Free Advice Is Worth Exactly That

Recently, the online Q&A website Quora forwarded me this question – Should I hire a Financial Advisor? What are the pros and cons? How much do they cost? That’s a common question I hear from many folks. It can be hard for some to justify the expense of hiring a professional. Rarely have people asked me what it costs to not hire an advisor.

Access to the internet has been a boom for do-it-yourselfers. Personally, I enjoy tackling jobs around the house. Unfortunately, the results don’t always add up to what a professional could do. Just last weekend, my sewer line backed up. I spent the better part of my weekend trying various remedies (including one that turned the entire house into a stink bomb). On Monday, I finally called a plumber. He spent 10 minutes fixing the clog and charged about half of what it I had spent trying to do it myself.

That being said, I believe that anyone looking for financial advice should start online. Advisors like myself often take time out of our day to get people started by answering questions on forums like Quora, Investopedia, or the like (my original answer to the question can be found here). New investors can find a ton of investment, saving and retirement planning information online.

There’s just one problem with that. Information is not an education or experience. If you don’t know what information you need, you’re unlikely to find the right answer by stumbling around the internet. Perhaps this is The Vanguard Group has found that working with a financial advisor provides a return on investment at around 3%. Advisors make their living off understanding the arcane and obscure rules of finance. That knowledge is how they provide client value.

In the past, I’ve answered questions about the benefits of hiring a financial advisor. I’ve also covered how they charge for their services in previous articles. My own fee structure can be reviewed here. What I haven’t covered is what it can cost you if you make financial decisions without running them by a professional first.

The Cost of Going It Alone

The problem for most is that the expense of not hiring a professional is often hidden. Many times, these costs only appear after it’s too late to avoid them. It’s extremely hard to quantify what one could lose if they make a financial mistake. For many, they may never even notice.

Just this week, a client of mine reached out about starting to take Social Security. Based on her situation, taking Social Security early made the most sense. She went online to apply and came to a page that asked about her income in retirement.

The benefit application asked her to list “all wages and tips that will be earned in 2018, including net income from self-employment.” From there, it continued by asking, “will you earn net earnings from self-employment over $1420 a month or perform substantial services in self-employment in all months of 2018? If not, select the months in which you’ll earn $1420 or less.”

In case you’re wondering why the Social Security Administration (SSA) was asking this, the answer lies in the Earnings Test. For people who would like to start collecting Social Security prior to their Normal Retirement Age (NRA), the government reduces the amount paid if the beneficiary has earned income. My client called the SSA phone support line to inquire further (a call with an hour wait time). She specifically asked about the meaning of “substantial services” and explained to the phone rep that her income came from rental properties. The phone rep “didn’t hesitate at all in saying [she] couldn’t file when [she] told him how much net per month [she] was making.”

This answer was incorrect, proving once again that free advice is worth exactly that. The Earnings Test excludes rental income received in statute §§ 1213. Had the client not reached out for paid professional advice, she would have most likely accepted the answer. The investment she made in hiring an advisor turned out to be worth thousands a year.

Not All Paid Advice is the Same

Of course, if you’re paying for advice, you get what you pay for. I started my career at a discount broker. We never offered advice simply because it opened the firm up to costly litigation. After working with discount brokers, I found myself working at more traditional broker-dealers. Those firms focused on commission-based investments.

Hopefully your online research has already steered you away from commissioned products. If not, here’s why you need to avoid them. When you purchase a commission-based investment, the salesman earns most of their pay from up front sales charges. Unless you have a large account that pays annual management fees, there’s little reason for the salesman spend time working with you after you pay the commission.

This was the case for an elderly woman I assisted with preparing her taxes over the last couple of years. She had purchased mutual funds years earlier and had transferred the account several times before landing at Edward Jones. The funds she owned were front loaded, meaning the initial cost to purchase the investment went to some other advisor some time ago.

The advisor she was currently working with might have made a few hundred dollars a year holding on to her investments. Considering that Edward Jones’ business model is geared towards commissioned sales, most of their salespeople are focused on selling mutual funds rather than financial planning. When the client reached out to her advisor and asked for a check… he had an assistant sell funds and send a check out.

The client thought nothing of the $10,000 check until tax season came. In most years, the woman had paid a small amount of quarterly taxes and owed nothing to the IRS afterwards. This time, she was hit with a tax bill for over $5,000. So, what happened?

Most folks don’t realize that Social Security payments aren’t always taxed. If you earn income for the year, you can lose that tax-free status. What the client didn’t know was that her $10,000 check from an IRA would cause 85% of her benefits to be taxed for the first time since she started receiving them.

Without knowing the guy personally, I can hazard a guess as to what happened. Most likely, the advisor had spent little to no time on the client since taking over the account. Sure, she had mentioned him pushing her to roll over her Thrift Savings Plan (TSP), but that was about the most work he put into her. After she declined that, he realized there wasn’t any commissions to be made.

When the call came for a disbursement, they simply cut her a check without thinking. No one took into account the fact that she had a pension or that the Office of Personal Management (OPM) was sending taxable annuity payments annually. Worse yet, this woman had a Roth IRA and taxable accounts at Edward Jones. Funds from there wouldn’t have counted as ordinary income. Was it too much work to recommend taking the money from those accounts? Maybe… after all, she might have wanted someone to see if any capital gains would have impacted her taxes.

This woman clearly needed financial advice and guidance, but that’s not the service she was paying for. Instead, she was paying for someone to hold onto her money until she asked for a check. And that’s the problem with cheap (or free) advice. You might save money upfront, but the costs of a mistake are far higher than you might realize.

So why does good advice cost so much? Mostly because it takes years to learn what’s needed to provide that information. A story I like to tell my client sums the value of paying for good advice.

A homeowner calls a plumber over to clear up a clogged drain. When he gets there, the two of them go into the basement. The plumber starts tapping around on the pipes with his hammer. Finally, he takes a big swing at a section of pipe. The clog instantly starts to clear.

The homeowner is amazed. Then the plumber tells the client it’ll cost him $100 for the service. “But you only hit the pipe with a hammer!” To that, the plumber replies, “It was only $1 to hit the pipe. The other $99 is for me knowing where to hit it.”