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What Financial Planners Don’t Want You to Know About Index Funds
Have you ever had a conversation that confirmed — without a doubt — you’re making good decisions with your own money? I have, and it happened a few years ago. The conversation I’m sharing here was weird and uncomfortable, yet it made me feel confident our investing strategy is absolutely on point.
It all started when my former neighbor Shawn, a financial advisor, asked how we were handling our retirement. He knew we were self-employed and was curious — at least that’s how he phrased his query: “So, you’re self-employed. How do you guys invest for retirement, anyway?”
I told him the very short version of a very simple story: We are boring investors. We have Solo 401(k) accounts with Vanguard and we invest in index funds. We invest the same amount (a lot) every month and pretty much ignore what happens next. We also own a few rental properties, one of which is paid off.
Shawn’s eyes practically rolled back into his head. “Index funds, huh? You’re losing money,” he said.
He went on to claim I would regret investing in index funds and with Vanguard in general. He also said that, if I wanted to know more, “I should make an appointment with a financial advisor.”
I pointed out, rather hastily considering I didn’t have anything in front of me, that plenty of research has shown index funds beat active management consistently.
All I got in return was another eye roll and a shrug. “Yeah, that’s what they say,” he noted, as if he had read the academic research but didn’t actually believe it.
He then made an astonishing claim: “I beat the market every year,” he said, before promptly stomping away.
I didn’t argue with him about any of it because, well, I didn’t care what he said and never asked for his advice in the first place. But, I got the feeling he didn’t like it that we don’t have a financial advisor. He also dislikes index funds, and Vanguard apparently.
Was this a case of different strokes for different folks? I think it’s more than that.
What Do Financial Planners Really Think About Index Funds?
Before we dive in, let’s be clear that we’re not saying all financial planners think like my neighbor Shawn. There are tons of financial professionals who help their clients invest in index funds (or not) for myriad reasons as part of a broader financial planning strategy.
Chris Ball, a financial planner who blogs at Financial Muscle Planning, told me that, with low fees, low turnover, and high levels of diversification, index funds “are often superior to mutual funds that charge more.”
“As a financial planner who is highly influenced by academic data, the evidence clearly shows that for the vast majority of clients, index funds are a superior way to invest,” he noted. As a fiduciary, Ball is legally required to find investments that are in his client’s best interests, and index funds often fit the bill.
Life coach Natalie Bacon, who is also a certified financial planner, says she worked for three years at a registered investment advisory firm that managed over $1 billion in assets. While part of their philosophy involved active management, the rest was passive, she says.
“The passive management portion included investing in index funds,” says Bacon. “Index funds are an excellent option for so many people because they have lower fees, are tax efficient, and it’s easy to create a diversified portfolio with them.”
What Financial Planners May Not Want You to Know About Index Funds
So, why is it that some financial planners hate index funds so much? Joe Saul-Sehy, creator and co-host of the popular Stacking Benjamins podcast, says any planner who doesn’t want you to invest in index funds clearly has an axe to grind.
“And that axe probably has more to do with his wallet than your financial goals,” says Saul-Sehy.
You see, financial planners don’t get paid if you don’t hire them. And, if individuals knew all index funds had to offer, they may be inclined to skip financial planners and their management fees in favor of investing on their own. Here are three reasons that strategy may be reasonable if you know what you’re doing:
Index funds tend to come with low fees.
When Ryan Guina of Cash Money Life visited a financial planner for the first time, he was steered toward high-cost, front-loaded mutual funds. On top of the front-loaded fee, there was also a management fee that exceeded 1.0%.
Guina says that, after he learned more about investing, he discovered he could invest in an index fund through a company like Vanguard for an all-in management fee cost of less than 0.20%.
“I pulled my money from that high-priced investment and moved all my investments to low-cost index funds,” he says. “Controlling my investment costs will help me keep more of my money in my portfolio and help me achieve my financial goals more quickly.”
This is one of the reasons Jeff Proctor of DollarSprout left his old career as a financial planner; he left “in part due to guilt from how high the management fees were,” he says. “I hated seeing people pay so much for so little in returns.”
Since leaving his old position, Proctor invests in index funds to make up part of his investment portfolio. They are less expensive, he says, and they help him sleep better at night.
This isn’t to say you should never hire a financial planner, however. Proctor says he wholeheartedly recommends hiring a fiduciary planner on an hourly or retainer basis to get help with complex financial planning issues. The big difference is, you’ll want to pay your planner for their advice — not as a percentage of the money you let them control.
Index funds let you ‘set it and forget it.’
Another benefit of investing in index funds is the fact that you don’t have to spend your free time researching investment data or market trends. You can pick a fund or a handful of funds, set up a regular investment schedule, and move on with your life.
Blogger Lance Cothern of Money Manifesto is self-employed and uses Vanguard index funds to invest for his own retirement.
“While I could try to pick stocks or actively managed funds myself with the hope they will outperform the market, I don’t have the time or resources to do the massive amount of research that experts dedicated to investing do,” he says. “Instead, I invest in low cost index funds that have a proven track record of providing the returns I need to meet my goals.”
Teresa Mears is another self-employed writer who started investing in index funds with Vanguard back when she had a company-sponsored 401(k). Mears, who manages Living On the Cheap, says she chose funds at random but still built up a healthy portfolio of nearly $200,000 by the time she left her full-time job.
From there, she converted to a personal IRA at Vanguard along with a SEP IRA and Solo 401(k). Mears says that, while she has dabbled in stock picking over the years, she ultimately found that any superior gains she earned were offset by worse performance elsewhere.
“I found I just don’t have the time or energy to be a good stock market investor, so index funds are great for me,” she says. “I like Vanguard’s low fees, too.”
Academic research backs up this investing strategy.
There are an endless number of studies that show how index funds beat active management once fees are factored in. These studies show that investing in index funds almost always leaves you better off over a long enough stretch of time, aside from the occasional exception.
This study from Morningstar is just one of the many. According to the report, which measures the performance of U.S. active managers against their passive peers within their respective Morningstar categories, “actively managed funds have generally underperformed their passive counterparts, especially over longer time horizons, and experienced higher mortality rates (i.e., many are merged or closed).”
This report doesn’t intend to settle the active vs. passive debate, but it does provide compelling evidence that active management doesn’t lead to greater returns over time.
Apparently, even Warren Buffett agrees with this premise. According to CNBC, he also put his money where his mouth is. As the story goes, Buffett bet $1 million dollars the Vanguard 500 Index Fund Admiral Shares would beat hedge funds over a 10-year period that started in 2007. The investing legend’s choice fund ultimately returned 7.1% compounded annually while the hedge funds chosen by his competitor earned an average of only 2.2% per year.
This is one reason of many that millennial investor Zina Kumok of Conscious Coins invests in index funds.
“I figure if it’s good enough for Warren Buffett, it’s good enough for me,” she says. “Every piece of serious investing research about index funds regards them as perfect investing vehicles for people who want low fees and a passive approach.