Work 401k Seminar Prep

As part of my job, I was recently put in charge of hiring new graduates to join our finance department. Once they start, we pair them with a mentor and I stay in touch and offer career advice and guidance as needed.

As part of my ongoing advice and guidance, I’ll be hosting a 401k seminar later this month. This is the first time I’ve done something like this, and I’m honestly pretty excited. I’ve solicited questions from the group and a couple of themes have emerged. As part of my preparation, I wanted to share some of my thoughts on these topics.

To provide some context, the audience is all 20-something recent college graduates working at their first job. We pay them pretty well (mid 50’s), are in a lower cost-of-living area, and provide some amazing benefits. Our company offers an excellent 401k match and relatively short vesting period.

401k Match – this is ‘FREE MONEY’ and there are almost no good excuses for passing this up. As an incentive to get you to contribute to the account, employers will often provide matching contributions. Make sure you’re at least getting your full match.

Vesting Period: The money your employer puts in your 401k might require you stay working there for a period of time. I’ve seen as short as 2 years and as long as 7. If you leave the company before you are fully vested, you may forfeit some of the employer contributions. The money you put into a 401k from your paycheck is always yours and you’ll never have to give it back. 

Q: What is the difference between After/pre-tax contributions and which should be a priority?

A: We have the choice between traditional and Roth 4o1k’s. My general advice to anyone is to focus on Roth contributions. This is especially true for those who are young. The difference between the two is that you end up with lower take-home pay by doing Roth, but you end up with much more in retirement. Here’s a simple example:

Either way, a 6% contribution puts $3k into your 401k. The difference today is that if your contribution is in a Roth, you end up paying slightly more taxes now, but won’t ever have to pay taxes on that money again.

If you invest $3k per year for 30 years and it grows at 8% per year, you end up with $339,000. Not bad for only investing $90,000, right? But you will pay taxes when you withdraw if your contributions are made pre-tax (traditional). All of a sudden that $339,000 is more like $288,000 (15% taxes). It’s even less if you want to take out so much that you get pushed into a higher tax bracket.

On the other hand, if you had been making Roth contributions, that $339k is ALL YOURS. This is why I sometimes say that Traditional 401k/IRA’s include ‘Phantom Money’. Even though you see the balance, it’s not all yours unless it’s Roth.

My preference is to have all of my contributions go into Roth. Since employer contributions can’t go into Roth, I’d prefer to have as much as possible actually be MINE. For those currently doing pre-tax contributions, I’d consider transitioning your contributions over.

Q: Can you talk about 401k early withdrawal penalties and payback options?

A: Honestly, I’d rather not. Long term you’ll always be better off finding ways to avoid taking money out of your 401k before retirement. While you are actively employed, the only way to get money out of your 401k is to take a loan. Loans are paid back via increased payroll deduction. Although it is true that you pay yourself back with interest, the interest rate you pay yourself is generally much lower than the returns you’d be missing out on if the funds had stayed invested.

The big risk of a 401k loan is that if you leave the company, the balance of the loan is due in full within 60-days. Any amount left unpaid is considered an early withdrawal, taxed, and penalized (if you’re younger than 59 1/2).

Several in my audience may be considering going back to school for an MBA in the next few years. To them, I would recommend avoiding student loans but definitely plan ahead and do not rely on 401k funds to pay for the degree. Although there are provisions where Roth contributions can be withdrawn without penalty, I still believe that it should be avoided before retirement.

Q: What’s the right mix of stocks and bonds?

A: This is perhaps the hardest question to answer because there really is no one-size-fits-all answer. The right mix for each person depends on your goals and risk tolerance. You may have heard that in the early stages of your career you should be as aggressive as you can tolerate, but without having gone through a bear market it’s hard to really know your risk tolerance.

There are rules of thumb out there like “120 minus your age is the percentage you should have in stocks and the rest in bonds”. Rather than give that blanket statement, allow me to share how my asset allocation has shifted over the years.

My Asset Allocation History

When I started my first 401k, I loaded up on stocks and maybe only 5% in bonds. This was back in 2006 and the market was hitting new record highs, sound familiar? A few short years later, I had built up around $25k with more of a 70/30 stock bond split. And then the financial crisis hit. My portfolio was basically cut in half in what seemed like a matter of days. This was a huge gut check for me and caused me to rethink my asset allocation. Thankfully, I didn’t get out of the market like many clients I was advising at the time wanted to.

I kept a 70/30 mix for years and was a believer of the age-based asset allocation model. When friends or family members were just starting out, I would recommend using Fidelity Freedom Funds or Vanguard Target Retirement Funds that automatically rebalance as you get closer to your target retirement date, eventually landing in a 20/80 stock/bond mix. There is nothing wrong with this approach, and for many people, it may still be a great one.

My Current Allocation Strategy

Where I differ now from the mainstream age-based strategy is that I am planning on retiring much earlier than traditional retirement age. Also, I believe that we in the DIY$ household have proven to not act irrationally during bear markets. During down markets, we don’t sell and continue to dollar-cost-average into our investments. This tells me that we can handle having a larger allocation to stocks. Our current asset allocation is over 90% stocks, and we plan to keep it that way until and during retirement.

I am subscribed to the strategy outlined in Simple Wealth, Inevitable Wealth. Simply stated, this strategy is to only invest in stock mutual funds, and during retirement to keep a cash reserve equivalent to 2 years expenses. During retirement, we will replenish cash from investments except during significant down markets. During those times, we’ll draw down cash to allow the market to recover and build the cash account back up after the investments recover.

This strategy may not work for everyone, but this is why personal finance is so personal. You need to find what works for you, develop a plan, and stick to it. That’s the important part though, having a plan vs. not having a plan. I’m sure we’ll have plenty more to talk about, but these are the thoughts I’ve collected thus far.

Overreaction leads to Underperformace

Have you ever heard of the Dalbar study? This company does an annual study that looks at the impact of investor behavior on returns. What they’ve found is that over time not only do mutual fund investors underperform the market, but they also underperform the underperforming mutual funds. Wow…that’s a lot of underperforming.

This underperformance is attributed to picking the wrong mutual funds and getting in and out of the market at the wrong times. Since it is impossible to time the market, I would argue that it is always the wrong time to be getting out of the market.

Here’s an example of a chart Vanguard put together using data from the Dalbar study:

source: Vanguard

What do YOU do when the market gets scary?

The answer to this question should be “nothing” or “buy more”. Sadly, research shows that many people do exactly the opposite. Selling everything when things are scary can feel good and provide a sense of safety in the short term. These same people will buy back in ‘when the coast is clear’, which typically means prices are much higher than when they sold in the first place.

For your long-term investment strategy, sitting out of the market is the one big mistake that you can’t afford to make. With craziness looming in North Korea and other parts of the world, it would be easy to self-justify getting out of the market right now. But when do you get back in?

Do you remember how Greece’s economy was going to destroy global markets? How about the fiscal cliff and government shutdown? Oh, and let’s not forget about the debt ceiling or the flash crash. For eight years the market has continued to rise, quickly recovering from any number of fear-inducing events. Over longer periods of time, short-term declines aren’t even noticeable.

It can best be summed up by a chart I have framed on my desk at work from Behavior Gap.

The Value of a Financial Advisor

I am a Do-It-Yourself investor. I think most anyone can successfully manage their investments without a financial advisor. Financial advisors will point to the chart above and argue that you need to have your accounts professionally managed to protect you from yourself. While there may be some truth to that, I think all you need is someone who can talk you off the ledge.

Even though I am a DIY investor, I have a financial advisor. He is someone I used to work with and trust his judgment and integrity. He doesn’t manage my accounts, but I get free dedicated access to him because of the size of my accounts. We talk a few times a year and he helps validate that I’m still on track to reach my goals.

If I ever were considering selling everything, he would (hopefully) be able to talk some sense into me and prevent me from making that huge mistake. The real value of a financial advisor is when they can remind you of your long-term goals in times of short-term uncertainty.

I’m considering breaking one of my own rules

When I was a financial advisor, many of my clients worked for publicly traded companies and often had significant portions of their nest egg invested in their employers stock. Many companies have employee stock purchase plans (ESPP) that allow you to purchase stock (often at a discount) that accumulates similar to a 401k, but without diversification. A lot of large 401k plans also have company stock as an option for your 401k contributions. Combine these two methods of buying company stock with paternalistic companies with multi-generational histories and you end up with people who have 90+% of their net worth tied up in company stock.

My advice was always to sell off the company stock and diversify. Did no one learn anything from Enron? If you have too much of your world tied up in company stock and things go south, you have risk of losing your nest egg AND your job. It is riskier for you to own shares of your employer than it is for someone who doesn’t also work there. Trying to convince people to sell company stock was always a difficult conversation, and I likened it to telling someone their kids were ugly. Holding the same stock for decades, people often would feel that the stock was partly responsible for their financial success, even if the stock had been a terrible performer.

My current employer is a large, publicly traded company, and I have made it a point to avoid buying any shares of stock. In addition to my concerns about diversification, because I work in finance I often have access to confidential information and so am only able to trade the stock during certain times (i.e., no transactions allowed near earning release dates or other major events).

From the time I was hired, our stock is up considerably (>3x), but so far this year hasn’t really kept up with the rest of the market. I attended a leadership meeting this past week and while listening to the CEO and CFO speak, I found myself thinking “Wow, we’re doing really well and our future is bright. Why don’t I have any shares of our stock?” I came home and mentioned this to my wife thinking/hoping she’d tell me to snap out of it and don’t do something stupid, but instead she just said “if you want to buy a few shares, just keep it small.

In the not too distant future, I could be in a position where a portion of my compensation is given in the form of company stock. At that point, what I decide to do with the stock will make a larger difference in my overall plan. My current strategy for stock received from my employer is to immediately sell at least half of any stock given, but to keep a small amount to show confidence in the work I am doing. Keeping stock that was granted to me somehow feels different than proactively going out and buying shares on my own though.

So here I stand…I’m probably only talking about a couple hundred dollars, which really isn’t going to make a difference long term, it’s more about the principle and not wanting to deviate from the advice I’ve given to so many other people.

Your own worst enemy

Last Tuesday 8/25, the S&P 500 closed down for the 6th straight day, with losses over the 6 sessions of more than 11%.

On the same day, investors sold $19B from equity mutual funds. This was reported to be the 2nd largest day of redemptions since daily data became available in 2007. Only time will tell whether this was a good time for investors to sell, but history tells us that it was likely a poor decision. While they may have avoided some short-term losses, we have seen that most of these investors will not re-enter the market until it has recovered to a higher point than when they sold.

This level of market movement isn’t new, but if you behave as many investors did last week the decision has a lasting impact. Charles Schwab recently released a report showing the portfolio growth of investors making similar decisions over time. A buy and hold investor ended up with nearly double the assets as the investor who reacted by selling in bear markets. If you find yourself selling out of the market out of fear, you are acting as your own worst enemy.


Be careful out there

The market had a rough day today, to say the least. At one point, the Dow was down more than 1,000 points and ended up down 588 points, or 3.6%. Personally, I checked our account balances and we are down over $10,000 in the past few days. It’s important to remember though that we haven’t lost anything because we haven’t sold anything. I’ve recently reflected back to 2008 when we last saw these types of declines. I didn’t sell back then, but remember my investment accounts getting cut in half from ~$25k to ~12k. Now that I have a considerable amount more invested I have been reflecting on how to make sure I keep the same discipline given that the dollar amount represented by the same percentage movement would be >10x what we experienced in 2008. In the back of my mind, I always know that a 6-figure loss is possible, but the dollar amount makes it feel like a lot more than saying “25%”. The best answer I have for myself at this point is to remember that I am working with a long time horizon, that it is impossible to time the market, and that I shouldn’t even try.

I used to tell clients that they should have the most aggressive portfolio that they were comfortable sticking with through all the ups and downs. Even if it is in an investors best interest long-term to be heavily invested in stocks, I knew that if they didn’t have the fortitude to stick with the strategy they may actually be better off avoiding stocks. No matter what portion of your portfolio you have targeted to be invested in stocks, the recent selloff is likely an opportunity to rebalance and buy more. I didn’t get the chance to buy more stocks today, but plan to do so shortly.

I have previously documented my intentions of allocating more of our assets to stocks, so any buying I do was already planned before recent large market movements. The most important thing to remember in this type of market is to make sure any transactions you make are not based in fear. As a co-worker used to always say: “Be careful out there”. Don’t be like far too many other people who make the mistake of selling stock positions AFTER big losses.

DIY Within a month

within a month


I recently came across this gem of a quote and had to share.

“There is nothing in ordinary gardening, carpentering, or work about a house that any intelligent man cannot learn in a month by giving his mind to it.” William J. Dawson, The Quest of the Simple Life

Personal finance isn’t all that different from home improvement projects in this sense. This is not to say that you can master something in one month, but if you truly dedicated every spare moment to it, it’s amazing what you can learn in a relatively short amount of time.

Investing in a 401k


I recently met with someone who has decided to begin investing in his work 401k but didn’t know how to get started. He had all of the plan literature from when he got hired, but had ignored it because he didn’t really understand it and it seemed like so much information that he didn’t know where to start. Unfortunately, I’ve found this response to be common. In an effort to remove some of the roadblocks to getting started, Congress now allows employers to automatically enroll new employees into their company 401k into default investments (usually ‘target date funds’). While this is a good start, it certainly isn’t enough. Below I will walk through the decisions you need to make when investing in your 401k.

How much should I put in to my 401k?

  • Your 401k through your employer can be a great place to invest. My rule of thumb is to invest whatever you need to in order to get the full employer match. Every 401k is different so you’ll need to look up your plan specifics. My employer matches up to 5%, so I make sure that I always contribute at least 5%. The person I helped the other day was eligible for a 50% match up to 6% contributions (so if he put in 6%, the employer matched with 3%). If you are able to save more than what your employer will match, you should set up a Roth IRA on your own. Why not just max out your 401k? Generally speaking, your 401k is going to have limited investment options. If you wanted to invest in something that wasn’t in the lineup, you wouldn’t be able to do so. Maybe the fund choices are great, maybe they’re not. I would only recommend adding non-matched money to your 401k after you have already maxed out your Roth IRA for the year (current maximum is $5,500 for IRAs).

Pre-tax or after tax?

  • Whenever possible, and with few exceptions, I recommend making your 401k contributions AFTER-TAX. This means that the money you are adding to your retirement is invested after you have already paid income taxes on it, but also means that when you withdraw it, you can do so TAX FREE. Money that your employer contributes to your 401k, or that you put in PRE-TAX, is considered taxable income when you withdraw it in retirement.
  • To illustrate the true power of TAX FREE growth, consider this example. If you invested $5,000 per year over the course of a 30 year career and earned an average return of 10%, you would have over $800,000 at the end of 30 years. How much is actually yours (as opposed to the tax man) depends on whether you put the money in before or after taxes.


  • Make sense now? I’ve talked about the power of compound interest, but here again you can see that of the if you invest for a long period of time the majority of your account ends up being earnings. The first column shows how much you’d have if you simply put $5k/year under a mattress and the second column is if you put it into a savings account (assuming a 3% return, which is currently very high but average over a long period of time).
  • The advantage of a 401k is shown in the last three columns. Under each of the three scenarios, I am assuming that you earn an average return of 10%, the only difference is how and when you pay taxes. If you invest $5k/year outside of a 401k, you’ll have to pay taxes on earnings as they happen and end up with the middle column, or about $500k. Not bad. However, if you invest in a 401k, you don’t have to worry about taxes each year, so you’re able to keep the entire amount invested and growing. You actually end up with the same amount in your account whether you are contributing PRE-TAX or AFTER-TAX, but the difference is if your account is PRE-TAX, then only about 75% of that money is actually yours, the rest you’ll have to pay to the IRS as you withdraw. If you withdrew the entire amount all at once, your tax rate goes up and you get to keep even less than that.
  • The takeaway here is that if you make annual contributions of $5k PRE-TAX, you end up getting an annual tax benefit of ~$1,250, but end up paying about $200,000 in taxes down the road, whereas if your contributions are made AFTER-TAX, you don’t get the tax benefit now, but end up paying a lot less in taxes over time.

How to invest the money once it is in the 401k

  • The most important part of saving for retirement is to actually put money in your account. The second most important thing is to minimize taxes. Once you’ve done this, the next most important part about saving for retirement is how you actually invest. This topic is often the part that is considered the most confusing or intimidating part of investing, but it doesn’t have to be. Unless your 401k plan has hundreds of investments to choose from, I generally recommend one of two different options, and it is dependent upon how much time and effort YOU want to put into managing your account.
    • Age Based Strategy: The aged based strategy is what I would recommend for someone who prefers to be hands off, doesn’t want to pay additional fees for customized professional management, and who has not yet done significant research into the various investment options that exist. Nearly all 401k plans will offer this type of strategy and you can often identify it by the funds including the target year (2020, 2030, 2040, etc). These tend to be very diversified and are invested with the assumption that you plan to retire in or near the ‘target year’ mentioned in the name of the fund. While I do NOT have any of my own money invested in these types of funds, I don’t lose sleep knowing that I have friends and family invested in them when they are bought for the right reasons.
      • A thought about Age Based Funds: I have frequently seen investors buy multiple different age based funds in their 401ks. I met someone recently who was wanting to retire in 20 years and had invested his 401k across several different age based funds (He had 2020, 2030, and 2040 funds). These funds are generally structured so that you only should be buying one, and investing the majority of your assets in that one fund. If you were to look at what the funds are invested in, you’ll see that you don’t get any additional diversification by having a different target year fund (they will generally invest in the same things, just in different percentage allocations). If, for example, you were to invest half in a 2040 fund and half in a 2030 fund, you’ve essentially just created a 2035 fund, which is probably a separate fund you can choose. If you feel that you need something more customized than this and want to do the leg work, you should build your own portfolio using other funds.
    • DIY Asset Allocation: This is the method that I invest in my personal 401k, and the method I recommend for anyone looking to manage their own 401k. Because the majority of 401k’s only have limited investment options, I almost always recommend looking for the index fund options. Index funds are invested to match the performance of an index, like the S&P 500, whereas other funds are invested to try and beat the market. There is a lot of debate out there as to whether mutual funds even can beat the market, but the data clearly shows that many funds do not do as well as the index they are trying to beat. Because you generally only have a few choices for funds in your 401k of the thousands of funds that exist, the odds of your employer selecting the best of the best actively managed funds in all categories in all times, is virtually zero. Once you eliminate the actively managed funds from your selection, you will probably be left with only 3-6 funds to choose from.
    • The next question you need to ask yourself is: How much risk can you handle? For these purposes, risk can be measured by the portion of your account invested in stocks vs bonds.
      It has been said that the younger you are the more aggressive an investor you should be. While I agree with this in theory, it isn’t a perfect one-size fits all approach. I would add two additional considerations. 1) If you are invested so aggressively that you lose sleep worrying about losing money, or if you find yourself frequently wanting to sell everything, you may want to invest with slightly lower exposure to stocks than your age would dictate. If you do this, you should understand that you’ll need to be saving and investing more to compensate for the lower returns you should expect. 2) If you are reasonably confident that you will NOT need to use a portion of your assets in your lifetime, and plan to leave an inheritance to your heirs, you should invest that portion with THEIR timeline in mind and not yours. This means you may have a more aggressive portfolio than your age alone would indicate.
    • The way I have invested my 401k is to put 50% in the S&P 500, 10% in International stocks, 10% in Small/Midcap stocks, and 30% in bonds. Roughly once per quarter, I will look at my account balances and see how this has shifted and rebalance back to the same mix. Over time, one would expect stocks to outperform bonds, so naturally the 30% in bonds may shrink. Gone unchecked for long-enough, the bond allocation could shrink so much that my whole account is more aggressive than I intended. Periodically rebalancing is a process to naturally ‘take earnings off the table’, by reducing exposure to whatever has had the best relative performance.


TAKEAWAY: The most important part about investing in a 401k is ACTUALLY PUTTING MONEY IN YOUR ACCOUNT. The next step is to make sure you’re doing so in the most tax efficient manner. Lastly, you’ll want to make sure that whatever you’re investing in is right for you.

Do you have any questions about your 401k?

Don’t invest in anything you don’t understand

When I would meet with prospective new clients, the main reason they said they were looking for a new financial advisor was poor performance. What I often found in these cases was that their former advisor had not done a good job of helping the client understand what they were invested in and why. As a result, I would find portfolios that didn’t make sense, had high fees built in, and the client had no idea what they were invested in.

The most common example I would see would be when someone had bought a variable annuity and had no idea how it worked, why they owned it, or what benefit it provided to their overall financial plan. In these scenarios, the penalty for ending the contract early often outweighed the savings they could realize by doing so, so they were effectively stuck with a poor decision for several years. In many cases, had they understood what they were investing in and why, it is unlikely that they would have actually made the investment.

Only investing in things you understand sounds obvious, but the fact that some of the worst financial products continue to be sold is proof that it isn’t. Individual investors aren’t the only ones guilty of this. In the run up to the financial crisis of 2008, the city of Narvik, Norway, lost $64 million investing in synthetic CDO’s, a complex product that essentially was tied to sub-prime US mortgages. A good book that talks about this in greater detail is David Fabers “And Then the Roof Caved In”.

Investing in things you don’t understand doesn’t always end poorly, but should be avoided nonetheless. Back in early 2008, I bought shares of Visa (V) right when they first began trading. I paid around $59 per share and held them for about 6 ½ years, selling for around $260 per share, earning an average annual return of 24%. Sounds good right? The problem with this investment was that when I bought the shares, I didn’t know how Visa made money! I figured it would be a good investment just because of the ubiquity of the brand name, but didn’t really know what would have made the stock go up or down. Did you know that credit card companies make money every time you use your card, but aren’t actually loaning you any money? This has become more common knowledge now that products like Square are allowing anyone to accept credit cards and pay swipe fees, but back in 2008, it was something I didn’t yet know. This investment worked out well for me that time, but I attribute all of that to luck and not to my own understanding of the investment.

One thing I’d like to make clear though, is that although you should never invest in something you don’t understand, not investing in things you don’t understand is not an excuse to avoid learning about investments. Just like starting to save early will have compounding benefits in the values of your investments, the sooner and more you can learn about ways you can invest your money the better. The benefits will compound as many different investment types are interrelated and you can understand how several work by learning the basics.

To help avoid investing in something you don’t fully understand, here are few questions you can ask yourself before taking the plunge.

  1. What factors will contribute to your investment going up or down in value?
  2. Are there any risks unique to this investment that wouldn’t affect the overall economy?
  3. What are some comparable alternatives and how have they done? Why is this investment better than the alternatives?
  4. Who is recommending the investment and what are their incentives?
  5. What are the costs, upfront and/or recurring?
  6. How do you get money out and how long does it need to be kept in?
  7. Are there any guarantees? If so, who provides the guarantee and what exactly is guaranteed?
  8. If there is a guarantee, how often in the past XX (100?) years would I have needed the guarantee? (hint – the answer is likely close to 0, and if so, you probably don’t need to pay for that guarantee).

If you can comfortably answer these questions, you’re in a good spot and should have a decent grasp on what you are investing in. The idea here is not to be so knowledgeable that you can run your own mutual fund, but rather have enough of an understanding of what you’re putting your money into that you are making a conscious decision of how to invest your money rather than simply doing something because someone told you to do so.

If you’d like to get a good handle of the basics, one of my favorite books for that purpose is Learn to Earn, by Peter Lynch. It’s a book I’ve given to recent high school graduates or college graduates and it explains very simply how mutual funds work.


Types of Financial Advisors

Remember when I spent a short stint working as a financial advisor getting paid 100% commission? This experience helped me learn how important it is to know the different types of financial advisors. Even if you don’t want to BE a financial advisor, you will likely interact with a financial advisor at some point, so it’s a good idea to know which type of advisor is best for you. The easiest way to differentiate between advisors is the way that they are paid. How an advisor is paid will determine what they are able to offer you, and can also be a sign of potential conflicts of interest. For simplicity, I’ll combine these into three groups, commission based, fee-only, and salary based advisors.

  1. Commission based – This is perhaps the most common way that an advisor is paid. This is also known as a broker. Whenever you make an investment through a broker, you are charged a commission (whether or not you realize it), which goes to pay the broker. Seems pretty straightforward, right? Unfortunately, it’s a lot more complicated than it sounds. You may or may not be aware of how much you are paying in commissions, and even if you think you do know, there are likely other behind the scenes payments that occur that you aren’t aware of. Another problem is that different investment products pay different rates of commission, with those that pay the highest commission often being the investments that are the worst things an investor could buy. When I worked under this pay structure, I saw this conflict of interest daily and usually saw co-workers leading with the highest commission paying products first. For example, if a broker sells a variable annuity or a private placement, they could earn as much as a 10% commission, quite a bit higher than if they were to sell you loaded mutual funds that pay a 5% commission up front. I don’t care who you are, earn twice the money for recommending one thing over another and you’re going to see the higher commission investment recommended more often.


    Unlike other critics of the commission model, I’m not 100% opposed to working with an advisor that earns a commission, where I do have a problem is when commission represents the vast majority of pay.


  2. Fee Only – A fee only advisor is just like it sounds, they only are paid in fees, and those fees can only come from you and there are no behind the scenes financial arrangements. A fee based advisor works for you, and when you enter into a relationship with one, you should have a clear picture of what to expect from them and how they are paid. Currently, a fee-only advisor is held to the fiduciary standard, meaning their recommendations must be in your best interest. This type of advisor could charge you in the $150-300 per hour range for things like financial planning, but the most common way a fee-based advisor is paid is on a percentage of assets. This means that they are actively managing your investments and charging you a set percentage based on how much they are managing. As your account balance goes up or down, so does the amount they can collect in fees. This is typically as high as 1%, but generally decreases the more you have invested.

    The challenge with this model is that most of these advisors will have high minimum account balances, usually requiring at least $500,000 to $1,000,000, making it nearly impossible for the average investor to work with a fee-only advisor until they are well on their way towards wealth accumulation. Lately there have been ‘robo-advisors’ popping up that attempt to offer the same service in a web-based, automated solution with minimal contact with an actual person, but I believe that these are still untested. The true test of the robo-advisors will be how they perform in a market downturn. I spent a lot of time in down markets trying to convince clients not to sell everything, and a lot of time in up markets trying to convince (in some cases the same) clients to not invest too aggressively. I’m not sure how well an automated system can reason with a human.

  3. Salary based –A salary based advisor generally can act as a broker or as a fee based advisor. Because they are licensed as both types of advisors, they can earn commissions when acting as a broker, but if they are acting as a fee-based advisor, cannot earn commissions. This can be confusing, so keep in mind that if you aren’t clear how you are being charged, the advisor is acting as a broker. To my knowledge, it is mainly large discount brokers (E*Trade, Fidelity, Schwab, TD Ameritrade, etc.) who will have this structure, and my belief is that it is done this way not to be schizophrenic in their business model, but rather to be able to offer as many different services as possible. These companies are generally in the business of having as many assets under administration (AUA) as possible, whether managed on a fee-only basis or on a commission model. An advantage of this is also that you can typically meet with a representative from this type of company when you are just getting started and don’t have to wait until you have accumulated the large minimums most fee based advisors require. They will also often have much lower minimums for fee-based relationships (between $50,000 and $200,000).


    When I worked under this model, my pay was roughly 25% salary, 25% commission and 50% bonuses that were based on customer retention, referrals, and customer satisfaction survey results. Yes, I was earning commissions, and yes, the commission rates were different depending on the product sold, but the difference in commission between products was very small. If a client invested $1,000,000, the difference between the highest and lowest commission I could earn was only $400. My real incentive was not to sell the highest commission generating product, but rather to develop strong relationships with my clients and to retain their business, whether that be fee based business or commission based business.

Should you find yourself needing a financial advisor, my recommendation would be to steer clear of the 100% commission based broker. Not only will you be paying fees and commissions, but they will likely be much higher than you are aware, and much higher than if you were to work with one of the other types of advisors.

If you’re curious how a financial advisor is paid, it should be as simple as asking the person you are meeting with. If you’d rather research on your own or before going in for a meeting, dig around on the company website and you’ll likely find what you’re looking for. Fidelity and Schwab have actually published their compensation details on their websites.

Step 5 – Grow Your Income – Financial Offense vs Defense

It’s been said that “Offense wins games, Defense wins championships”. Similar to sports, you need good offense and defense to be successful financially.

I like to refer to things like budgeting and frugal living as financial defense. Spending money can be very easy, and have good financial defense ensures that you aren’t spending everything you earn and are saving and investing for the future.

Financial offense is your income. Growing your income and career are some of the best investments you can make to enable financial success.

Financial success is NOT guaranteed with a higher income, but it certainly helps.

To illustrate this point, let me share an interaction with a prospective client several years ago that I will never forget. He called my office and asked to set up an appointment with a financial advisor. Our office had 8-10 different financial advisors, and like many financial service companies, we generally determined what advisor a client was paired with based on the amount of money they had to invest. This segmentation of clients is common since different strategies and complexities exist for larger portfolios than smaller portfolios that may not have as many alternatives. The prospect wasn’t very forthcoming about his investments, but assured the scheduler that he probably should meet with the most experienced advisor in the office. When he came in, it wasn’t long before we realized that he was the poster child for the phrase “all hat, no cattle“.

This prospect bragged that for the preceding 8 years, his income had been between $500,000 and $800,000 per year as an attorney, and felt he had reasonable expectations for that income level to continue. Clearly he had done well growing his income and playing financial offense. The problem though was that he was not very good at financial defense. His total investable assets (checking/savings accounts, investment accounts, retirement accounts) were only about $100,000. Where did it all go? Well, he had a beautiful house and an equally beautiful vacation home, both of which were worth considerably less than he owed on them. He also had multiple very expensive luxury vehicles with very large car payments. If that wasn’t enough, he also felt that his income justified picking up aviation as a hobby, so he had bought a small airplane for $300,000 or so. In total, his debts were approaching $2 million and he had a negative net worth. It was hard to believe that someone with that high of income could be living paycheck to paycheck.

Sadly (or maybe not so sadly), this person never ended up becoming a client of ours. He didn’t have enough investable assets to meet my minimums, and our philosophies differed so much that it wasn’t worth making an exception.

On the flip side, I have met several people who have become millionaires while earning average $40-50,000 incomes, but mastering financial defense.

The point of this is that YES, growing your income is useful in building wealth, but doing so can be meaningless if financial defense isn’t also practiced.

In the next post I’ll continue discussing financial offense, including my income history and what I’ve done to grow my income.