People always assume I am so deeply passionate and stoked about finance. Like I jump out of bed and get excited about interest rates. That's not exactly true. I am super stoked and passionate about helping people, feeling like my work matters and having autonomy over it. So when people ask me why I started The Hell Yeah Group, the answer is often that, " I looked inside of my tool box of skills and realized I had some sharp tools that all pertained to bookkeeping, running a small business and personal financial planning.” As much as I wanted to create a cool company that had nothing to do with finance, I had constraints: I needed to earn money and there was no denying the skills I had, no matter how uncool I thought it was. Not exactly visions of grandeur, more like shining a turd.
But I’ve really grown to love how my work makes me feel, regardless of it’s non-passion status. I want to share the industry-specific things I’ve learned and observed over the years that I think everyone should know.
Most people don’t need to hire anyone to help them with their investments
The majority of people don’t need to hire anyone to help them with their investments. “Financial experts” might know the ins and outs of financial products really well or understand certain economic indicators, but that doesn’t mean you need to pay anyone to learn the basic principles. Here are the basic principles:
Investing is all about the relationship between risk and reward. The bigger risk you take, the greater potential gain and potential loss.
You invest your money based on when you need it and what’s it’s for. When you need it and what’s it’s for will dictate the amount of risk you take with the money.
Active management is when a bunch of people (usually a mutual fund company) try to pick a portfolio of stocks and bonds to “beat the market.” Passive management is when you “buy the market”. Instead of trying to beat the S&P 500 (an index that measures the 500 largest U.S. publicly traded companies) passive managers buy an index fund that mimics the index. Literally, if you can’t beat them, join them. Active management: 0, passive management: 1.
Passive management tends to cost a lot less then active management because you aren’t paying anyone to use their brains, you’re just covering the cost of administration. And lower fees means you keep most of your returns or your gains. Another strike against active management and a point for passive.
Asset allocation is looking at your assets by categories. There’s stocks (equities), bonds, cash, foreign and domestic markets, small companies and large companies.
Diversification is making sure your asset allocation isn’t unbalanced by holding too much of something, like investing 99% of your money in only small Australian companies. If something negative impacts small Australian companies, you risk losing all your money. It’s not putting all your eggs in one basket.
Buying single stocks or bonds is really risky. Don’t do that. But if you’re going to do it, because I know some of you are still going to do it, only use an amount of money you can afford to lose. Again, diversification is key.
If you have an employer-sponsored retirement account, you can invest in a target date fund that will allocate your assets according to when you need the money. It does all the work for you, including re-balancing and diversifying. Contribute regularly and don’t let your emotions dictate anything. Even if you don’t have an employer-sponsored retirement account, you can do this yourself with an IRA or the like. The online technology allows you to allocate and diversify your portfolio at the click of a mouse.
Invest early on and frequently. $5 a week is a start; $50 a week is a better start.
If you do hire someone to manage your investments, give you investment advice, or help you create a financial plan, make sure they’re a fiduciary
A fiduciary is a professional who is legally required to act in their client’s best interest. Unfortunately, not everyone who works in the financial services industry is required by law to act as a fiduciary. I know, it’s crazy. But here’s an example. Sal is a financial advisor, but he isn’t a fiduciary. He has two potential recommendations to give to his clients, Dirk and Dave. The first investment gives him a higher commission than the second option. The first option is the best option for Dirk and Dave, but the second option, is still suitable. If Sal isn’t a fiduciary, he can legally recommend the second option.
If you’re considering hiring an advisor or maybe someone at the bank is advising you to start investing and wants to open up an account for you. You can find out if they are a fiduciary. All you have to do is ask the person, “Are you a fiduciary?” If they say yes, then you can trust that any advice or recommendations they give you are in your best interest. If they say, no or don’t know how to answer the question, that’s a red flag.
Understand the difference between financial services and financial products
Financial services are things like advice and counsel. Services can be billed to you as a flat-rate fee or a percentage of the assets under management. In the industry, the latter is called AUM. Other financial services like free apps use your data to then recommend financial services and products to you, like Credit Karma, Mint and Personal Capital.
Financial products are instruments to help you with things like every day transactions (checking accounts), savings (savings accounts), borrowing money (mortgages, loans and credit cards) and insurance. Financial institutions create and sell financial products. These institutions include banks, credit card companies, insurance agencies and brokerages, investment firms and some government-sponsored agencies. When you use a financial product, it’s important to understand how you are paying for it, how it works, exactly and all the potential ways you could get screwed.
If someone is selling you a financial product, don’t be afraid to ask them to explain it to you as they would to a five-year old. In fact, I recommend you do that. You’ll see how much they understand the product they’re selling. Not every single product works the same. Think about it. Some banks don’t charge a service fee for their checking accounts while other banks require a minimum balance in your checking account in order to avoid a fee. Once you start to familiarize yourself with the different types of financial products, you’ll start to learn what questions to ask.
Don’t buy financial products you don’t understand
This is huge. It’s important that you understand exactly how a financial product works and how it will impact your life before you buy it. This means if you’re looking for a product you’ve never used before, like a mortgage or small business loan or a credit card, you have to do some initial research to understand the basics of how they generally work. Once you understand the basics, you can start to ask the right questions. Things like: Is the payment on your small business loan fixed or does it vary? If it can vary, by how much? Is there a cap to how much it can increase to? Does the changing interest rate mean there is a potential for a ballon payment at the end of the loan?
It’s totally okay if you don’t understand how a product works, but it’s not okay if you get yourself into a mess because you willfully and ignorantly bought into one. One thing I learned from the wealth management firm I worked at was not to invest in anything you don’t understand and that it’s totally ok to admit you don’t understand it. Financial products are confusing. I don’t want to say it’s on purpose, but they could stand to be a lot simpler. So don’t take all the blame for being ignorant, take all the blame for staying willfully ignorant.
Hidden fees will cost you a lot more than you realize
The financial services industry is really, really good about not disclosing fees upfront the way other products and services do. When you go to Costco, shop on Amazon or hit up a garage sale, the price for something isn’t hidden, nor does it require math based on hypothetical numbers. But when it comes to financial products, interest rates are buried on the fourth page of a credit card statement and investment management fees are expressed solely as a percentage and are probably only mentioned one time during an initial conversation.
Particularly, with investing, if you were to pay an investment management fee of 1% annually, you could potentially be giving up 6% of your return over 10 years, 12% of your return over 20 years, 18% of your return over 30 years and 25% of your returns over 40 years. Maybe 25% of $1.00 doesn’t sound like much, but $400k of $1.7M sure sounds like a lot.
When your only tool is a hammer, everything looks like a nail
A big, big issue I have with the industry of selling financial products and only selling financial products, is that people who sell financial products have to sell financial products. In other words, regardless of whether or not the person they’re selling to actually needs the financial product, if it’s your job to sell it and you only get paid that commission if a sale is made, then the industry has created incentives that are misaligned with the best interest of the consumer. Which kind of brings us back full circle to the whole fiduciary thing.
People in financial services are not inherently bad or evil people. It's incentives and the system that these people find themselves existing in that can create problems.