#1 The Financial Advisor Bait and Switch

There are hardworking, honest financial advisors. Then there are those who will do a bait and switch. The bait is the promise of low fees and costs. The dishonest advisor proclaims the low fee they will charge for their services. And the upfront fees are low.

The switch is in what they end up selling. You end up buying high-fee products, which are sometimes also mediocre or poor—funds, annuities, insurance, so forth. Those high-fee products share the profits made from you with your financial advisor.

It’s not illegal. But you are going to have to read a lot of legal fine print in those documents you are signing to figure out just how much money is being made on you. Using a Registered Investment Adviser (RIA), a legal fiduciary who works for you and only charges a management fee, is a better option for most investors.

#2 Gold Coins and Physical Gold

Gold and precious metals can be an important part of an investment strategy. But you need to be very careful to not get scammed when buying physical gold. It’s arguable whether the cost of buying physical gold is worth it even with a minimal markup.

In terms of physical gold scams, there are the obvious ones, like when you send money and never get your gold or receive items containing less gold than promised. But there are also the legal scams, where you are sold “investments”, particularly collectible gold coins, at big markups—sometimes more than 30%.

Of course, there are honest gold dealers out there. But for most investors, there are far better options for gold exposure through low-cost funds or ETFs (exchange traded funds).

#3 Who Has Your Money?

A typical RIA does not take custody of an investor’s funds. In our case, we work with qualified custodians, like Fidelity or Charles Schwab. We direct how money is invested in a client’s account, but we cannot withdraw or access their money.

It is not generally necessary to cede custody of your investment assets to your advisor for her to invest in stocks, bonds, and other public securities. There are exceptions, like directly investing in real estate or a small business but those should be a small portion (or none) of your overall assets.

Be wary of any arrangement that requires you to place your money anywhere but a qualified custodian. Once you hand over your money, getting it back could prove difficult.

#4 Insurance and Annuities Math

People sometimes forget insurance and annuities companies exist to make a profit. The premiums you pay are invested by the insurance company. The difference between what they pay policyholders and what they make on their investments is how they generate profit. The obvious question is: why couldn’t you do that yourself? Or, couldn’t you hire someone that charges a lower fee to do it for you? Insurance companies and their agents are very expensive middle men.

The value of insurance is that it allows you to mitigate specific risks. Homeowner’s insurance covers damage to your home and you hope to lose money on it. You don’t want to have a claim. But if you’re house burns down, you’ll be glad you have it.

Insurance products should be used for insurance purposes. If you don’t need the insurance, you can find plenty of other, cheaper, more effective ways to invest your hard-earned cash.

#5 The Problem with Stocks and Bonds

The typical portfolio constructed by a financial advisor consists of stocks and bonds. It is sold as a diversified portfolio because stocks are considered risky and bonds are considered safe. But is any of that true?

There is no doubt that stocks are one of the best long-term investments you can make. Financial advisors add bonds to client portfolio to reduce risk/volatility, to diversify. But to achieve true diversification, you need to own assets that don’t move in lockstep. Most of the time that is true of stocks and bonds. If stocks fall, bonds are expected to rise and offset some of your stock losses.

That isn’t always true. In 2022, US stocks fell 18.2% but bonds also fell, down 13.0%. Since the turn of the century, stocks and bonds have generally moved in opposite directions – they have been inversely correlated. But in the 70s, 80s ,and 90s, stocks and bonds mostly moved together, as they did last year.

It is during uncertain times that one needs true diversification. That can only be achieved by owning a variety of assets whose returns exhibit a low or negative correlation to each other. In 2022, while stocks and bonds were losing, commodities were rising 26%. Now that is true diversification.

Full diversification is especially important for investors near or in retirement. Having a non-diversified portfolio can lead to large losses that are hard – or impossible – to recover. Portfolios that hold a wider variety of low correlation assets will provide a more consistent return with lower volatility.

#6 Making Money Off You with Turnover

Brokers typically make money off commissions. This means they have an incentive for you to buy and sell securities. Like financial planners, they can also make money off high-fee funds or other products. But for #6, we are going to focus on what you need to beware of when it comes to trading and turnover.

Investment advisors like us don’t make money from commissions or selling high-fee funds. We are a fiduciary with a legal obligation to act in your best interest. Brokers are salespeople and have no fiduciary duty. Some are honest and competent, but all of them have conflicts of interest that are hard to overcome.

Ethically challenged brokers must find ways to generate activity to get paid so they’re always looking for something to do. They’ll regularly call you with great new investment ideas that require you to sell something and buy something else. Most of the time the best trade in your portfolio is the one you don’t do, but that doesn’t pay your broker’s bills.

Our clients’ portfolios are invested using a specific and agreed upon strategy. That means sometimes we just do nothing, and let the strategy work. Activity is actually the enemy of good performance. Studies have shown that investors who trade less generate higher returns. Trade less, earn more for yourself, and less for your broker.

#7 Selling Past Performance 

“Past performance is no guarantee of future results.”

We’ve all seen that disclaimer in mutual fund literature and other investment offering documents, but few stop to consider what it means.

Recency bias is a cognitive error that favors recent events over historic ones. If tech stocks have been performing well recently, people will want to buy more tech stocks. If a fund has performed well recently, investors will pour money into it in the hope that the hot streak will continue. But more times than not, this leads to disappointment.

Investments that have performed well recently attract new investors who bid up the price of the investment. In the absence of a big change in the future prospects of the investment, such a rise will actually reduce the expected return – because it already happened.

Advisors are just like anyone else; they don’t want to work any harder than they have to. It is a lot easier to convince a customer to buy something that as done well recently than something that has done poorly. But it is often true that the poor performer is the better investment today.

At the end of 2020, energy stocks were the worst performing sector in the S&P 500 and had lost nearly a quarter of their value over the previous 10 years (-23.4%). Technology stocks, on the other hand, were riding high, up 506.8% over the prior decade. However, over the next two years energy stocks would more than double, while technology stocks fell in value, while over the following three years energy stocks more than doubled the performance of technology stocks. Past performance was certainly not a guarantee of future results. Good recent performance may make it easy on the salesman but it can be disastrous for the investor.