January Update

graph

OK, Let’s Get This Over With

Yeah, that graph is looking pretty pathetic.  Our average monthly spending is actually down slightly.  However, the .2% improvement in spending has been slightly overwhelmed on the chart by a 5.5% drop in our asset value.

It could look even worse.  In addition to continuing our normal monthly investments, I moved a large chunk of money from my checking account that had been building up with year end incentives and bonuses.

After factoring everything in, our assets dropped from 15.8 to 15.0X our annual spending.  We basically lost a year’s worth of living expenses in a bad month.

As we wrote about in last week’s post, once you have done your research and developed a good plan the key is to trust your processes and follow the plan.  Seeing our graph continue downward does not mean that we are making bad investments, any more than buying a “winning lottery ticket” is a good investment, as Justin at the blog Root of Good pointed out in this entertaining post.

Now on to some seriously good news for the Elephant Eaters……

Free at Last!

The big news in our financial lives is that we have finally broken 100% free of our former financial advisor.  This is extremely exciting to us as it has been a two and a half year process and has taken a tremendous amount of time, stress, money and energy.

We started this blog in large part to become consumer advocates after our poor experience with the financial advice industry.  We are trying to openly share our past experiences and all that we are learning along the way.  There are massive conflicts of interest faced by the financial industry in the common models (commission based and assets under management) of working with people who don’t already have a high net worth.

Hopefully, our story will find some people just starting out, and open your eyes to what you’re up against.  If you already get it, please share our story with any young person who it may help.

Cost While a Client

In one of our first posts we shared how we were being charged fees of about $8,000 on our investment portfolio in the last year we worked with our advisor.  We honestly had no idea what fees we were paying while using the advisor, as most were hidden out of sight instead of being clearly disclosed and displayed on our statements.

While we were initially appalled by the fees, we didn’t yet fully understand the tax implications of his recommendations which in retrospect were even more detrimental to our wealth building process.

Looking back with the knowledge I now possess, I can tell you that we paid over $8,000 in excessive income tax each year by not fully utilizing tax deferrals to invest in our work sponsored retirement plans.  We were advised against it because our advisor could provide us with much better investment options than what we were limited to within our retirement accounts.  It is now obvious that we were given this advice because the advisor earned commissions only on the investments he sold us.

We invested only in actively managed mutual funds and primarily in taxable accounts.  Thus we paid tax on short and long term capital gains distributions that these funds produced every year.  We didn’t understand the impacts or know there were any other options at that time.  As we explained in this post, we now understand that this is totally unnecessary with passive index funds.  This investing strategy cost us over $4,000 in completely unnecessary taxation in just our last year using the advisor.  These high fee funds however are much more beneficial to the person selling them.

We also followed the advice to rebalance annually.  Again this was all done in taxable accounts and there was no attempt to design a tax efficient portfolio.  Therefore we were always selling funds that were up in value, producing taxable events to us.  Since designing our own portfolio, we have again learned that this taxation is completely avoidable through appropriate asset allocation and location.

Finally, because of all of the extra taxable income we recognized due to these tax planning blunders, our income was elevated to a level that we could not fund our Roth IRA’s while investing with our advisor.  Thus all investments were subject to annual taxation of dividends and eventual taxation of capital gains when selling off taxable investments, which is all eliminated when using a Roth IRA.  This decision will continue to cost us for years.

Tally it all up, and the expenses of using an advisor as well as the cost of bad tax planning cost us well over $20,000 in just the final year we invested with him.  Worse yet were the opportunity costs compounded over time.  All of this to be sold funds that statistically are almost guaranteed to do worse than our current passive index investing approach.

Divorce Costs

Once we began to see the impacts of the advice we were given we knew we had to change course.  We decided to take complete control and become DIY investors and planners.  However, as I shared in this post last year, financial advisors have a way of putting their hooks into you and not making it easy to just start over.

We had several options to start over.

  1. We could just sell everything at once and be done.  However, this would have massive immediate tax effects.
  2. We could hold onto everything until retirement when our lower income would make selling more feasible.  However, we didn’t know how long it would take us to get to the point where we are making no or a very low income.  In the meantime, we would continue to have to pay high fees and unnecessary taxes that come with actively managed funds every year.
  3. We eventually chose a hybrid approach of trying to sell off as quickly as possible, but in a way that we would limit our recognized income to the level that we could both fully fund a Roth IRA each year.

(Just to be clear, we still are not sure if this was optimal and are not recommending you follow any particular strategy.  These decisions are highly individual.  We are sure that by becoming DIY investors we were guaranteeing ourselves to eliminate the massive fees and horrible tax advice.  We could afford to make some mistakes in the learning process, write them off as the cost of educating ourselves and still end up far better off!)

Year 1

In the first year of managing our own money, we still ended up paying our old advisor and his firm $7,500 between a surrender charge on a variable annuity and expenses for investments that we continued to hold due to tax considerations. We then had to pay taxes on the dividends and capital gains for the funds we held.  These actively managed funds held in taxable accounts generated large capital gains distributions that cost us over $2,500 in unnecessary taxes.  In addition, we had another big tax bill last year due to the investments that we did decide to sell off.  The taxes on the long-term gains of the funds cost us well over $3,000.  (We were only selling them to get rid of the ongoing fees and taxation.  We did not want/need to sell because we needed the money.)  In year one of being DIY investors we were still out over $13,000 in fees and taxes due to the investments deemed “suitable” by our former advisor.

Year 2

Last year we did much better.  We sold all but one of the remaining funds in January, 2015.  The remaining fund was worth only about $40,000 with an expense ratio of 1.1% costing us $440 for the year going back to the advisor and his firm.  We also did better on the taxes.  This one remaining fund managed to produce capital gains distributions that cost us $1705.95 (We found this almost unbelievable in a year when the fund lost 7%).  We also generated another $14,806.23 in gains by selling off most of our remaining investments.  This cost us $2,221 in additional taxes just to get rid of these funds.  Tally it up and we were still out $4,367 in expenses and taxes paid on investments sold to us by an advisor 2+ full years after we were done working with him.

Year 3

This month, we were finally able to cut the final connection with our former advisor.  We did this by selling off our final actively managed fund at the start of the new year.  Finally, we will never pay any more fees back to our advisor and his firm (though they did OK collecting nearly $8,000 from us AFTER we cut ties.)  We did generate one final unnecessary tax bill selling off this last fund.  With a long-term gain of $1,168 we will have a tax bill of $175.20.

Finally Free

So with all due respect to MLK Jr, I felt the need to steal the “Free at last” quote from his iconic speech that I caught on TV again this past month.  While our struggle pales in comparison to the civil rights movement he helped lead, I can tell you that breaking free of a financial advisor is indeed a struggle and one that is not cheap.

Make sure you take that into consideration when you have that urge to think that you can “learn this stuff later” as we did for years.  Trust us, it is an expensive mistake.

Have you had any big milestones or accomplishments to start the new year?  Are you struggling watching the market volatility?  Or is it business as usual for you as you follow your plan?  Share your thoughts below.

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14 comments on January Update

    1. Thanks for the positive words. On the down side, we would love to be further along on our path to FI. On the up side, I decided to turn this negative experience into a positive and started writing the blog and I’ve found something that I really love doing with the potential to help many people.

  1. Gah!!!!! That’s my only response to the financial advisor boondoggle. I’ve had a lot of conversations at work with people new to investing about advisors. I ask, “how much do they charge, and do you know what you’re invested in? Do those funds have high fees associated with them?” The answer has been a unanimous, “Not much, and not really”. I then show them a little powerpoint I made, seriously I made one. It was from when I met with an advisor and realized, “Hey, we’re good. No thanks, we got this.” lol

    Glad you’re free from their clutches, man that sounds expensive!

  2. Woow…. It is hard for me to grasp this… It takes 2,5 years to break up with an advisor…?
    Looks like the Belgian system is some more “move bank” friendly. We can actually transfer stock, funds, trackers from one bank to another without having to sell.
    For some products, we are in the same boat as you: once you sign, you are hooked on for a long time. Getting out would create a lot of tax penalties. This are more insurance like products and are similar everywhere.
    It must be a great feeling to be free!

    1. AT,

      Sorry if not clear. It does not HAVE to take that long to break things off. However, it took us that long by making calculated decisions which involved making trade-offs between paying surrender fees, trying to minimize our taxes and paying some ongoing fees for funds we continued to hold. We could have been done in one day if we so chose. However, this would have had some negative tax consequences such as pushing our recognized income to a very high level such that we would not be able to make ROTH IRA contributions and having our income taxed at even higher percentages. Hope that helps to clarify.

      EE

    1. Wow that sucks! It is difficult enough to navigate the complexities of one country’s tax system. I think that your situation is interesting in many ways, but from a tax perspective it sounds like a headache.

  3. I knew that you had had a bad experience with a financial advisor and were still working to fully disentangle yourselves, but I had no idea it was THAT bad. Wow. Some of that stuff doesn’t seem like it can even be legal. But hooray for getting free of all that once and for all!

    We’re down a good two years of expenses since year end, if it makes you feel any better re: your graph. 🙂

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