WCI #3: How to Choose a Financial Advisor

This is the White Coat Investor Podcast where we help those who wear the white coat get a fair shake on Wall Street. We've been helping doctors and other high income professionals stop doing dumb things with their money since 2011. Here's your host, Dr. Jim Dahli.

Welcome to the White Coat Investor Podcast Number three.

Do you ever find yourself wishing there was somewhere to go to ask your finance, insurance or investing questions? The White Coat Investor community is a great place to turn. We have a thriving community across all of our social Facebook, Twitter, Instagra, Reddit and our WCI Forum. We have been discussing solutions to your money problems since 2011. Join the Conversation with thousands of other White Coat investors. Follow WCI on your favorite social media platform for financial resources, tips and strategies. Just head to your platform of choice and search for the White Coat Investor. You can do this and the White Coat Investor can help.

Thank you for listening to the podcast. Thank you for those of you who have sent us feedback and who are giving us great ratings, we appreciate it. That helps us to spread our message to others. By way of disclosure, you should be aware that I'm not an insurance agent, a financial advisor or an attorney and thus you should consider anything you hear in this podcast. As for your information and entertainment only, be sure to check up on anything with what you consider to be a reliable source before implementing it in your own financial life. Thank you for what you do, not only in spreading our message to others, but but also in your profession itself. Medicine and other high income professions can often be very thankless work and sometimes you wonder if anybody there cares about all the dedication and time you put into learning how to do it and to practice it on nights, weekends, holidays, evenings and always the most inconvenient times. Today we're going to be talking about financial advisors. I've got this reputation out there for being anti financial advisor. I'm actually not anti financial advisor. I think the truth of the matter is that probably 80% of doctors need a financial advisor and want a financial advisor. That's not to say that doing it yourself is not reasonable. It is. But it requires a certain amount of interest, knowledge and discipline that frankly a lot of doctors just don't have. I've been trying to instill that desire into people now for almost six years. And the truth of the matter is some people just aren't going to learn how to do it themselves well enough that they that they can justify doing it themselves. But if you can bring yourself to have enough interest in this subject matter then you will rapidly Acquire the knowledge you need, and you'll likely also be able to acquire the discipline you need to stay the course and to actually manage your own investments. I think if you can bring yourself to read five financial books, you can probably manage your own money. The difficult thing for a lot of people, though is getting through one. I'm amazed how many people can't even read a single financial book just because they find the subject matter way too boring, despite how valuable the information in it is. This particular podcast isn't going to be about how to manage your own investments, not about doing it yourself. It's going to be more about interacting with financial advisors. And it's important that you understand that financial advisors don't go into their profession for the same reason that kindergarten teachers, nurses, and even doctors do. You remember that personal statement you wrote back when you were applying to med school about how you love science and you just want to help people? Well, financial advisors don't write that when they go to financial advising school as if there is such a thing. They simply are doing it for different reasons than the reasons that people go into being kindergarten teachers. The other thing to keep in mind about financial advice is it is really expensive stuff. No matter how you're paying for it, it's expensive. You might be paying an asset under management fee. It might be 1% a year, which is about the industry average. That's 1% of your portfolio every year. So if you have a $2 million portfolio, that's a $20,000 a year fee. That's expensive. It turns out if you run that number out for the course of your life, that's going to work out for most doctors to be something like 1 to 2 million dollars that you paid to a financial advisor simply because you have that much less money than you would have had if you had learned how to do this stuff on your own. So you got to bear in mind when you're dec to hire somebody or whether you're going to do it yourself, that it's really expensive stuff. If you want to get good advice, even if you're getting a fair price on it, it's going to cost you a pretty penny. The other thing to keep in mind is, despite what they will sometimes tell you, a financial advisor is not a doctor. Part of the issue is you can go out and if you went out and hung out a shingle and declared yourself that you were a doctor, you would rapidly be picked up and thrown in jail for fraud. However, you can go out and hang up a shingle as A financial advisor while knowing very, very little about financial advising. The vast majority of financial advisors out there, or rather people who call themselves financial advisors, are really commissioned salesmen. They're not financial advisors in any way, shape or form. There's a phrase out there being used this day among fee only financial advisors calling themselves real financial advisors. And I think that's useful to distinguish them from commission salesman masquerading as a financial advisor. The other thing to keep in mind is that hiring a financial advisor is not the same as hiring someone to mow your lawn. You got to bear in mind that managing your own money is probably the best use of your time. For example, if you're paying somebody $20,000 a year to manage your portfolio for you, they might only be putting in 20 hours throughout the whole year on your portfolio. And so what are you paying them? Well, you're paying them about a thousand bucks an hour in that scenario. And that's almost surely more than you're making, no matter what you're doing. And so this is not like hiring someone to mow your lawn because you have better things to do with your time. You probably don't have better things to do with your time. Let's talk a little bit about how to choose a financial advisor. As I mentioned earlier, you want to choose an advisor that is fee only. Notice that's different from fee based. Fee based means you're paying fees commissions. You don't want to be paying commissions. The problem with paying commissions is the worst products pay the highest commissions. And so a commissioned advisor has this terrible conflict of interest that he must face every single day of whether to do the right thing for his client or to put food on his table to feed his kids. And you don't want an advisor who's having to struggle with that conflict of interest. So you want to pay somebody just like you pay an accountant or an attorney or a physician. You want to pay them a fee for their advice. That's what a fee only advisor is. You want an advisor who will sign a fiduciary statement with you. That means they will act in your best interests, even if it isn't in their best interest. That's the meaning of the word fiduciary. Now, as physicians, we assume every other profession already has an agreement like that. I mean, it's just like the Hippocratic oath that we swear when we graduate from med school. But guess what? Most financial advisors, or those who call themselves financial advisors don't have any sort of fiduciary duty to You. In fact, in the beginning of the summer of 2016, they actually passed a law saying advisors have to act on a fiduciary basis to you, but only with regards to your retirement accounts. If it's not in a retirement account, they can still sell you whatever's best for them. I think it is also useful to have an advisor who has a meaningful designation. Now, if you've looked at the letters behind financial advisors names, it's like Alphabet soup. You can't tell which of these mean anything and which ones don't. So in my view, there's really basically four meaningful designations that you ought to be considering. The first is a Chartered Financial Analyst or a cfa. This is probably the hardest of the bunch to get. It's not very common in financial advisors, but it's pretty frequent in people who manage money for large institutions. But it requires three difficult tests taken over a couple of years and three years of experience. The most common designation out there is a certified Financial Planner. And you would think from the way these guys push this designation that it's the equivalent of going to medical school and residency. But in reality, when you ask these guys how long they study for the test, it usually works out to be about 200 hours. And 200 hours sounds like a lot of training, right? Until you think back to residency and realize that you're working 80 hours a week. So 200 hours is really the equivalent of, you know, two and a half weeks of residency. When you think of it that way, it doesn't seem like quite that much training. That said, it does show a bit of commitment to the profession. You know, if most people out there calling themselves advisors don't even have a cfp, well, at least the guy is committed enough to the profession and is planning to be in it long enough that it was worth it to him to put that 200 hours of studying in, pass the test, and have the three years of experience that's also required to get the designation. Another designation, the Chartered Financial Consultant, is often picked up by people coming out of the insurance agent world. It's a very similar coursework to the Certified Financial Planner. It doesn't require the test, but there is an extra course or two in there that I would put those pretty equivalent to each other. Finally, if you are a CPA or an accountant getting into financial advising, what you typically get is a personal financial specialist or a PFS designation. And I think what that is basically adding on a CFP to your cpa. And I think that's also a meaningful designation. But all those other Alphabet soup designations, they don't mean a lot, so don't put a lot of faith into them. Some of those are like a weekend course and that doesn't mean a lot to me. After spending four years in med school getting an MD and three years in residency and an oral and a written test to become board certified in my specialty, I'm not impressed by a weekend course designation that gives you six letters behind your name. You also want an advisor that has some experience. You're not looking for the 22 year old kid fresh out of college. You want somebody with some gray hair that's helped clients through a bear market or two. And so I would just look for somebody a little bit older. I'd say 30s at least, and preferably more. It's not like you're going to be able to pick up somebody that's going to be with you for your entire life anyway, because this guy's going to retire. Even if he's your age, he's going to retire about the same time you do. And you're going to have to get a new advisor. So plan on having to change, but go for somebody with experience. And really you want somebody who's already pretty well to do. You don't want someone who's still scrambling to make a buck and trying to make it in the world. Right. The best advisors are those who don't need your money because they can be much more objective about giving you advice. You want an advisor who believes in a passive investing philosophy. The data is very clear on this. If you go back and look at any of the academic investing literature literature that the best way to invest is passively keeping your costs, both investment fees and taxes, as low as possible. It turns out the real bang for your buck when you're paying for financial advice is not so much in the asset management, but it's in the financial planning. Setting up your original investment plan, making sure you're using the right accounts, doing tax management, those sorts of things. That's where the real bang for your buck is not so much in the ongoing asset management, much of which can be automated. You may be wondering at this point in the podcast whether you're getting ripped off by your financial advisor. And if you're wondering, chances are good that you are. What I recommend you do is go get a second opinion. This is very common in medicine and we don't take offense to it. If someone, you know, you recommend surgery to somebody and they go to another general surgeon to see if that general surgeon really thinks they need their gallbladder out. That doesn't offend us, but it's very uncommon in the financial advising world. However, it's relatively inexpensive, sometimes free to go see another fee only advisor and ask them what they think of the financial plan that you've been provided. And if you have any doubt whatsoever, after talking to the second advisor, it's time to begin a search for a new financial planner. Briefly, let's just talk about robo advisors for a minute. There are a dozen or more robo advisors out there that basically function as a financial advisor, but without the touch, the personal touch of a live advisor. And you can do this either over the phone with big firms like Schwab or Vanguard, or you can do it mostly online with some of the more common firms like Betterment or Wealthfront. And they tend to charge much lower fees than you would pay a traditional financial advisor. For example, if you're paying a traditional advisor 1% a year, you might be paying a robo advisor 0.15% or 0.3% a year. And so the fees are much lower. And I really like that aspect of it. The other aspect I like about it is you almost always end up in a reasonable portfolio. Going through these robo advisors. I've seen some crazy stuff come out of recommendations from live advisors, but that's very rare for a robo advisor. They've had enough people looking at their portfolios, they're using something reasonable. I really like that. Some of them also have automated their tax loss harvesting, which is a valuable service that basically helps you to have up to $3,000 a year to put against your regular income and save yourself some money on your taxes. That's also very useful. The problem with robo advisors is it's a pretty small step to go from a robo advisor to just managing your portfolio yourself. And the other issue is none of them are going to manage your 401k for you. Not unless your 401k is at that robo advisor. And so that makes it really tricky. If you've got the robo advisor managing your IRA and your taxable account, but you're not your 401k. You really want to have your advisor looking at all of your accounts together and managing them as one big account. And the robo advisors are still struggling with how to do that. And so the benefits sometimes outweigh the downsides for people. And I think it's a reasonable thing to do. But always bear in mind that as you learn more, you may want to Start doing it yourself whether you're using a regular full service advisor or whether you're using a robo advisor. All right, let's move on to a few questions I've been getting lately. Here's one. I'm currently in residency and engaged. I'm filing single for 2016. I plan on opening a Roth in January 2017. I'm well under the modified adjusted gross income for a Roth IRA right now and contributing $5,500 to that when we file our taxes jointly for 2017. I will then have to open a traditional IRA as well and start the backdoor process. Is this correct? He then notes, my fiance does not have either a traditional or a Roth IRA. She just finished residency and has a salary of $200,000. Does she need to open both a traditional and a Roth IRA this January if her modified adjusted gross income is above the limit for a Roth? The only retirement savings we have right now is our 403s, which I take are not part of the pro rata conversion. So what he's talking about here is the backdoor Roth ira. If you're not familiar with this, I recommend you go to my tutorial on the website called the Backdoor Roth IRA Tutorial. But basically this is a way for high income earners to move money into a Roth IRA through the back door. That means contributing it to a traditional IRA and then converting the traditional IRA to a Roth ira. So his questions are, will I also have to open a traditional IRA to do a backdoor Roth? Well, yes you will, because the money's got to be in there for at least a day before you can move it into the Roth ira. So both of them will need a traditional IRA as well as a Roth ira. His last question has to do with the pro rata calculation. And this is one of the rules with the backdoor Roth IRA. At the end of the year, December 31st of the year, you need to have a balance of $0 in anything with the words IRA after it. That includes a traditional IRA and a SEP IRA and a simple IRA, but obviously not a Roth IRA. And the reason why is because of a calculation that has to be done on IRS Form 8606, which is the one where you report a backdoor Roth IRA. And basically, if you still have a SEP IRA, the IRS looks at all of IRAs as one big IRA. And you can't just take out the 5,500 non deductible contribution that you made into the traditional IRA out of an IRA in which also has tax deferred money. So the way you get around that is you just roll your SEP IRAs or your traditional IRAs into a 403 or a 401k, or you just pay to convert the whole thing to a Roth ira and then going forward you can just do the backdoor Roth IRA each year with a contribution of $5,500 into the traditional IRA which is then converted to the Roth IRA the next day. One more question. I was able to refinance last year with DRB for 4.25% on a five year fixed loan, down from 6.6% with the feds. I'm graduating residency this year and have a job lined up starting in July. I plugged in my data with my projected yearly salary with SoFi. They quoted me rates of 3.375% for five year fixed and 2.185% for a five year variable. I'm wondering if I should refinance again and if so, what should be my timing for doing so. Right now the interest accruing is separate from the principal with drb, which I assume will capitalize when I refinance again. My strategy of staying put would be to pay off that interest right before I enter the standard repayment phase with DRB. Right now I pay $100 a month to avoid it being added to the principal. Also, I'm not sure I can even finance with them at this second to get this rate because they ask for a pay stub to verify income. I'm wondering if they will accept a signed contract as verification. Well, a lot of questions in there. First, should you refinance again? Refinance again when you get out of residency? And obviously, as you can see from the rate quotes he's getting, that answer is yes. If you can get a better rate when you come out of residency, as you usually can, you should refinance again. The other questions he was asking in here was when should you do it? Well, you ought to do it as soon as you can. I think people worry too much about capitalizing interest. If you actually run the math on that, it's really a very minor addition to your loans. And so what you really want to do is function on the overall rate for all of the principal rather than focusing only on, you know, the capitalized interest being added to it. You've got to have a lot of capitalized interest for really to make much of a difference. Lastly, he's asking if SOFI specifically but all these companies in general will accept a signed contract as income, and most of them do. If you have a signed contract, that's usually good enough to get the attending rates on refinancing your student loans. Obviously, anytime we're talking about refinancing student loans, make sure you're not refinancing loans that somebody's going to forgive. Because once you refinance a loan, you're out of the Public Service Loan Forgiveness program. Alright, Our quote of the day comes from David Swenson, the longtime manager of the Yale Endowment. He says, ironically, upon acquiring sufficient information to assess the skill of an investment service provider, individuals end up empowered to take control of their portfolios and make their own decisions. Boy, isn't that true. It takes so much to figure out who's a good advisor and who isn't that by the time you have, you know enough to do it yourself a.

Lot of the time, do you ever find yourself wishing there was somewhere to go to ask your finance, insurance or investing questions? The White Coat Investor Community is a great place to turn we have a thriving community across all of our social Facebook, Twitter, Instagram, Reddit and our WCI forum. We have been discussing solutions to your money problems since 2011. Join the Conversation with thousands of other White Coat investors. Follow WCI on your favorite social media platform for financial resources, tips and strategies. Just head to your platform of choice and search for the White Coat Investor. You can do this and the White Coat Investor can help.

Thanks for listening today. Be sure to send us feedback so we can improve this podcast. And thanks for giving us a great rating so that we can share this message with others. See you next time.