Financial Planning for Doctors

It is no secret on this site that I am a fan of independent insurance agents and fee-only financail advisors.  The reason why is that I believe this is the best way to minimize conflicts of interest, because – at the end of the day – as a consumer of financial advice it is your job to get the best advice at the cheapest price and with the least conflict of interest.  The independent insurance agents and fee-only advisors recommended on this site can help you do just that.  And they certainly help you avoid the two worst ways to pay for financial advice as outlined below by the White Coat Investor.

Today’s post is a WCI network Saturday Selection, which was originally published on The White Coat Investor.  Take it away, WCI.

The Worst 2 Ways to Pay for Financial Advice

I thought I would share two emails I received in a 24 hour period earlier this year. They are very similar to other emails I get multiple times a week and demonstrate very well why I believe paying commissions is the absolutely worst way to pay for financial advice.

My Least Favorite Way to Pay for Advice — Commissions

Lots of advisors I interact with like to discuss the intricacies of and the possible rare needs for financial products like cash value life insurance. But they don’t see the damage being done by financial salesmen masquerading as financial advisors. These emails demonstrate that problem better than anything I could possibly write:

Email # 1

I am a hospitalist; I love your website and have learned A TON from your posts about investing. So my question is regarding a front load SEP-IRA (my wife’s) and my Roth IRA (also filled with front-loaded mutual funds) we have through Northwestern Mutual vs. doing stuff on my own through Vanguard. My financial guy (CFP) is telling me that in the end I will make more with front loaded mutual funds (about 4%) vs. a Vanguard fund (he says they charge 1% a year on the fund which I cannot find anywhere on their website). I think he is just trying to stop me from transferring all my money to Vanguard. What do you think?

Email # 2

First of all I want to thank you for what you do.  It’s because of you that so many thousands of professionals have a firmer grasp of personal finance and the steps they need to take to ensure fiscal health.  I first got turned on to your blog a few months ago by a colleague, and the knowledge I have gained as a result is beyond measure.  Here’s an example of how I personally have benefited.  As many others, I am a victim of unscrupulous financial planners.  Toward the end of my residency in Anesthesiology, we were approached by a couple of financial advisors who had arranged to hold a seminar/sales pitch at our hospital after hours.

How they were even allowed to do this is beyond me, but there they were, extolling the virtues of their services as “specialists in physician financial management”.  Wanting to get started on retirement planning, but not having a plan in place, I signed on.  And there began the pouring of my money into high load mutual funds and life insurance.

The funny thing is, from the beginning, I never fully trusted them, and constantly wondered if their guidance was really in my best interest.  But with my complete lack of financial literacy, I wasn’t able to validate those suspicions.  Worse, I didn’t even know how to go about investigating the question!  And anytime I did manage to feebly inquire why they had me in these high cost mutual funds with 5% loads at Fidelity, they always had slick (and confusing) answers that I had no power to comprehend, let alone refute.

Then when I had built up enough of a portfolio, they moved me to “cheaper” institutional funds where each fund had an ER in the 1.5-2.5% range AND an additional 1.1% fee for all AUM.  But, finally, after reading your blog and some of the selected works you recommend, I gained the confidence I needed to dump those advisors, liquidate my funds and move them to Vanguard, and come up with my own asset allocation and investment plan.

As a result I’ve already saved hundreds if not thousands in unnecessary fees, and I finally feel like I’m in control of my financial future.  Anyway, I know that’s a long story but I wanted to illustrate just how helpful you’ve been to me and I’m sure many others who come out of residency both very competent practitioners and very lousy stewards of their money.  NO MORE!

But I do need some advice on one other remaining problem and I’m hoping you’re willing to provide it. The other way these guys screwed me is by getting me into an indexed universal life policy.  I started paying into it in October 2010.  So far, as of this month, I’ve paid 33,800 in premiums, and my cash value is 31,427.  The surrender value is 25,894.  So during the last 4.5 years, while we watched the stock market’s meteoric rise, I ended up thousands in the negative, and I lost out on a real opportunity for gains that I may never see again.

Commissions

As perfectly exemplified by the experience of these doctors, the very worst way to pay for your financial advice is through commissions. If you do so, you are likely to be receiving bad advice, and probably at an unfair price. The worst financial products pay the best commissions, so the advisor, even if he were competent, is facing a terrible conflict of interest. However, most of these advisors have had little to no training, and the training they have had is in sales. The bottom line? Don’t pay for your financial advice using commissions or you’re likely to end up like these docs, paying loads, high expense ratios, and commissions on lousy mutual funds and life insurance policies and maybe even an additional Asset Under Management (AUM) fee.

The worst financial products pay the best commissions, so the advisor, even if he were competent, is facing a terrible conflict of interest.

The Second Worst Way To Pay For Advice — AUM fees

Speaking of AUM fees, I consider this the second worst way to pay for advice. It’s not as bad as commissions, since the advisor is being paid directly by you and only for their advice and service. So it is truly fee-only, but there are still five significant problems with this model.

5 Problems With the AUM Fee-Based Model

# 1 Conflicts of Interest

Paying commissions and AUM fees is never any fun. Add yours up to see if you’d be better off with an hourly or flat-fee advisor.

You still have a conflict of interest. The advisor gets paid only for money under his management. So if he’s not managing your 401(k), but is managing your IRA, he may advise you to do a 401(k) rollover, even if you’re in a great 401(k) or maybe should be doing backdoor Roth IRAs (and thus don’t want a tax-deferred IRA.) The advisor is also more likely to recommend against paying down student loans or mortgages. Not to mention investments managed by someone else, like real estate.

# 2 AutoPay

AUM advisors generally withdraw their fees from your account rather than asking you to write a check to them. Being “out of sight and out of mind” has the effect of you being anesthetized a bit to just how much you are paying. If you actually have to consciously pony up the cash every year, you might be more likely to negotiate, move on to a lower cost advisor, or learn to do it yourself.

Paying AUM fees doesn’t have to result in higher fees than paying an annual retainer or an hourly rate, but too few investors with advisors ever really add up all the fees to see just how much they’re paying. Advisors don’t like clients who do that sort of thing. They’d much rather fill their client rolls with nice “price-insensitive” doctors who feel they’re too busy to deal with “the little stuff” and love how the advisors tell them how important they are and how valuable their time is. Meanwhile, the advisors are laughing all the way to the bank.

They wouldn’t even think about working for the mere $100-300 an hour that the doctor is working for. Doctors think the advisors are the “hired help” when in reality, it’s just the opposite. The best-paying jobs, and certainly the jobs with the highest ratio of income to education/training required, are owning a business that manages other people’s money. AUM advisors might argue that investors really want their fees out of sight because it is psychologically too painful to pay them up-front, and if they quit paying them, they’ll be worse off due to their behavioral mistakes. I find that patronizing, although it may be true for many investors with little knowledge and poor discipline.

So why do advisors try to specialize in doctors? Because doctors have money. But guess what? They don’t look at all doctors the same. They would much rather advise an orthopedic surgeon than a pediatrician. The capitalist in me knows why. If I were an advisor, I’d charge AUM fees and find as many highly paid specialists as I could find to advise. The capitalist in me can easily see it is a great business decision. But the consumer in me can’t help but cry “Foul,” or at least, “Caveat Emptor.”

# 3 High Minimums

Another issue with AUM advice is that the advisor has very little incentive to help you with your money when you don’t have much money, which is precisely when you can benefit most from good advice. Minimums are often as high as $1 Million, but almost always at least $100-500K. If a flat annual fee or an hourly rate is good enough when your assets are under $100K, they should be good enough when you have $10 Million.

# 4 Rates Come Down Too Slowly

It simply doesn’t take twice as much time and effort to manage $2 Million as $1 Million. Some advisors seem like they’re lowering costs by offering to manage that second million at 0.9% instead of the 1% they charged on the first million. But come on, that means you’re charging $19K a year instead of $20K a year. Some discount. If they really wanted to charge a fair price, they’d charge 1% on the first million and 0.1% on everything above that.

Speaking of decreasing rates, you always want to be sure exactly how that advisor is charging for the “second million.” Is the fee 1% of the first million and 0.75% of the second million, or is it 0.75% of EVERYTHING once you have over $1 Million. It’s different for every advisor, so be sure you check.

# 5 You’re Someone Else’s “Great Investment”

So, while paying AUM fees is far better than paying commissions, I’d much rather see doctors paying an annual retainer for investment management and hourly rates for financial planning. I probably wouldn’t pay an AUM fee at all, but I certainly wouldn’t do so without adding them up so I could compare them to a flat-fee or hourly advisor.I had a fee-only advisor remark to me that “AUM fees are the best kind of passive income.” Well, do you really want to be somebody else’s best investment? He’s right, of course. The income comes in year after year after year, gradually increasing, while the work required goes down as the years go by. Most investment plans are eventually pretty automatic. Even if the advisor has to do some hand-holding during a bear market every 5 to 10 years, no big deal.

What do you think? How do you pay an advisor? Do you like that method? Why or why not? Comment below!

6 thoughts on “The 2 Worst Ways to Pay for Financial Advice”

    • I would love to talk about that. It seems that if I were counseling the patient in that situation – and it was truly the same work – I would recommend they go to the one for whom they have to pay $3,000. Just like I’d advise a financial planning client to get the best advice at the lowest price with the least amount of conflict of interest.

      That aside, I’d love to hear how a financial advisor who determines their own fee is the same as our complicated (and admittedly broken) health care system where there is a middle man called an insurance company?

      P.s. I didn’t write this one, WCI did.

  1. Lol at your 5 “reasons” you don’t like AUM fees.

    #1: that’s just called not trusting people… Your doctor’s in this case have the same conflict you describe. They could recommend you come see them instead of going to a cheaper urgent care. Should we not hire doctors?

    #2: Your issue is with AutoPay?? LOL if you think clients are going to consider this the same as their Nextflix account and just ‘forget’ how much they are paying. Also most brokerages have all their fees disclosed on every monthly statement soooo I guess you’re just saying people are too stupid to check?

    #3: yes because we all know that clients with only $100k have the same needs as the client with $10mm…. The irony is that you actually make the point for higher minimums here. Think about it, if the fee is $150/hour, would the person with only $100k in a 401k and a negative personal balance sheet going to ever approach an advisor? You’re just white-knighting for millionaires.

    #4 Let’s ignore the fact that you can’t even do simple math here (.9% of $2mm is….?) and just continue to take advice from you about who to choose for managing our finances. Yes, everyone should ask what there are being charged, just like we do with literally everything else in our lives.

    #5 Ahh, the thing I like about this is that you really wanted to clean this up with 5 “reasons” but clearly ran out of material. Again, you just assume that people are ready and willing to pay for nothing.

    I look forward to seeing you defend this heap of trash!

  2. Sorry I wasn’t clear. The difference in cost IS for the same physician and for the exact same procedure. The difference in cost is whether a patient has health insurance, the insurance companies negotiated rate, the network and whether the patient self-pays. The physician controls which insurance companies, networks, and at what price they will receive reimbursement.

    This happens everyday to people who are private pay, who have high deductibles and copays, who are not in network, or have a poor rate negotiated through their typically nongroup health plan. Usually, it is near impossible to find out exactly what your bill will be for a given service. Many physicians seem to be clueless as to how their services will be billed.

    “I’d advise a financial planning client to get the best advice at the lowest price with the least amount of conflict of interest.” I certainly agree with you about that. How do you know your are getting the best advice or even good advice? Much like when I visit a physician.

    Also, how about the huge inherent conflict of interest, often undisclosed or more likely buried in fine print now a days, created by the physicians who own surgery centers, labs and diagnostics equipment such as MRI’s and CAT scanner?

    Yes, you didn’t write the article but you republished it.

  3. Hey Mark. I’m the author of the article. I certainly agree with you that if there is an industry that is worse than financial services with regard to lack of transparency of pricing it’s health care. But fixing that is not the mission of The White Coat Investor. If you’d like to start a blog to address that I encourage you to do so.

    Addressing your other points:

    # 1 I agree all models of financial advice have conflicts of interest. If someone gets paid, there is a conflict. I think the worst is commissions, the second worst is AUM fees. I’d be more willing to trust if I didn’t see so many doctors getting ripped off.

    # 2 Yes, I agree people should be smart enough to actually check and see what they’re paying. But unfortunately, you and I know that there are thousands of doctors who have no idea what they pay in financial advice. They’d know better if they wrote out a check every time.

    # 3 I do “white-knight” for millionaires. Thanks for pointing that out. But I don’t have a problem with a minimum fee. I have a problem when there is no maximum. And yes, I know lots of docs with $100K (or more likely -$100K) who are more than willing to shell out $150/hour or more for advice.

    # 4 Good catch on the typo. Turns out nobody’s perfect. Not that it matters of course as $18K is just as “too high” as $19K considering there are folks willing to do it very well for $3-10K.

    # 5 It’s a good enough reason for me, but apparently not for you.

    I won’t be responding further here, if you wish further response from me, leave a comment on the original.

  4. Hello Jim. Thanks for weighing in. You have attempted to justify your position (some of your points are valid others not so much) while totally skirting the issue I raised of the immense and largely undisclosed medical conflicts of interest. Financial service non-disclosure pales in comparison. BTW, the response to your 5 points were not my comments, they were made by someone else.

    No we don’t see eye to eye on the lack of transparency in financial services. Financial services is probably the most regulated industry out there and works on full and fair disclosure and has by statute since the 1930’s. Failure to disclose conflicts of interest in financial services can and does result in disgorgement, fines, penalties and loss of career. Not so much in the medical profession. Seldom does it result in loss of life either. So please come down off your high horse about that issue.

    Why are there “thousands of doctors who have no idea what they are paying in financial advice” when it is legally required to be disclosed and for AUM fees on brokerage statements every time there is a charge? Are these not adults with significant education? I hope they are spending their time reading the latest medical journals and keeping up with technology and honing their skills rather than prescribing opiates without bothering to do any research or independent investigation.

    I’d be happy to start a blog on your website. Just tell me how to go about doing so. Thanks.

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