It was late 2008 and I was at Fort Jackson, North Carolina, training to go on my final Navy deployment as part of a land-based Joint Task Force. It was O-dark-thirty on a drizzly morning and we were crammed into a standing room only reconditioned school bus wearing full body armor and headed to the rifle range. We were groggy, gloomy, uncomfortable, and quiet. That’s when I heard Beyonce’s Single Ladies for the very first time. It came out of the Bus Driver’s radio and he instinctively bumped up the volume. It’s not a song that changed my life, but I’ll never forget how it made that bus come alive. Wearing 50 pounds of extra gear and with almost no room to move everyone was suddenly dancing. Even the Commander next to me was bopping and swaying to the beat in his seat. By the time we got to the gun range we were awake!
I can never hear that song without thinking about that moment, and I thought about that song when I was writing this article for the ladies. It isn’t just for the single ones, but that song came to mind anyway.
Women Do Not Save Enough for Retirement
A 2016 study by Aon Corporation shows that while American women participate in their retirement accounts (IRAs, 401(k)s, 403(b)s) as frequently as American men, they do so less vigorously. Women are using their accounts at the same rate as men, but they are saving less when they do. A staggering 83% of American women are not saving enough to meet their retirement needs. It is a problem compounded by the fact women typically need more money in retirement because they tend to live longer.
After reading a summary of this study I read a few articles by people attempting to explain why this phenomenon exists. There were several that seemed plausible, and I suspect it is a combination of reasons that brings about the current retirement savings gap between the sexes. Below is a synopsis of the prevailing opinions on the matter.
Women earn less than men. Whatever the reasons, across the spectrum of American society women earn less money than men. This makes it more difficult for them to save and also impacts their ability to obtain maximum matching contributions from employer-sponsored retirement plans.
Women are more likely to put their children’s needs first. I would add to this that women have a lower threshold when it comes to classifying something as a need for their children. I have spoken to many women whose initial impulse is to forgo saving for their own retirement in order to save for a child’s college education. I once spoke with a woman who could have been comfortably retired, but was instead taking unskilled labor jobs to maintain a 5-bedroom house “just in case” any of her grown (and successful) children ever needed to move back home.
The white knight syndrome. Some women believe they just need to get by until a man comes along who will take care of things for them. I think it is a concept that is less prevalent than it was decades ago, but my sense is that it still persists.
In most families the man takes care of the finances. The theory is that the man is taking care of the finances and the woman trusts him and is therefore not engaged (or, is elsewhere engaged). I read this, but I am skeptical. After a few years in this business I think my married clients are split just about 50-50 as to whether it is the husband or the wife who tends to the family finances. In my own experience Tade and I have shifted the responsibility back and forth several times throughout our marriage. I decided to include it here because it is probably true for at least a few women in my reading audience.
My plea to the women reading this is to not become a part of this under-prepared statistic. Don’t be one of the women who are not saving enough to support themselves in retirement. Do not wait to take action. The relentless rules of humble arithmetic do not care if you are male or female. They work the same for both sexes. The longer you wait the more difficult it becomes to reach your goals. Take action now.
A 4-point Plan to Get You Started:
1. If your employer sponsors a retirement plan with matching money, use it! If you are not contributing at least enough to get the maximum matching contribution from your employer you are leaving money on the table. If you need to rearrange your budget to free up enough cash to do this, do it now.
2. Learn everything you can about money management, retirement planning, and investing as efficiently as possible. They didn’t teach you about this in school, so you’re going to have to learn it on your own. Read anything you can find by John Bogle. Check out the local Bank On program. Visit America Saves. Even the Consumer Financial Protection Bureau has some good stuff.
3. Make a plan so that you know your objective. The objective is not to save. The objective is to reach your goal of a comfortable, secure retirement. If you don’t know where you are going, how will you know if you’re on the right path to get there?
4. Don’t be afraid to ask for help. Money is both personal and emotional. If we don’t have any we don’t like to talk about it for fear it makes us look foolish. If we do have some we don’t like to talk about it for fear we will look flashy or it will attract moochers. The problem with that mentality is that it leaves us isolated when dealing with issues that are as important as they are complex. Find someone you can trust and share ideas with them. Ask for feedback. Get a second opinion. If you are able to get a financial adviser make sure you are paying for advice from a fee-only, fiduciary financial adviser. If they try to sell you insurance or a fancy investment you don’t understand, run away!
Permanent life insurance policies – whole life, variable life, universal life, and all their mutations - are oversold in America. By oversold I mean they take up space in people’s financial plans that could be better allocated to something substantially more useful. Study after study has shown only a small percentage of the population benefits from having a permanent life insurance policy. Yet insurance companies push them on the masses as hard as they can. They make a lot of money from selling these policies and they incentivize their sales force with huge commissions – typically in the range of 50% to 110% of the first year’s premiums.
I have wanted to write about this topic for a long time, but I wasn’t sure how. The issue is complex. The policies are complex. It is a tough concept to write about in a clear, concise manner.
And then there is the insurance industry... The defenders of permanent life insurance are strident, pervasive, well-coached, and relentless. They will come at you like a spider monkey for talking bad about their product. They seem immune to reasonable arguments. As Upton Sinclair once said, “It is difficult to get a man to understand something when his salary depends on him not understanding it.”
I think I finally have an angle, though. A way to present the topic without having to reinvent the wheel. I was recently doing some internet research and I came across a website called “The White Coat Investor”. It is written by a physician who has an extreme interest in personal finance and is on a mission to help other doctors make the best choices when managing their money.
He has written a number of articles on the topic of permanent insurance. I have read most of them and they are excellent. Even more impressive (and educational) than the articles themselves are the comments and responses to his blog posts. Insurance salesman after insurance salesman post comments (sometimes longer than the original article) attempting to refute his assessments. While I would find this highly irritating on my blog, he simply (and unemotionally) exposes their intellectual dis-ingenuousness with an articulate response. I don't impress easily, but this guy impresses me.
If you are considering purchasing permanent life insurance you should spend several hours over on his website reading his articles and the accompanying comments. That probably sounds fantastically boring to most people, but permanent insurance policies are a huge financial commitment for most Americans. Before you enter into that commitment, spend a few hours benefiting from the research and analysis of someone who is not being paid a fat commission to sell you the policy.
I contacted The White Coat Investor and asked for permission to quote his articles on my website. He agreed with some reasonable limitations. There were many fantastic selections to choose from, but I winnowed down my list to a few of my favorite parts of his articles.
If you don’t read anything else, read the 4-part series called “Debunking the Myths of Whole Life Insurance”. These myths are typically created and spread by the people who sell insurance, so if you are considering a permanent insurance policy you are probably being told one or more of these myths to convince you to purchase the policy. Read his articles to get the other side of the story. Here's a quick sample:
Myth # 1 Whole Life Is Great For Pre-Retirement Income Protection
Whole life insurance is not the best way to protect your income, term life insurance is. Before you retire, you can purchase inexpensive term life insurance to take care of your loved ones in the event of your untimely death. A 30 year level premium term life insurance policy with a $1 Million face value bought on a healthy 30 year old runs $680 per year. A similar whole life policy will cost more than 10 times as much, $8-10,000 per year. That is money that cannot be spent on mortgage payments or vacations, nor invested for retirement.
Here is a screen shot of one of the comments and White Coat Investor’s response:
I dream of being so dispassionately smooth. I would probably have told “Tyler” to go take a math class or stop trying to intentionally deceive people.
My absolute favorite thing White Coat Investor has posted about permanent insurance is the “Should You Buy a Permanent Insurance Policy” flow chart at the end of his article called Twelve Questions to Ask Yourself Before Purchasing Whole Life Insurance.
He should sell poster-sized copies of that flow chart. I would buy one, frame it, and hang it in my office. Seriously. People have won the Nobel Prize in Economics for significantly less useful work.
The bottom line I want MY readers to take away is this:
This guy –White Coat Investor - is a doctor, passionate about personal finance and writing advice targeted specifically at other doctors. These are high income professionals with higher salaries, more money, and more financial intricacies than most of us are dealing with. Yet, he is telling them permanent insurance is not a good value.
If it isn’t a good value for the $200K+/year salary crowd, why would it be a good value for you?
The answer is it probably isn’t a good value for you. There are probably better solutions to your financial planning needs. If you want help finding them give me a call.
If you already own a permanent insurance policy don’t feel bad. I once owned a whole life policy for a few months. I was young and naive and got sold on it just like many others before and since. Fortunately, I read some good books and got out of the policy after a comparatively short time. If you own one don’t just dump it, though. Let’s take a look at it and see if we can determine the best way to make a little lemonade from your lemons. If you’ve had it for a while there may be some value in it. We’d want to take advantage of that value to the best of our ability.
Life insurance is necessary. What isn't necessary is conflating the income protection (a.k.a. death benefit) life insurance provides with saving, investing, tax avoidance, self-financing, or any of the dozen other things permanent insurance is purported to do efficiently. Because for nearly all of us we can find more efficient ways to do all of those things. Don't ask me - ask the doctor.
At the risk of exposing just how deeply my nerdism runs, I am going to share this little story from my youth because I think it will help me make an important point.
When I was 12 or 13 I made my first music purchase. It was the album Barry Manilow Live, and it was on 8-track tape. I listened to it hundreds of times on a sound system that was fairly advanced for its day.
I think I still have that 8-track tape in a box somewhere. I could never part with something with so much sentimental value to me. It’s a keeper. But one day I will be gone and my children will inherit it – at which point they will very likely discard it. Once a best selling album produced in the highest-available-quality format, it is no longer useful. The father’s music collection is not the children’s music collection.
A similar phenomenon is starting to play out in the world of financial advice. Stick with me as I walk you through this...
In the years following World War II there was a surge in the US population. Seventy-six million Americans were born between 1946-1964, and they are collectively known as ‘the Baby Boom’ generation. Raised by the Greatest Generation, the Boomers continued the efforts of their parents. They worked, designed, innovated, and invested to build the United States into the richest and most productive nation the world has ever known. Along the way they became the wealthiest generation of Americans. Baby Boomers have an estimated $30 Trillion in accumulated assets.
The inexorable march of time is catching up with them, however. The Social Security Administration estimates 10,000 Baby Boomers die every, leaving behind accumulated assets that can’t be taken with them; assets that become inheritances. The next twenty-five years will see an unprecedented generational transfer of wealth the likes of which the world has never seen.
What Will the Children do with Their Parents’ Money?
This movement of America’s wealth is starting to become a concern for the brokerage houses and large Registered Investment Advisory (RIA) firms. For decades they have thrived from the growing wealth of the Baby Boom generation. Times were good. Assets were flowing in, and their once-innovative fee structure based on a percentage of assets under management (AUM) made them wealthier every year. There was no urgency to evolve or improve.
They sold their clients fee-heavy mutual funds from the fund families that paid huge commissions. They constructed portfolios without regard to costs or tax implications. Most advisers to Boomers never bothered with any real financial planning, and when they did it was a cookie cutter template. Why engage in financial planning when the goal is to get assets under management? Success was measured by accounts and assets, not client results.
The inexorable march of time is catching up with these advisers, too. Technology has significantly impacted client expectations. Think about it. If I get a quarterly investment statement delivered to my mailbox I don’t open it because I want to know my account balance. I open it to find the procedure for turning off paper statements. Quarterly statements by mail? Seriously? If I want to know my account balance I should be able to access that within 60 seconds from my cell phone.
Throughout the world of financial advice the mustard is coming off the hot dog. Post-Baby Boom clients know they can get generic analysis with charts and graphs for free on the internet. They are no longer willing to pay what their fathers paid for a service they don’t find valuable. When Client Smith dies, his heirs are frequently walking out the door with their inherited assets, shopping around for a new adviser.
Some RIAs are adapting to the new realities, but many are not. They seem to be clinging to the notion the changes in the industry of the past few years are just a fad, not a revolution. They try to keep transferred assets in the firm by appealing to your desire for stability and consistency. “Your father invested with us for 40 years,” they will tell you, “we can take care of you, too.” This is probably a reassuring message to someone who recently experienced significant loss. (Especially if you’re relatively new to the arena of money and investing.) But is it enough?
As a wise man once told me - the only thing that stays the same is that everything changes. The financial planning/advising industry is not exempt from this maxim. A horse was once the most efficient mode of transportation; Fotomat booths once littered strip mall parking lots from coast to coast; Blockbuster used to remind us to “be kind, rewind”. Investment advice used to come from a man in a suit backed by a large (but invisible) team that performed analysis in some back room, crunching numbers on their HP Financial Calculators and producing charts showing how your portfolio was going to increase in value. The client was expected to pay for all that overhead through high commissions and fees.
It’s not like that anymore. Things have changed.
It’s not the Boomers’ fault they paid high fees for impersonal investment advice. Just like me with my Barry Manilow Live 8-track, the Baby Boom generation did the best they could with the options they had available at the time. But things have evolved since your parents started investing. Just like my children aren’t required to use my music collection, children of Boomers aren’t required to use the investment accounts they inherit. They are taking advantage of new technology, personalized service, reduced fees, comprehensive financial planning, and the tax agility they can get with a financial adviser who embraces the revolution that has taken place in financial planning.
I am not your father’s investment adviser. I’m the one he wishes he could have found. Personalized service, transparent fees, and sound investment strategies form the foundation of my financial planning philosophy at PIM Financial Partners. You should never expect less.
If that interests you, give me a call. (757) 407-4189
Managing multiple retirement accounts can be confusing and time-consuming. Getting them under control is what motivates some of my clients to hire me in the first place. The good news is that it can be done, and it is often in your best interests to combine some (or all) of your accounts. The bad news is that it often requires an upfront investment of time and effort to make this happen.
The average tenure for a US worker at their current job is 4.2 years. That means the average worker in the US will likely have 8 or more jobs during their working life. If each of these jobs has an employer-sponsored retirement plan (i.e. 401K), then the average worker could end up with 8 or more different retirement accounts by the end of their career. That can be a lot to manage.
Fortunately, accounts that receive the same tax treatment can usually be merged into a single account. By the same tax treatment, I mean whether they are taxed before the money goes in (think ‘Roth’) or taxed after the money comes out (think ‘traditional’). (There are other variables at play, but those two categories cover most people.) In other words, most of the time, all your traditional retirement accounts can be merged into a single traditional IRA, and all your Roth retirement accounts can be merged into a single Roth IRA.
But – just because you CAN move them doesn’t mean you SHOULD move them. The question is – is it in your best interests to merge some or all your accounts? Let’s look at the pros and cons of merging.
1. It is easier to see how the portfolio is being managed. The most important factor in reaching your financial goals is proper asset allocation. When your portfolio is spread out over 6 or 8 accounts, and each account has several different investments you can easily lose track of how your portfolio is allocated. Making asset allocation easier to track is a good thing.
2. It is easier to know what your fees are. Each retirement plan has a different fee structure (as do the funds the plan invests in). Fees are the second most important factor to long term investing success. Tracking your fees over multiple accounts and multiple investments per account can be a real hassle. Reducing the number of accounts to track makes it easier. (It may also make it possible for you to reduce fees.)
3. It is easier to make sure your account beneficiaries are correct. Beneficiaries are the people you want to receive your account in the event of your death. You should have beneficiaries declared for all your retirement accounts. Doing so enables them to bypass probate and get released to the beneficiary(ies) sooner. Over a 40-year career many people get married, have children, get divorced, get remarried, and maybe have more children. Each of those events might lead a person to want to change their beneficiary designations on their retirement plans. That’s a lot of updates! Reducing the number of accounts simplifies beneficiary designations.
4. Better investment options. (This one is often true but not always true.) Companies typically hire an outside firm to manage their employer-based retirement plans. Those management firms are trying to be as profitable as possible. To that end they will often limit the investment choices in the retirement plan to funds that earn them the most money. By moving your retirement accounts to an IRA, you can often get more and better investment options. (A notable exception to this is the federal retirement plan, TSP. I never recommend people move out of TSP while they are still working.)
5. You don’t have to update your address as often. In addition to changing jobs, people also move more frequently these days. If you want your account paperwork to find you, you’ll need to provide each account with a change of address update. (It is common for a client to tell me they think they have an account with XYZ, but they haven’t seen a statement in a long time, so they aren’t sure. The reason they haven’t seen a statement in a long time is because they moved and never told the firm managing their retirement account where to send the statements!)
6. Fewer statements to review. Investment accounts are required to send you periodic statements. This is for your protection, and you should review your statements when you receive them. While the government requires the statement to be sent, they do not mandate a specific format for the statement. You may have noticed this already. You must train yourself to read the different statements from the different companies sending them. It is annoying and frustrating. Fewer statements would streamline this process and reduce the annoyances.
7. Simplifies the distribution of funds when you retire and start withdrawing from the accounts. Once you reach age 70 ½ you are required to take minimum distributions from your traditional retirement accounts and employer-based Roth accounts. It may be advantageous to you to liquidate your holdings in a specific order. If you have multiple accounts with multiple holdings in each account, managing the order of liquidation can be difficult. Additionally, if you move your employer-based Roth accounts to a Roth IRA you are not required to take distributions at age 70 ½ - which can provide you with more options in retirement.
1. Expect it to be an annoying paperwork drill. In this glorious internet age I can open an online investing account, connect it to my bank, fund the new account, and then place an order to purchase stocks, bonds, or funds all within an hour and without leaving my chair. It is simple, intuitive, and lightning fast. Yet, if you want to move money out of your retirement account most retirement plans require you to call them on the phone, fill out a lengthy form they will send to you, and then fax it or send it via snail mail. There are several reasons for this, and some of them are for your protection, but the people currently managing your account are making money from you and if you move your account they will no longer be making that money. The law says you can move your account, but many account managers do not make it easy. Expect delays and Janice from customer relations to explain to you why you shouldn't move your money out of your account with them.
2. You might not be getting a better deal. Last year the Obama administration enacted something known as the fiduciary rule. The intent of the rule is to ensure investment advisers are providing clients advice that is in the best interests of the client. The government took this action because there were many investment advisers who were not doing this. Americans have trillions of dollars invested in retirement accounts. That's a lot of money to be managed. Some advisers were encouraging their clients to move their current accounts so they would be under the management of the person giving this advice. Often the new account managed by the adviser was offering worse investments and charging higher fees than the old retirement account. The fiduciary rule has slowed this practice, but it hasn’t stopped it completely. There are still advisers out there trying to lure clients into moving perfectly good retirement accounts into accounts designed to bring the adviser higher fees and commissions. You need to be careful before moving your account based on the advice of someone who gets paid to manage accounts.
Merging your retirement accounts is often a good financial move. It can help you save time, reduce fees, streamline the administration of the accounts, get you access to better investment options, and simplify the distribution of account funds when you need them in retirement. There are some downsides to the process, but it is often the best course of action.
I review client retirement accounts and recommend clients merge accounts when it makes sense to do so. If you were considering merging some of your retirement accounts, give me a call and I can help you assess whether it is the best move forward for you.
What if a portfolio manager told you his portfolio was averaging a 25% annualized return over the past 3 years? That sounds pretty good. He is handily beating the market returns. Do you want him as your investment adviser?
My answer to that question is possibly. I can't really be sure, because he has only told me half the story - the half about the rewards he is reaping. He hasn't mentioned anything about risk. Risk is an important piece of the story, but unfortunately it is also complex, and most people don't understand it.
I am going to explain some things about investment risk, but first I'm going to tell you something else that is easier to understand so you can see the importance of knowing the other half of the story.
Do You Know Jack?
Jack went to Las Vegas, and when he returns he tells you that he won $5,000. You are intrigued. Winning $5,000 is a much better result than most people get in Las Vegas. Perhaps Jack knows some things about gambling that you would like to know in case you ever take a trip to Las Vegas. So you ask Jack how he did it.
"Easy," says Jack, "I found a guy who was willing to bet on a coin flip. We made the bet, I won, and he paid me $5,000."
Jack's story is starting to look a little less interesting at this point, isn't it? Guessing right on a coin flip really isn't a skill you can capture for your next trip to a casino. Jack doesn't seem to have any real gambling skills, he was just lucky. Good for him, but it's not really something to brag about, is it? "So, you just bet $5,000 on a coin flip?" you ask.
"Oh no," says Jack, "HE bet $5,000 on the coin flip. I bet $12,000. But I won, so it was a good bet."
Jack bet $12,000 against $5,000 on a coin flip. Now we can see that Jack isn't just lucky. He is a lucky fool.
He is a fool because the reward he received was not worth the risk that he took. He had a 50% chance of losing $12,000 and a 50% chance of winning $5,000. It is a situation where it is easy to see that Jack took more risk with his money than it was worth. He was lucky - he won - but that does not make it a good bet.
All Investing Carries Some Risk
Let's get back to our portfolio manager with the 25% annualized returns for 3 years. All investing carries some amount of risk. Our portfolio manager has told us he has captured a good reward - 25% annually - but he has not told us how much risk he took to capture that 25% return. We cannot know if investing with him is a good idea until we know if it is worth the risk.
Unfortunately, as I said, portfolio risk is much more difficult to quantify than the simple betting scenario with Jack. It is more difficult to understand, but just as important to making sound investment decisions. Trying to explain how to calculate investment risk in a single article would not be possible (not to mention boring and confusing). Suffice it to say there are numerous sources of risk in a portfolio. Some can be reduced with diversification and asset allocation. Others can only be reduced by not investing at all.
One of my duties as an investment adviser is to manage risk on behalf of my clients. There are two parts to this. The first part is that I need to make sure the amount of risk in your portfolio is reasonable for the rewards we expect. I accomplish this through diversification. The second part is that I need to make sure the amount of risk is suitable to the client's situation, needs, and desires. I accomplish this by getting to know each client and their situation. There are no shortcuts to this. It takes a little time.
If your financial planner has never explained this to you, ask them why.
You don't have to look too far to find a news story about an unscrupulous financial adviser who took advantage of his client(s) and stole their money. It's shocking and sad when it happens, but those stories are the exceptions, not the rule. Very few advisers are so brazen as to outright steal from their clients' accounts. There are, however, some common ways in which many financial advisers mislead their clients with subtle, but much more pervasive lies. Hopefully this article will shed some light on these myths.
#3. Bigger is Better
This is the theory that the large, well-known firms provide the best value. Probably based on the perception that Fidelity, TD Ameritrade, Northwest Mutual, USAA, etc. offer better security and/or the best price. Neither is true. The large firms actively try to reinforce the idea that their size gives them strength and stability. They know many investors are nervous about putting their money at risk in the securities markets, and they exploit that fear by representing themselves as powerful enough to protect their clients from market volatility. They also use the perception of their stability to charge the highest prices they can get.
In reality, their size plays no part in protecting your assets. All investments, even those well-diversified to mitigate risk, are subject to the volatility of the securities markets. The size of the company helping you select your investments doesn't matter. What matters is having an appropriate asset allocation for your situation and goals. Firm size plays no part in that process.
Their size does, however, influence their ability to provide the one thing most investors want more of – personalized service. Most clients seeking financial planning and investment advice want to work with an adviser who has a real interest in their values, goals, needs, and desires. They want an adviser who will take the time to get to know and understand them. Clients are more likely to have this type of personal experience with a smaller firm than a larger firm.
The largest financial firms also tend to have their own proprietary products; mutual funds and/or ETFs that they have created. Advisers at these large firms are strongly encouraged to recommend these products to clients above all others, compensating those advisers when they sell them and sometimes even punishing them when they don't.
#2. Fees Based on a Percentage of the Portfolio Put the Adviser and Client 'on the Same Side of the Table'
This is the theory that by charging a percentage (1% being common) of the client’s portfolio as his or her fee, the adviser’s primary incentive is the same as the client’s – to grow the portfolio. This is not true, and it isn’t true for several reasons.
If the adviser is paid based on a percentage of assets under management, then his or her goal would be to have more assets under management. How does an adviser accomplish that?
One way – the one that led to the recent Department of Labor Fiduciary Rule – is to convince clients to move all their assets under the management of the adviser. Frankly, if you have a good employee-sponsored retirement plan, such as the Federal TSP, it would not be in your best interests to move your assets out of that plan and into an account managed by your adviser. Yet, the charging of fees based on portfolio size makes it attractive to the adviser to gain control over all the client’s assets - even the ones already being managed well.
There are also risk management issues to consider. The client’s goal is to grow the portfolio while taking the minimum amount of risk necessary to achieve their desired financial state. When greater financial risks can equal greater financial rewards, the adviser receiving a percentage is incentivized to take greater risks than may be necessary to achieve the client’s desired financial state.
An adviser who gets paid based on a percentage of assets under management is also more likely to resist a client’s efforts to try to spend their own money. It’s only natural. If my compensation was based on the amount of your money I was managing it would be contrary to my economic interests for you to take money out of your account. That attitude is not going to be helpful in providing the best advice to a retiree who needs to start drawing down their savings to pay for their retirement. It certainly doesn’t put the adviser ‘on the same side of the table’ as the client.
Finally, acquiring more assets under management is much more easily done by acquiring more clients than it is by growing the portfolios of existing clients. Not that I think there is anything wrong with advisers seeking to acquire more clients. My retainer fee model incentivizes the same thing. The more clients paying retainer fees I can acquire; the more profitable PIM Financial Partners will be. I just don’t like it when advisers try to hide the true nature of their compensation by making the claim that it puts the adviser and the client on “the same side of the table”. It’s misleading. Although, to be fair, I think some advisers honestly believe it.
#1. A Financial Adviser Can Predict the Future
This is the implied theme of active portfolio management. The adviser and his or her team is smart. They are smarter than everyone else. They know things no one else knows. They can read economic tea leaves and accurately predict which securities, sectors, and/or geographic regions are going to be the best and worst for investments in the upcoming quarter or year. They know when to get into the markets and when to get out. Or so they would have you believe.
Numerous academic studies have shown this is not true. The reality is that those who try to predict the markets are wrong more often than they are right. In fact, one study showed that a cat was better at picking stocks than a group of so-called stock-picking experts.
I would love to be able to predict the future. I would make mind-boggling amounts of money in all kinds of markets. Unfortunately, I cannot. What I can do is remain focused on the investment strategies over which I can exercise influence – appropriate asset allocation, maximum tax efficiency, and the lowest possible fees. Doing these things well is both valuable and attainable.
I can assure you of something, however. If I ever develop the ability to predict the future I will not sell that priceless skill to you for my currently affordable retainer fee. I won’t even sell it to you for 1% of your assets under management. The ability to predict the future would be worth much, much more than that. Anyone who claims they are willing to sell the ability to predict the future to you for a 1% cut is deceiving you.
Don’t be fooled by advisers who try to use one of these myths to influence you into becoming (or remaining) a client. If your adviser (or a prospective adviser) is propagating one of these myths, run! (And keep your hand on your wallet on your way out the door!)
Consider $100 today, and then consider $100 one year from today.
Which has greater value? Is one of those $100 worth more than the other? Do they both have the same value?
Most people would say the $100 today is worth more than $100 a year from now because of inflation, and that's quite a reasonable answer. In our lives there has always been some amount of inflation. We know from personal observations inflation decreases the purchasing power of our money over time.
As a bonus, thinking of inflation also gives you the correct answer to my original question: $100 today is, in fact, more valuable than $100 one year from now. However, inflation isn't the best reason for that fact.
So, let's forget about inflation. $100 today is worth more than $100 a year from now for another reason. $100 today has the opportunity to go to work for a year. $100 today can be invested for a profit. For example, it could be used to buy a bond paying 8% interest per year. One year from today our $100 would be worth $108.
Therefore, time provides opportunity that adds value to money. This concept is known as the time value of money. Simply put, it means a dollar today is more valuable than a dollar in the future. Remember, this is not because of inflation. It is because we have the opportunity to put that money to work. We can use the money we have now to earn more money over time.
It is important to understand this concept. It is the foundation of finance.
Don't worry, I'll keep the math very simple here. I'm not trying to teach a finance class, but I think seeing the formula helps illustrate the role of time in adding value to money.
The value of money now is known as its present value. The value of money in the future is known as its future value. The Present Value (PV) of a sum of money and the Future Value (FV) of that same sum of money can be related to each other through this equation:
Where i is the interest rate (expressed as a decimal)
and n is the time period of the interest rate.
In our previous example we used 8% (or .08) interest rate for a time period of 1 year. Therefore, i = .08 and n = 1.
FV = $100 (1 + .08)1
FV = $108
If we wanted to know the future value of $100 in two years at 8%, then i would still equal .08, but now n would = 2.
FV = $100 (1 + .08)2
FV = $116.64
Note that time (n) in the formula is an exponent. Time has exponential influence over the growth of money.
That's worth repeating: Time has exponential influence over the growth of money.
Also note the formula I am using is for compounding interest. With compunding interest the previously earned interest also earns interest. In our example the $8 of interest earned the first year earns an additional $0.64 of interest the second year. That may not seem like much at first, but the (exponential) impacts over time can be astounding.
Here is a chart of that $100 invested at 8% per year for 40 years. Notice how things start slowly, but after some time has gone by that money begins to grow rapidly. In the last few years it is growing very rapidly. That is the impact of compounding. The more time the investment has had to compound, the faster the investment will grow.
This is why financial advisers preach long and hard about starting to save and invest as early as possible. It is in your best interests to put as much time on your side as you can.
Many people put off saving and investing when they are young and don't start until they are middle-aged. I think that is somewhat natural. It's difficult to start saving when you are younger. Life comes at you fast. There are many pressures in our society to spend more money. You're at the low end of your earning expectations. Kids, student loans, etc. etc. etc. It's tough to save.
It's difficult, but it's also really, really important.
Look back at the graph of $100 compounding for 40 years. If you wait to start saving it might seem like you're just missing out on the first few years – the smaller bars on the left side of the graph. But that is not the case. You are missing out on those huge bars on the right side of the graph. If you wait five years to start saving, peel off the five largest bars on the right. At the end of 35 years your investment is worth just $1369 (bar 35) instead of $2012 (bar 40). A difference of more than six times your initial $100 investment was lost because you waited for five years to start!
Finding the means to start saving now might be difficult, but it is very, very worth it. If you want some help building a plan to start saving now, give me a call. You work hard for your money - let's put that money to work for you!
I am writing this article because I see far too many financial plans that have not survived the test of time. The clients met with their ‘planner’ for an hour or two and then a week later received their ‘plan’. Usually a beautiful document, full of tables, charts, and graphs artfully bound, covered, and presented. They are designed to look professional so you feel comfortable and confident with the advice you are being given. By design, this document looks like something you will keep and use for the rest of your life.
The problem with this type of ‘plan’ is that it is supposed to cover a lifetime of earning, spending, saving, investing, and insuring, but it is based on a snapshot in time. Someone has essentially taken a still photo of you and your family and made the movie of your lives. They imply they can predict the future because they know what is happening today. Real planning does not work that way.
There is a military expression that “no plan survives first contact with the enemy”. It means no matter how long and intensely you plan, no matter how many different possibilities you conceive, unexpected things will happen. This same phenomenon happens in financial planning. No matter how many different possibilities you plan for, unexpected situations will arise. It’s called ‘life’.
That reality doesn’t devalue the planning process. The military expression about the plan not surviving is somewhat tongue-in-cheek. The plan survives; just not in its original form. It must be modified in order to reach the ultimate objective – which has not changed. In fact, the true value of the plan may lie in the clear articulation of the objectives and milestones. There is significant merit in having everyone on the same page with respect to where you’re going.
Let’s get back to that professionally bound and confidence-inspiring book you were told is your financial plan. How flexible is that plan? How adaptable is that plan when you have another child? Or you lose your job? Or you have an epiphany and your goals change? Are those charts and graphs still going to get you where you want to go?
Perhaps, but are you willing to stake your family’s future on it? I wouldn’t.
That’s why I do things differently. First off, financial planning at PIM Financial Partners is a process, not an event. I can’t possibly get to know you – your goals, your values, your concerns, the areas where you’re strong, the areas where you need the most help – in a single meeting. I accomplish this by discussing your financial situation with you, devising some scenarios, gaging your response, educating you on possibilities, and helping you articulate your specific objectives. This takes a little time, usually several meetings. You use the time between those initial meetings to locate additional documents we need. I use it to research your specific situation. It is time well spent.
An adviser who doesn’t know his client gives generic advice. You can get generic advice from a website. Or a professionally bound document. You get personal advice from a person. A person who knows you. A person who has spent time with you in order to understand your goals, values, concerns, strengths, and weaknesses.
Once I know who you are and what you want we build your plan together. We are partners in this process. I provide the knowledge and technical expertise. You provide the direction. We establish the objectives, we build the base, and then we prioritize the actions to get you where you want to go. We plan for foreseeable challenges, and we build flexibility into the plan for the unforeseeable challenges.
Then we execute the plan. We take the necessary steps to achieve the objectives. At this point we meet as often as you want. My fee structure is a retainer. You are retaining my services for whenever they are needed. You can contact me whenever you need to in order to ask questions or solicit advice.
And when the unforeseeable happens we sit down again and figure out how to flex the plan. Together we determine how to work that unforeseen event into your plan and get you back on track to your financial goals. This process never stops until you no longer need money and the plan ends.
Documents, charts, and graphs can be useful. They have their place, but they are not a plan. Unfortunately, more often than not, when they are professionally bound and presented they are just a sales tool to help close the deal. They are provided to make you sufficiently comfortable to move to the next phase – purchasing the financial products recommended in your document. It’s not a plan. It’s a brochure.
At PIM Financial Partners I don’t sell financial products. I sell financial planning. We may put together a binder of information for you to reference in the future, but that isn’t your financial plan. Your financial plan is a living, changing, growing entity we develop, nurture, and modify over a lifetime.
If you are ready for a new experience in financial planning, give me a call today.
The word ‘fiduciary” has been in the main stream news a bit over the past few months. If you read investment and financial planning oriented news like I do, you would see it mentioned in many news stories every day.
So, what’s all the fuss about? What is this fiduciary thing, and why is it such a newsworthy topic? Well, in short, it’s a very simple concept that turns out to be not so simple when the government tries to turn it into policy.
Fiduciary is a strange, rarely used word, but in the context of financial advice it represents a very simple concept. To be a fiduciary, the adviser must put the best interests of the client ahead of his or her own personal interests. It’s really that simple.
You would think the fiduciary standard of putting the client’s best interests first was built into the term adviser. I mean, isn’t that what an adviser does - provide advice that is in the best interests of the person being advised? Unfortunately, that is not what financial advice means. In America, you can sell your clients financial products they don’t need because you earn a fat commission on the sale and still call yourself an adviser.
I’ve never liked that. I find it misleading and unfair.
President Obama also found it misleading and unfair for people to call themselves advisers, but not put their clients’ best interests first. He directed the Department of Labor (DoL) to develop a fiduciary rule that requires anyone providing investment advice on retirement accounts to be held to a fiduciary standard. After months of public debate, drafts, and revisions the DoL released the Final “Conflict of Interest” Rule in April 2016.
The rule itself took 58 pages to explain how the government was now requiring any investment advice on retirement accounts to be in the “best interests” of the client. Additionally, the DoL has also published an 88-page rule known as the Best Interests Contract Exemption – which essentially provides exceptions to the Best Interests rule to allow so-called advisers to continue accepting compensation models such as commissions and revenue sharing.
You see, the government can’t just tell investment advisers they have to work in the best interests of their clients. They have to spell out what best interests means. Then they have to spell out who a financial adviser is. Then they have to spell out who the client is. Then they have to spell out what things are specifically prohibited. And then, of course, they have to spell out how to get an exemption to the things that are otherwise specifically prohibited so the financial adviser can keep on doing them anyway. Because if the government doesn’t spell those things out in the rule the courts will eventually have to determine what the government meant when it said financial advisers must work in the best interests of their clients.
Fixing old problems with new laws can be strange, messy business.
The President and the DoL correctly identified a very simple (to understand) problem and has given us a highly complex system of new rules to fix it. Will it help? Many people are already proclaiming it a success, but I am not yet ready to join them. While I am an ardent believer in the fiduciary standard, the rule was just released last April, and financial advisers are not even required to abide by it until next April. I think we need to give it some time to take effect.
I also think there is a very real probability many who call themselves advisers will find ways to skirt the law. Most advisers already provide you with a 25+ page document that most people don’t read. They will just increase that to 35+ pages and bury their exemptions in it someplace. They’ll be legally covered and you still won’t be getting real advice. (I got into this business because I am skeptical, and that hasn’t really changed.)
Also, let’s keep in mind the rule only applies to retirement accounts. If you have money in an account that isn’t a covered retirement account, then financial advisers are not required to give you a fiduciary level of care when advising about those accounts. They can still sell you financial products that are not in your best interest to own. They just can’t sell them to you in your IRA or 401K.
There are financial advisers out there who don’t play those games, though. They want to provide you with honest advice and they will provide you a fiduciary level of care no matter which of your investment accounts you are discussing. The problem is finding them because the bad ones are allowed to call themselves advisers.
So don’t just look for a financial adviser. Look for one who promises to provide a fiduciary level of care. That’s the word that means your interests must come before the adviser’s interests. If your adviser is willing to put that word in their client service agreement and their form ADV-2 (that mass of documents that makes you think you would rather eat something directly from a dumpster than read them), then you can have confidence you are working with a true adviser. Someone who is giving you honest advice, not just trying to sell you a product.
During one of my Navy tours I was part of an F/A-18 Hornet squadron. This is a story from that time about how people can react emotionally to money issues.
We were underway on the carrier and the pilots who flew into harm's way were getting combat pay. It wasn't much, but a little something extra to compensate them for the increased hazard of their mission. The Navy's role was limited, so not all of the pilots were getting sorties across the magical line in the sky that triggered the extra pay. It looked like we would be sailing to another part of the world before all of them did. When the squadron's Executive Officer, a fine gentleman full of wisdom and good sense, realized not all of the pilots were going to be eligible for this extra money he called a meeting of the Officer's Mess. Once gathered he proposed that anyone who received the extra pay should donate it to the Officer's Mess so we could have a grand party for all of our families when we got home. A seemingly harmless suggestion based on a sense of fairness.
By the reaction in the room you would have thought he had pulled out a pistol and threatened us at gun point.
The pilots who had already earned that money felt like they were being robbed. Those of us who had not earned that money (the other pilots and the 'ground pounders' like myself who didn't fly) were also aghast at the notion of being given something we hadn't earned at our friends' expense. The Commanding Officer quelled the rising mob with a phrase I'll never forget: "Money is an emotional issue".
And so it is.
Money means many things in our society. Money represents success (or failure), security (or insecurity), and opportunity (or constraint).
Consequently, there are not many things in life that influence our emotions as much as money. It can make us happy, sad, angry, fearful, satisfied, discontented, jealous – the entire spectrum of human emotion.
The fact that money can influence how we feel also influences how we feel about money. It influences how we use money. Financial planning is about the effective and efficient use of money, and our emotions can sometimes interfere with that. It is essential we understand our emotions with respect to money. To the greatest extent possible, they need to be accounted for within the financial planning process.
People are all different and this uniqueness extends into financial planning. One size does not fit all. We can derive a mathematical solution providing a person with the highest statistical probability of achieving their financial goal, but if it doesn’t feel right to them it is unacceptable. It has to feel right.
Financial planning isn’t about the accumulation of wealth, it is about increasing our quality of life. You must be comfortable with your financial plan, which means it must meet your emotional needs as well as your financial goals. Those two things – financial goals and emotional needs - are hopelessly intertwined. You should not sacrifice your emotional needs for your financial goals. Your life will not be better for it if you do.
Likewise, you should not sacrifice your financial goals for emotional wants. Wants are different than needs. An emotional need is based on an enduring underlying principle. An emotional want is typically impulsive and fleeting. People who have had trouble saving or sticking to a budget might be putting their emotional wants ahead of their financial goals. That will need to be addressed if you are serious about making and sticking to a financial plan.
A few common ways people use money to satisfy emotional wants include:
1. To change a mood. Have a fight with someone or a bad day at work and you just want some shopping therapy? Do you actually need those items? Would you still be buying them if you were paying cash for them instead of running up the credit card?
2. I don’t feel like dealing with it now. Putting off resolving a financial situation in order to avoid some unpleasantness can be costly.
3. Addictions. Problem drug use, alcoholism, and compulsive gambling can be very costly, to be sure, but there are also more subtle addictions. Online shopping and gadgetry hobbies can also eat up your money.
4. Being a hero. Helping out friends and family in times of crisis can be a good thing, but it can also go too far. Sacrificing your own financial goals for someone else is rarely helpful in the long run.
There are numerous other ways emotion can seep into our financial lives. Until the late 1960s finance models assumed investors behaved rationally - predictably always seeking maximum returns. Then two cognitive psychologists, Kahneman and Tversky, observed that sometimes investors behaved irrationally. People have different approaches to problem solving and cognitive biases (and emotion) can and do influence our financial decisions. Kahneman and Tversky called it behavioral finance.
Take my observation above about the pilots and their combat pay. I was part of numerous small group conversations after that meeting where the XO proposed sharing the wealth. Nearly everyone agreed that if the XO had made his proposal before any of the pilots had flown over the line that earned the extra pay it would have been more warmly received. His mistake had been waiting until after the fact to bring it up. In other words, having the money made it seem much more valuable to the people who had earned it. They would be forgoing the same amount of money no matter when the decision to share it was made, but the fact that some of the pilots already owned that money made the thought of parting with it seem like a greater sacrifice. Even those of us who didn't own any of that money understood why this was true.
The same phenomenon can be seen in many different ways. Ever have anyone express outrage that someone offered them $275,000 for their house when it is clearly worth $350,000? Is the house really worth $350,000 or does the act of owning the house inflate its value in the owner's mind?
Or look at the chart to the right. It shows a generic market cyle where the market goes up, then goes down, and then ends up right where it started. Plotted along the curve are the emotional phases investors go through during this cycle. While it's somewhat humorous because we recognize ourselves in this cycle, it is also tragic. Making investment decisions on that emotional roller coaster costs investors trillions of dollars.
Part of the value I provide as a financial planner is a more objective view of your money than you have. I get to know my clients and I want them to succeed, but I don't have the same level of emotional interest in their money as they do. As I like to say, when it comes to your money, I am the calm, rational one.
If you're interested in an objective opinion on how to best reach your financial goals, please contact me.