A couple weeks ago I gave some advice to a young person that was invested with a robo-advisor. I urged patience and giving up on the goal of a perfect portfolio, especially when you come to the decision that you would like to invest in a low-cost, diversified asset allocation approach.
One of my younger readers followed up with a great question that wasn’t addressed:
How does one even make that decision? And what other decision is to be made by a 20-30 something investing in IRA’s? I’ve never really consciously made that decision, but I wasn’t really aware of any other option besides paying a guy 1-2% to do the same thing for me.
There are many young investors out there that could use some guidance from a legitimate financial advisor. The thing is that most advisors have minimum asset thresholds that 99% of young people can’t hit, so there are very few good advisors taking on younger clients.
I’ve had plenty of old high school and college friends ask for advice over the years about the advisor they chose. Most went with a friend from college that was trying to build up their book of business, but the advisor never offered any attention or actual advice. They picked a few mutual funds, never met to discuss their goals or financial situation and collected a fee for basically doing nothing.
So the conundrum is that while young people could use advice from a financial professional, it’s hard to find a good advisor that’s willing to give you that advice because you don’t move the needle quite yet.
If you’re considering ‘paying a guy 1-2%’ to do these things for you, you’re probably wasting your money. Anyone charging you a 2% fee is not looking out for your best interests in the first place. In fact, if all they’re doing is choosing funds for you, the fee should never exceed 0.40% or so.
While they’re not perfect solutions, a robo-advisor or a targetdate fund in an IRA or defined contribution retirement plan should do the trick for most young people starting out as they find their way as an investor and try to increase the size of their their portfolio. Dollar cost averaging through a periodic savings plan into these types of vehicles is a great way to build up your savings. Once you have more capital in your accounts you can reassess to see if your situation call for a financial professional. There are even some advisors that offer hourly rates if you’d like to test the waters, but it’s not the norm.
I wish that there were better ways for young people to get personalized investment and financial planning advice. Maybe other young people will fill that void eventually. In the absence of that, here are a few things young investors should be focusing on:
- Developing good savings habits.
- Making sure your personal finances are in order.
- Taking advantage of tax deferred retirement accounts.
- Understanding yourself as an investor and how you handle market volatility and losses.
- Finding a strategy that gives you a high probability for success that you are comfortable sticking with over time.
You’ll notice investing falls pretty far down this list. Your investing style will matter at some point, but it’s not your top priority right out of the gate.
The greatest asset you have as a young person is time — time to earn more money, time to allow your savings to compound and time to figure out what it is you would like to do with your life. Focus on these things and the hope is that you’ll have more than enough money to meet the minimums for the really good financial advisors later on if that’s the route you choose to take.
Further Reading:
Advice for a Young Robo-Investor on Asset Allocation
The Robo-Advisor Challenge
Financial Advice For My Fellow Millennials
Recently I helped someone about five years out of college decide what to do in a 401k plan at work. It presented 37 choices, with nothing but fund titles. Some of them were high-expense, actively-managed funds that probably had paid for ‘product placement.’ Several were target date funds. One was an insurance company money market fund. Every one of them had to be googled to even find out what they were.
Buried near the end of the list were S&P and BarAgg index funds, with moderate (though not lowest cost) fees.
Another option offered professional allocation advice for 0.6% annually. Nice gig if you can get it.
My young protege chose a mix of the stock and bond index funds. But I wondered how the other employees made their way through the long, opaque list of funds, lacking even a description of their investment objective.
In general most 401k are a mess. Like you said — too many fund choices, difficult to understand what each fund really does, information buried everywhere. The problem is the people that run these funds for the organizations don’t have the right experience or knowhow to implement a good 401k plan so they get taken advantage of. I read somewhere that close to 85% of all 401k fund options are still overpriced active funds. One of the last places where milking fees hasn’t been exposed. Hopefully ETFs begin their takeover soon.
Why doesn’t the SEC step in and enforce or create rules that would make it easier for everybody let alone young recent graduates? My nephew is having a difficult time with this issue too. He has a financial advisor who doesn’t seem to know what he is talking about. That sounds paranoid I know. When I make suggestions based on what I have read, he stifles laughter. He is headed for disaster. His father, my brother, doesn’t have a clue either. It’s all so depressing. I feel I should do something but don’t know where to begin.
Good question. Unfortunately it can be tough to find legitimate sources of financial advice. Here are a few posts you can send them for some food for thought on the advice they’re getting:
https://awealthofcommonsense.com/what-would-you-say-you-do-here/
https://awealthofcommonsense.com/vetting-sources-financial-advice/
https://awealthofcommonsense.com/financial-advisors-can-fend-robots/
Good luck.
Thank you Ben! I will read links and forward them to my nephew.
In my experience, too many lack a basic understanding of how to manage their finances – especially so for young adults. In a world in which the concept of “delayed gratification” seems to hold little value, the two most valuable (in my opinion) financial principles: 1) spend less than you earn and 2) save early and often, are regularly ignored. So, yes, young adults are in need of financial advisors, but on an easily accessible and cost effective basis. I like the robo-advisor concept that is growing in some firms, especially when low cost funds are paired with low/no management fees. However, firms need to do more on-line to provide better reporting and education that is now largely the domain of the fee for service world. This could be supplemented with limited 1-800 access to a live rep – say, 1-2 hours per year, with additional time on a reasonable per hour basis.
The financial community needs to expand their capabilities for smaller investors partly for social reasons, but also for very practical reasons. The competition for investors who have wealth now is getting stiffer and will only worsen as the pricing model for traditional wealth management continues to erode. In my view, most firms do a very poor job of bringing in clients who are still accumulating their wealth, preferring instead to try and lure them away from another service provider when they become more attractive. This is an expensive model and does little to build long term client loyalty.
Good point on the education. I think regular communication is one of the keys here to keep people engaged and on track. And you’re right that most firms are overlooking smaller accounts that could become the millionaires next door some day. I think that’s why the robo-advisors have had so much success thus far in such little time — they’re hitting an underserved market segment.
[…] Along a similar theme, Ben Carlson asks – do young investors need a financial advisor? […]
This is precisely why I wrote my paper for people in their 20s which I distribute to my college friends and others who hear about it in some way. Young people need to understand that after contributing enough in an employer plan to obtain the employer match, saving up an emergency fund (3 – 6 months), saving for a down payment on a car and possibly a house, and buying only insurance that they really need – health, disability, term life in that order of priority – they need to get started dollar cost averaging into some sort of tax advantaged retirement plan — in my opinion a Roth IRA makes the most sense — with a low fee fund company such as Vanguard or Fidelity. Because they generally get now education about this sort of thing, a mentor (with no financial interest in the outcome) of some sort is desirable. Formal education is high school and college would go a long way towards solving the lack of confidence, skills and knowledge problem.
I’m curious if the young people you talk to are receptive to financial advice. Thoughts?
Some are — I hear from a few from time to time. What encourages me is that almost everyone continues to receive the occasionally updated papers and the monthly articles. They all know that all they have to do is email me and ask me to remove them from the distribution, and that happens rately. Recently a young person that did that a while back emailed me and said she had grown up since taking that action and wanted back on the distribution. My hope is that they will keep the papers where they can find them later and refer to them when they need to make an important financial decision or when someone is pressuring them to do something regarding finance, insurance and investing.
Right now I am volunteering with a local group that supports young adults who have aged out of foster care. I am working with two of those young adults right now on managing their finances and eventually, when they have them under control I will start to educate them about investing in retirement plans. I hope to work with many more in the futures. They really need help and support and they are grateful for it.
One final thing — I generally hear back more from folks in their 30s and 40s and those who are nearing retirement. It is amazing to me that they know so little.
That’s great. Glad we have people like you out there helping others. Good work.
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