want to be.

So that’s what I do. I love my job. I love learning, reading, graphs, stats, and talking to people, which are all wonderfully part of the work. If there’s anything I can help you with, don’t hesitate to let me know.