The first day of your first job is tedious. You try to arrive early and then realise that you’re not sure where to park. The guard at the door forces you to sign the visitor register. Lunch is a takeaway from that brightly-coloured place that no one goes to after their first visit. And you spend an inordinate amount of time in IT, trying to set up passwords, access keys and an email account.
It’s a day of lonely admin.
In between that, you usually get handed a stack of forms: medical aid, retirement funds, company-assisted investment schemes, and so on. And you’re suddenly appalled by the reality of deductibles. Also, concerningly, you want to throw up after that lunchtime wrap.
But back to those forms, because you have a sneaky suspicion that you’re about to make some decisions that will change how much cash gets deposited directly into your bank account on the 25th. So you ask some friends what they’ve done, and you get a variety of answers, most of which are variations of:
I just signed up for the cheapest ones.
Then you get that one friend:
Well obviously, you should RF at 15% not 12%, because obviously. And don’t use that Medical Aid with the pink form – those kids are a pyramid scheme. Wait – what employee share purchase option did you say they gave you? That’s crazy – I only got a 30% discount to MV at grant date. Are you sure yours says grant date? Not vesting date? Man – I gotta call HR and see if they updated the terms.
So you put the phone down, and still feeling ill from lunch, you sign up for the cheapest ones.
By the time you get to your next job, you’re probably feeling a little more pressured to make some plans to build an asset base. Maybe you want to buy a house, which is making you re-think some things. Either that, or you’re watching your parents retire, and that aging/mortality fear is creeping about at the back of mind.
Cue: a visit to a Financial Advisor.
Fact: Not All Financial Advisors Are Created Equal
If I’ve learned anything, it’s to ask to see a transcript. Despite the eventual outcome, I’m not sure that anyone really studies finance with the grand goal of one day planning to help other people invest their money. People study finance with the grand goal of being someone who needs help with investing their money (somewhat counter-intuitive – but then most university degrees have fuzzy links to reality).
Some might say that financial advice positions are the jobs that are taken by those who don’t get into Corporate Finance. Some.
Either way, the point is that financial advisors are just people: people who are likely to be bored by their job, frustrated by their paycheck, and not really sure why they’re doing what they’re doing, but they have a mortgage and a child and that’s that.
And it’s worth being aware of a few things (I think) before you put your money where his mouth is.
The Things To Watch Out For
1. The Financial Advisor that really wants to save you tax.
Tax is a sad fact of life, sure. But when your entire investment philosophy is guided around being tax efficient, you are probably going to end up poorer than if you’d just accepted some tax burden. After all, two observations:
- governments want progressive tax systems that tax the rich in order to re-distribute wealth; and
- governments use taxes to dis-incentivise “unhealthy” behaviours (like sin taxes)*.
*AKA the pigouvian tax.
So if you’re aiming to be tax efficient, you’re going to have to avoid those areas where government is taxing people (ie. you’ll avoid the investment strategies of the rich), as well as engaging in behaviours that are tax-free (ie. incentivised by the government).
And for the record, the government likes to incentivise non-risky investment strategies. Which, funnily enough, are usually required to hold pre-determined levels of government debt bonds in order to qualify for the tax advantage…
Either way, this does mean that tax-efficient investment strategies are going to be earning lower returns (and there are studies out there to show that this is empirically true). Let me put this into numbers:
- James and John each invest $100. James puts it into a high-risk equity fund. John decides to go for a tax-efficient Retirement Annuity Fund.
- Over time, James earns an average pre-tax return of around 12% each year (ie. $12 per year), where John earns 6% (ie. $6).
- James pays tax of 25% on capital gains, so he hands the tax authorities $3 a year, and is left with $9.
- John saves the $1.50 that he would have had to pay, and keeps his $6.
- Penny-wise, pound-foolish.
It’s a bit fictional – but the point I’m making is that a financial advisor that just wants to save you tax is delivering you a feel-good “I’m so clever for avoiding tax” treat, rather than helping you toward investments that make sense for your overall health.
A good financial advisor should be finding the right investment strategy for your risk and income profile, then working (really hard) to try and make the process as tax-efficient as possible.
2. The Financial Advisor that really wants to limit your risk.
Many people are extraordinarily loss-averse. It’s the bird-in-the-hand approach to life – when they watch their portfolios go down, it hurts more than that euphoria that comes from watching the portfolio grow. They’re also the most annoying type of investor-client, because they can get pretty abrasive and red-eyed when the market is going against them.
Unfortunately, that means that your FA is quite incentivised to guide clients (just in case they’re overly loss-averse) toward an investment portfolio that doesn’t make them feel bad (ie. one that doesn’t make many losses). Because, well, that means that he/she will have fewer angry phone calls and death threats. Naturally, less losses means less potentials for gain – but that’s a small price for the FA to pay. When the gains aren’t happening, he/she can blame the end-of-the-world, Syria, and the slowdown in China.
If you’re a risk-averse, loss-averse kind of person, then that’s great. But if you’re not, then low-risk strategies are not great. The point is: this should be about you and your wants, not your FA and his want not to be bothered.
3. The Financial Advisor that likes rules of thumb.
Run.
A good Financial Advisor has opinions, but not a bias. And a rule of thumb is just a systematic bias.
And systematic bias was how the American banking industry felt toward home loans around the middle of the last decade.
Obviously, there are other warning signs as well. Like a fixation on a particular finance house (a classic example: my love of the Allan Gray); or regular soundbites on the market that were picked up off CNBC this morning…
If I was to put this in a nutshell, I’d put down these key points:
- A financial advisor should not be trying to sell you a product.
- Instead, they should be asking you questions, getting a feel for your investor personality, and then offering you some options that make sense.
- Then you pick an option.
Also, when in doubt, get a second opinion.
