This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.
Wall Street has many messages for people who are or who may become its customers:
- "We help people, businesses and institutions build, preserve and manage wealth so they can pursue their financial goals."
- "Our processes are finely tuned, deliberate, time-tested and risk-aware, all in the mission to achieve sustainable, above-market results."
- "Investment professionals design and manage a portfolio aligned to your goals..."
These messages are designed to make you believe you really need the services of their highly trained, often highly compensated professionals. To be sure, some folks can do very well using such services. But when you do so, you'll often be paying a not-insignificant fee -- perhaps 1% or more of your invested assets, every year. If the company is managing, say, $200,000 for you, it may be collecting $2,000 or more from you every year. Over 10 years, that's $20,000.
But keep in mind a few things about financial professionals:
- They're not all equally talented. Some may not be that good at their job.
- Some may have conflicts of interest. If they're not fiduciaries, they may not act in your best interest.
- Even if they serve you fairly well, a hefty annual fee will shrink your return.
You can do well without Wall Street investment advisors
A key secret that Wall Street doesn't want you to know is that you can do quite well without their financial advice. If you're thinking you need to pay a lot to professionals to manage your money because you don't know much about investing, think again.
In that case, you might just invest in a broad-market index fund that tracks an index such as the S&P 500. Most index funds charge fairly low fees, and many charge minuscule fees. There's very possibly an index fund or two available in your 401(k) plan's menu of investments. And if not, you can just set up a brokerage account and buy index fund shares there.
If you're thinking that opting for index funds will be a kind of compromise or settling, and that it will deliver lower returns than those professionals can deliver, consider this: Over the 10 years ending in 2021, fully 83% of managed large-cap stock mutual funds underperformed the S&P 500 index, and a whopping 94% of them underperformed it over 20 years.
That's right -- it's really hard to beat index funds as a perfectly powerful way to build long-term wealth.
How money can grow in index funds
Just how powerful can index funds be? Well, know that the stock market has averaged annual returns of around 10% over long periods, though it will likely sport a higher or lower average over your investing time frame, which might be 20 or 40 years.
The table below shows how much you might amass over time if you sock away certain sums every year in an index fund that averages an annual gain of 8%:
| Growing at 8% for | $10,000 invested annually | $15,000 invested annually | $20,000 invested annually |
|---|---|---|---|
| 5 years | $63,359 | $95,039 | $126,718 |
| 10 years | $156,455 | $234,683 | $312,910 |
| 15 years | $293,243 | $439,865 | $586,486 |
| 20 years | $494,229 | $741,344 | $988,458 |
| 25 years | $789,544 | $1,184,316 | $1,579,088 |
| 30 years | $1,223,459 | $1,835,189 | $2,446,918 |
| 35 years | $1,861,021 | $2,791,532 | $3,722,043 |
| 40 years | $2,797,810 | $4,196,716 | $5,595,621 |
Source: Calculations by author.
See? Powerful.
There's little reason to think that you're best off handing off your hard-earned dollars to financial professionals who will take a meaningful cut of your profits -- especially if they aren't delivering market-beating, or at least market-meeting, returns.
You can also aim to do better than the market's average returns, by adding some hand-picked stocks to your portfolio. Take some time to learn a lot more about investing first, though, so that you can be acting with a lot of knowledge and confidence, ideally investing in undervalued stocks.
The case for financial professionals
Despite the arguments above, there are times when it can be smart to tap the services of financial professionals. For example:
- If you are very familiar with a money manager and their track record, and you trust them to deliver solid returns over the long run. (Remember -- any investor, amateur or professional, can have a bad year here and there.)
- If you need help with financial planning, such as for drafting a comprehensive retirement plan or for tending to your estate planning.
- If you just cannot bring yourself to do your own investing.
Financial professionals are not necessarily bad at all, but don't just assume that they will do a better job for you than you can do for yourself, especially if you opt to minimize fees by using low-cost index funds. If you're considering using a professional, do some digging into who exactly will be serving you and how talented and trustworthy they are.
This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.
