Who Needs A Financial Advisor?

Welcome to this week’s edition of Cape May Wealth Weekly. If you’re new here, subscribe to ensure you receive my next piece in your inbox. If you want to read more of my posts, check out my archive!

As a ‘niche internet micro-celebrity’ in the world of investing, I get the occasional honor of being invited to be a podcast guest. One such attendance was on the recently released edition of the Unicorn Bakery podcast, where founder and good friend Mike Mahlkow and I took a deep-dive into what founders should and shouldn’t do when it comes to their personal wealth. 

We covered all phases of a founder’s journey, from the early days (where the best financial advice might be to optimize for a market rate salary), to the first glimpses of success (like what you should do with that first secondary), to what to do when you actually hit the ‘jackpot’ in the form of a multi-million euro exit. You can listen to it here (in German), and for further reading, check out Investing for Early-Stage Entrepreneurs and Investing for Later-Stage Entrepreneurs.

And during that podcast, Mike asked me a question that I frequently receive: Do I really need a financial advisor - or can’t I just make do with one, two, three ETFs?

And I love to answer that question. It’s a question that every investor, affluent or not, should ask themselves as they consider to work with a financial advisor or similar third party (i.e. a wealth manager or private bank). But it’s also one to which every financial advisor should have a good, honest answer. I certainly have mine - but more on that later in this article.

The Case Against Financial Advisors

The unfortunate truth is that the term financial advice, with all its related terms (wealth management, asset management, etc.) is not sufficiently legally defined. As a result, many market actors, good or not, take that name, and leave it to the end client to find out whether their qualifications are sound, and whether the service they provide is worth its money. This ‘title inflation’ can also be seen when it comes to the term family office, which is being used by more and more parties that in my view don’t fit that definition. (We at Cape May have been careful about describing us as a multi-family office, because we don’t yet offer services which I think define such an organization - think wealth reporting, accounting and bookkeeping, and/or concierge services. But hopefully, we will do that soon, and we can fairly claim that title.)

Furthermore, remuneration models differ substantially. In my home country of Germany, a strong lobby has ensured that advisors can continue to work with retrocessions (“kickbacks”) paid by the product providers - meaning that advisors are paid not by their clients but by the product providers (or even worse, also charge the client on top of that). And you can imagine whether kickback-driven firms pick the cost-efficient ETF that pays no retrocession, or the actively managed fund with a dubious track record but a generous retrocession scheme. Hopefully, we can soon follow the model of other countries and ban such schemes, and ensure that its only clients that pay their advisor.

As a result, many individuals and firms active in our industry are not up to the quality standard that we and many of our colleagues across advisory firms and banks hold themselves to. To tell a few examples:

• Millionaire dentists with brokerage portfolios filled to the brim with ‘flavor of the month’ actively managed funds, all with dubious track records but generous retrocessions payable to their financial advisor. “I never had to pay my advisor anything” - because they got paid by the product providers.
  

• Fee-only advisors (Honorarberater) proudly telling fellow advisors that they ‘sell their clients one fund, charging 1% p.a., and only call them once a year.’ (Perhaps better than the first option, but in no way a fair pricing for what little service they provide.)
  

• Private bankers taking their clients to fancy dinners and sports events, but failing to answer even the simplest of questions. Meeting follow-ups? Might take weeks, if they even send them at all. And if you get a portfolio report, you might see portfolio performance before before fees compared to benchmarks after fees. (True story working with a shockingly large private bank.)

Some might think that it’s just retail investors that are getting bad service and overpriced fees, but unfortunately that is not the case. As we talk to our affluent clients, we hear more and more horror stories of overpriced fees, absent advisors, and subpar performance.

So in those cases, I have to give an honest answer: You are likely better off without them.

Of course, those are the bad apples. We might be biased, but we think that many financial advisors (including us!) are worth the money. But before we explain why we think that that’s the case, let’s explore another question: Can affluent investors make it work without a financial advisor - and how would that look like?

The Case For … Being Your Own Advisor

I frequently write about the so-called democratization of finance. Over the last few years, the topic has come up especially in the context of alternative investments, as platforms such as iCapital try to make private equity and other alternative asset classes accessible to affluent and sometimes even retail investors - often, at higher costs. (See Private Equity for the Masses if you’ve wondered whether those platforms and their products are worth looking into, or not.)

While such access providers should have to be critically reviewed before investing, many critics of this ‘democratization’ fail to see its benefits. Neobrokers such as Trade Republic or Flatex have radically reduced trading commissions for retail and affluent investors alike. Finance publications such as Finanzfluss or Finanztip here in Germany have done a terrific job in educating a newer generation of investors in staying away from dubious financial advisors like the ones we spoke about earlier. And in the more affluent segment, investors are much more open in talking to one another - and share their insights on LinkedIn, X, podcasts, or newsletters (like this one). 

It’s what makes it possible for ‘small’ family offices to exist. And it makes it possible for skilled affluent investors to make due without any financial advisor at their side. To once again give a few examples:

• Liquid Assets: You don’t need a financial advisor to open a brokerage account and/or to place trades, but can do that (likely more easily, and more cheaply) through a neo-broker.
  

• Private Equity & Co: You don’t need to be a client at a private bank to know about private equity, but can read about it on social media and/or the publication of your choice, and can invest in it through platforms like iCapital or Moonfare.
  

• Venture Capital: In many jurisdictions, you can easily invest in your friend’s new start-up, or can even invest in third-party deals through platforms such as AngelList. Looking to structure a deal on your own? No problem, there’s ready-to-use drafts for convertible loans, SAFEs, or even full financing rounds.
  

• Taxes: No need to get a tax advisor - if you have a German broker, you get your tax information directly from your brokerage firm, and can do your tax return in minutes through an online service.

Or in other words: What would’ve needed the full service offering of a private bank and other service providers a few years ago can now be done by a single investor in an entirely self-directed manner. We advise a number of successful entrepreneurs that have built substantial fortunes and are managing them entirely on their own, even if the size of their investable assets would easily allow for access to the most exclusive banks, if not for their own family office.

But of course, running a portfolio of such size and complexity requires clear knowledge of what the investor is trying to do, and perhaps more importantly, what they don’t want to do. Practically, we typically see this as follows (and would do it that way as well):

• The investor has a strong focus on one or two asset classes where they see their time best spent - think ‘high Alpha’ asset classes such as real estate, private equity funds, or direct venture investments.
  

• For other asset classes, they take a simple, time-efficient approach - think a fund of funds or a passive equity portfolio.
  

• Lastly, they often decide to explicitly exclude a number of investments for reasons specific to their own needs - such as avoiding venture investments given the need for broad diversification or avoiding fund investments due to the complexity of liquidity management or capital calls.

However, managing your own money and not having a financial advisor doesn’t necessarily mean that they have no advisors at all. If anything, they rely more on specific service providers, such as a trusted accountant that keeps day-to-day bookkeeping and tax questions away from them, or a talented lawyer that executes the transactions that the investor has decided on. They sometimes also use advisors like us to help with specific questions, or to give a second opinion on their overall setup - and are happy if we give them a thumbs-up or some ideas on what can be done better. (If you’re such an investor yourself and are looking for a third-party opinion, don’t hesitate to reach out to us.)

While we know some soon-to-be affluent individuals (think high-earning developers or managers) that are actually invested in just a single ETF (think MSCI/FTSE World), we admittedly see that less in the affluent space. Investors that can go about managing their wealth themselves often enjoy the intellectual challenge of it and hence try to find areas where they think they can generate Alpha, whereas those who don’t want their wealth to be entirely self-managed often end with financial advisors that build more diversified portfolios to (rightfully) be worth their fee. (You typically don’t want a financial advisor to charge you 1% to buy a single ETF or fund unless its their own.)

So to summarize: If you are the right type of person willing and capable of managing your own portfolio, you really might not need a financial advisor. 

But might you still be better off with some sort of your support in all your financial matters? In the final section of this newsletter, let’s answer the original question why I think that having a financial advisors can make a lot of sense.

The Case For Financial Advisors

As outlined either, there are some clear arguments against having a financial advisor. Besides the aforementioned ‘flood’ of people calling them financial advisor without being worth the title, the democratization of finance has made a lot of the products that the industry is offering less attractive. Especially when it comes to investment-related solutions (think your typical managed account), the hard truth is that even well-meaning financial advisors often design portfolios that are simply not worth their fees.

But admittedly, that’s not where I see the main purpose of a good financial advisor. Rather, it’s their value-add across a wide range of wealth-related matters, brought together in one person. To mention a few reasons:

• They work with you to build a holistic concept for your personal wealth. Think financial planning (how much money can I spend? And what target return do I need to achieve to maintain this spending?), asset allocation (how should I design my portfolio to fit my quantitative and qualitative investment goals), and other structural questions such as taxes or estate planning.
  

• They design and manage a personalized portfolio. Most liquid investment solutions are somewhat commoditized, but that doesn’t mean that what your financial advisor might offer you is necessarily bad. Outsourcing the management (or at least supervision) of a well-designed, well-priced, and broadly diversified liquid portfolio to a financial advisor might result in some risk-adjusted outperformance, or at least give you the security of having someone on your side to avoid the typical ‘psychological’ mistakes associated with investing. However, don’t expect substantial outperformance - that is better sought in other parts of your portfolio, like your Aspirational Bucket.
  

• They know what products make sense for you, and which don’t. One of my first clients came to me asking to invest in private equity. But as we went to the exercise of assessing their situation and their financial goals, it became very clear that we shouldn’t spend time on private equity, but on what was essentially restructuring of their personal balance sheet and spending. We still work together, and they are grateful that I keep on reminding them what their priorities should be - but that I also help them create room for their new ideas within their portfolio and investing goals. Today, I know what alternative assets can be relevant for them, and keep my eye open to see which might be a good fit as an addition to their liquid portfolio.
  

• They save you time. Once again a question of balance, but in my view, the main benefit of a financial advisor. Just as you might outsource cleaning around your home to a housekeeper, or your tax return to your tax advisor, even if you could theoretically do either yourself, you can outsource many investment-related tasks to your financial advisor. That is actually the biggest reason why affluent investors should work with a financial advisor: Especially if they are younger and still active as entrepreneur and/or investor, their time is likely better spent on those matters, where they can generate a substantial return on time and capital, rather than spend time on basic financial tasks like coordinating an ETF portfolio or preparing your monthly wealth overview.

So if you can find a financial advisor with a sophisticated planning process, who builds portfolios that are low-cost and ideally have a chance to outperform, offer adjacent services like alternative investments or wealth reporting, and charges a reasonable fee for their services: By all means, go for it.

But it doesn’t have to be the only way. If you are willing and able to take care of your financial matters yourself, by all means, do it. Or find a hybrid solution where maybe you outsource some of your financial matters to an advisor, and take care of some of them yourself. There’s no wrong choice here, except maybe one: staying with a bad financial advisor.

Liked what you read? If you enjoyed this piece, make sure to subscribe by adding your email below. I write about topics covering the world of family offices, asset allocation, and alternative investments.