Most of us rely upon financial advisors, who dispense their counsel freely, for what we believe is good financial advice on budgeting, investing and our retirement. However, as a study from the Rand Corporation discovered, that can be a very bad bet – particularly in market downturns. In Rand’s paper, “Impacts of Conflicts of Interest in the Financial Services Industry,” the researchers wrote clearly, “We find empirical evidence suggesting that financial advisors act opportunistically to the detriment of their clients.” The Financial Planning Commission (the industry itself) admitted the problem after the research was published, writing, “The current regulatory framework allows Advisors Interests to be misaligned with Retirement Investors interests… There are significant loopholes that allow for the sale of products that may not be in the best interest of the Retirement Investors.”
So, what should you do about it? The first thing is to understand how the ruse works. Below are a few real-world examples of the high cost of free advice, and how the sales pitch is deceiving.
1. Bloggers. Bloggers with little experience and no proven track record, including broker/salesmen, are able to write on popular financial websites, which is why you must grade your guru before reading anything she writes. I recently came across a blogger on a popular platform who advised that the markets return after recessions 100% of the time. Therefore people should invest and ride out recessions, rather than letting “short-term pain impact your long-term gain,” he said. This is a popular sales line in recessions. What this blogger isn’t saying is that when you lose more than half, it takes more than a decade to crawl back to even. A 10% gain on a million is $100,000, whereas a 10% gain on $450,000 is $45,000 – taking 12 years to come back.
Most investors who waited out the Great Recession are still underwater. That is why the better plan is to always keep at least a percentage equal to your age safe. A 25-year old can afford to lose more than half and then crawl back to even by the age of 35. A 65-year old might lose other assets in that same scenario, in addition to losing half of their retirement. When your assets implode, so does your credit score and your ability to pay bills. Sadly, due to the devastating losses in the last two recessions, many people had to postpone retirement. The blogger neglected to mention that.
2. Broker/Salesman. Many broker-dealers are paid commissions on the products they sell. The higher the commission, the higher the risk of the product. That means the broker/salesman earns more by putting you at greater risk, creating a conflict of interest between protecting you and paying their own rent. However, the client rarely knows what those back-door commissions are because when a client asks about fees, the broker discloses the costs that the client bears. She doesn’t necessarily reveal the commissions that are paid on the back-end. It is difficult to clearly understand how this works, how high the commissions are and the true risk of the product, if you are relying upon the “free” advice of the broker/salesman for your information.
Another detail most broker/salesmen don’t disclose is that, while his percentage appears to be low, most clients are underperforming the markets, due to the fees. And that is in the good times bull markets. In recessions, clients who are not properly protected are losing more than half. (See the Recessions section below for additional information.) An easy way to see this is to ask the broker/salesmen for a chart of their portfolio returns compared to the S&P500 for the last ten and 15 years. That way you’ll see the bull market (probably underperforming) and the Great Recession (when most investors lost 55%).
3. Life Insurance Salesman. Insurance pays great commissions to their salesmen. However, most people pay into this product and never reap the gains. (If they did win big, insurance companies would be out of business.) The returns included in calculations are often much higher than reality, and the way the literature is written, most people don’t realize that their fees will increase dramatically, and their benefits will be slashed, as they age. Depositing that money into a tax-protected retirement account offers many benefits that life insurance doesn’t, including the most important benefit – that money is yours to keep no matter what. It doesn’t go away if you can’t make a payment. In retirement, instead of you having to pay life insurance (at a much higher price), your retirement pays you. That’s key because when you retire, your costs are typically higher (particularly your health costs) and your income is typically lower than when you are an income-earner. There comes a day when the choice is to eat, receive medical care, keep your home or make your insurance payment.
Sadly, I knew one couple that chose to put all of the husband’s Social Security payments back into the insurance plan, where the million-dollar policy had been cut to $250,000, and the premiums had soared to $20,000/year. The husband is still alive, at 92. His uninsured wife passed away at age 66. Financial stress was one of the things that deteriorated her health. (They paid $700,000 over a 35-year period from age 65 to 90 to keep that $250,000 policy alive.) Another 80-year old couple was paying $40,000/annually for life insurance. They were sold into life insurance as a strategy for their kids to be able to pay the taxes on their millions in real estate and art assets. Last year, the couple went into bankruptcy. They lost their real estate and art assets, and are living with their kids on the small amount of money (less than $150,000 each) that they were able to salvage in the restructuring.
When you are diligent about putting 10% of your income into tax-protected retirement accounts, and investing it, you can have millions built up by the time you retire.
5. Annuities. Annuities are one of the few investment products where your principal decreases the moment you buy in. They call it a surrender fee. Many times the annuity is linked to an index, which means that if stocks go down, you could actually lose money. It is also a product with no backstop. If the company you purchase the annuity from gets into trouble, you’re likely to receive pennies on the dollar back. This is key because if the U.S. had not bailed out AIG in 2008, more than 50 million insurance plans and annuities would have evanesced. AIG is back to being the biggest annuity provider. (Multiple companies with different names are owned by AIG). Losses are not a thing of the past for AIG. Last year, AIG lost another $6 billion. In the most recent quarter, the losses were $1.3 billion. If your company is privately held, it may be difficult to access their financials. However, fiscal health is an important factor to consider, if you are placing your future in the company’s hands.6. The Apocalypse Portfolio.
Sometimes the financial advisor will try to get fancy, particularly when they have a fearful client, selling their client into a high-risk strategy and calling it safe. This strategy might be overweighting into bonds (which are vulnerable today) or into oil and gold. Keeping a percentage equal to your age safe, and overweighting safe this late in the business cycle, is a good idea. However, you need to know what’s safe at a time when bonds are highly leveraged and vulnerable to capital loss. The right strategy for your at-risk side isn’t all-in on gold or oil either. If you believe those industries will soar going forward (or any other industry for that matter), then you can have up to 4 hot slices in your diversified plan. It’s never a good idea to go all in (or all out) on a strategy. Market timing is almost always a money loser, because most people are selling low and buying high when they are investing on fear or blind faith.
7. Recessions. The last two recessions have looked more like depressions. Most people lost more than half in the Great Recession and more than 3/4ths in the Dot Com Recession. As I indicated above with the math, when you lose more than half it takes a decade or more to crawl back to even. With these catastrophic recessions occurring every 8-10 years, most people are still underwater.
Buy and Hope worked before 2000. Since 2000, however, Modern Portfolio Theory with annual rebalancing has been the only plan to save the day. Today is a different world, with very high debt, an aging demographic and very low GDP growth. The economy has been fueled by low interest rates, which create bubbles. When bubbles pop, they are devastating, which is why the last two recessions, and likely the next one, have wiped out investors.
Many brokers say they use Modern Portfolio Theory, and then sell you into whatever plan their brokerage offers, or pays the highest back-end commissions. As the Rand Corporation noted in their study, and yes it bears repeating, “We find empirical evidence suggesting that financial advisors act opportunistically to the detriment of their clients.”
That is why you have to be the Boss of your Money, particularly this late in the business cycle (10 years), when economists have now pegged the likelihood of a recession in 2019 at 25%. Wisdom is the cure.