The Top 5 Ways to Manage Your Money

I’ve written a few Top Five posts so far, and the five top items have generally been listed in no particular order. That won’t be the case today. Presenting, from best to worst, the Top Five ways to manage your money:

1. DIY (Do It Yourself)

Invest in low-cost stock and bond funds. Diversify. Invest early and often. Know the tax implications. Create an Investor Policy Statement with a thoughtful asset allocation for your portfolio. Read a book or three. Avoid costly mistakes.

Acknowledge that you don’t know what you don’t know, like the future, for example. Educate yourself. Understand that time in the market beats timing the market. When you have a question, you ask it in the Bogleheads Forum and get free advice from intelligent and experienced investors, several of whom have published successful investment books. To get started, see my comprehensive 20 Steps to Effective DIY Investing.

2. Tie (RoboAdvisor, hourly rate financial advisor/CFP)

Either an hourly rate financial advisor or roboadviser, such as Betterment or Wealthfront, can supplement a DIY approach. I’m calling it a tie, although there are certainly pros and cons to each. The structure of this list is going to be lowest cost to highest cost. Which of these two options comes out ahead depends on your net worth, since the roboadvisor will charge a very small portion of your invested assets, while the hourly rate advisor will charge… wait for it… wait for it… an hourly rate.

If you choose to go either route (or both, as they are not mutually exclusive), you had better have at least a basic understanding of your finances. You don’t have to be as well versed as the 100% DIY investor, but you need to know enough to understand what’s going on with your money. The human is going to be better able to talk you through this compared to the robot. The robot might be a better dancer.

3. Fee-only financial advisor

Consult with a fee-only advisor with a fiduciary responsibility. Such an advisor may charge an AUM fee (Assets Under Management), which can really add up, particularly when you have a high enough net worth to retire. On the plus side, a fiduciary is required by law to disclose any conflict of interest and has a “duty to care” about your portfolio and its appropriateness. The advisor will not be paid commissions and the products you purchase ought to be low cost. Your incentives are aligned. As your net worth grows, the advisor’s fee typically grows right along with it. This is a reasonable option for someone who likes to be more hands-off when it comes to personal finance.

Ideally, you will like this advisor as a person. You will be contributing handsomely to his or her retirement. A $3 million dollar nest egg with a typical 1% AUM fee generates $30,000 a year for the advisor, and comes directly from your retirement stash. Think about that.

4. The friendly downhome advisor/planner/“money guy”

insurance salesman

Invest with the friendly neighborhood fee-based financial planner, or whatever designation they are going by these days. This is an individual who does not have a fiduciary responsibility, but is held to a “suitability” standard, which is much less rigorous. Expect to be pitched whole life insurance and annuities. You can expect to be invested in “suitable” mutual funds with high expense ratios, 12b-1 fees, and perhaps a front or back load. The layer cake of fees may also include an AUM fee, and you can expect to pay a fee to transfer your money out when you realize that half of your investment gains are going into the smiling advisor’s pocket.

high school

It can be hard to say “no” to this person. He’s your son’s soccer coach. She helped organize the church bazaar. He was a drinking buddy in college, although he never graduated. And he’s a good salesman, which is what makes him successful. You can do worse than to sign on with her, but you can do much better.

5. DIY (Do It Yourself)

Invest with emotion. Get in while the gettin’ is good (buy high). Get out when the bottom drops out (sell low). Put all your eggs in one basket, and perhaps take on debt to put a couple of someone else’s eggs in there on margin. Buy the stocks recommended by the loud man on the television. Pay for the newsletter and buy the sure-things recommended there. Chase returns. Worry not about tax implications. The rich need to pay their fair share, and you’re one hot streak away from being rich. Invest in your buddy’s latest business. He’s due for success this time.

I kid, but studies have shown that the average investor underperforms the indexes by 4% to 7% by making many of these same poor choices. DIY can be good. DIY can also be very, very bad.

My rank order is essentially a list of the least costly (to your portfolio) to the most costly. To be fair, options 1 and 2 require the investor to have gained a working knowledge of investing and other matters related to personal finance. To come out ahead, you need to be have a sound plan, and be willing to stick to it through thick and thin. It’s not brain surgery, but gaining that knowledge takes requires some level of interest and a fair amount of time.

Option 3 can become costly, particularly as your assets grow, but it can also save someone a lot of time and prevent a busy professional from making bad choices (see options 4 and 5). I point out the fact that it can be expensive, but there are professionals who manage sizable portfolios for a lower fee. Even a 1% fee that prevents you from trailing the indexes by 4% to 7% is an excellent investment. NAPFA is a resource to find a fee-only advisor.

Option 4 sounds like a really bad idea when I describe it this way, and it’s how many truly oblivious investors (but not The Oblivious Investor Mike Piper) have their money managed. The storefronts are everywhere and the people inside the store are gregarious. All the best salesman are. They may be good people, but if their luxurious vacations and new F-150s are being financed by their fees, which come from your pocket, how can they truly have your best interest in mind? A conflict of interest gets in the way of sound financial principles. Your incentives are misaligned.

Option 5 is truly the worst and is frighteningly common as well. The White Coat Investor posted a list of the worst financial mistakes by physicians. It is long and frightful. Learn from their mistakes. Don’t make them.

What do you? 1, 2, 3, 4, 5, or some combination thereof? I have a little experience with No. 4 from my first IRA, but I now do No. 1 exclusively. There are times where it has cost me more than it saved, but I consider my errors to be tuition paid toward an education in personal finance that continues to pay dividends.