Too Complex For Their Own Good?

This week on my Forbes post, “Don’t Outsmart Yourself Financially,” I took issue with an article written by Nobel-winning economist, Paul Krugman, for his rationalizing of the enormous debt load of our country.  But while economists have and will wax eloquent on the past, present and future utilizing brilliant theories well beyond the bounds of common sense (and often practical application), we have no such allowance in the realm of personal finance.  Indeed, YOU SHOULD NEVER PURSUE A STRATEGY YOU CAN’T UNDERSTAND.

Here are a collection of financial strategies that sound impressive but may be too complex for their own good:

  • Equity Indexed Annuities—EIAs are actually fixed annuities, but if you ask one of their passionate purveyors[i] how they manage to offer market upside with none of the downside, I hope you’ve set aside some time because you’re in for a very long conversation…if the agent even knows enough about their inner workings to  educate you.  In short, insurance companies buy bonds with your investment and use the interest payments to purchase stock options to materialize the upside of the stock market.  They hedge their bets—I mean, positions—by handcuffing you with some of the biggest (7%, 9%, even 12% and higher) and longest (10, 15 or even 20 years) surrender charges in the business.  Like too many financial products, these instruments are sold, not bought, and I don’t recommend tying up your money in one of these financial experiments.
  • Life Insurance As Primary Retirement Vehicle—There’s a wow-inducing sales system (called the LEAP system) that was built for life insurance agents seeking to increase their sales in one of the best-paying commission products on the market, permanent life insurance (whole life, variable life and universal life).   After an hour of mind-numbing chart-flipping, you’ll be ready to divert your 401k savings into a brand new life insurance policy![ii]  But unless you make over $250,000 per year or have millions in net worth, you simply don’t need to worry yourself with the variables in permanent life insurance.
  • “Option Arm” Mortgages—The landscape of mortgage products has dwindled significantly from the pre-crash days when you could literally pick the payment on your mortgage in the now infamous option arm mortgages.  A mortgage broker in Pennsylvania at one point pitched me on a joint collaboration in which I would lend financial credence to his recommendations for clients to take on these crazy mortgages and they would, in turn, invest all the extra money they didn’t have to pay towards their mortgage in accounts I would manage.  I laughed at first, thinking he was kidding.  Then I realized he wasn’t.  Especially with rates as low as they are today, there are very few reasons to take on any mortgage other than a fixed mortgage, but there is NEVER a reason to take on a mortgage that increases your debt instead of paying it off.
  • Exchange Traded Funds—This one may surprise you, and I should be quick to point out that ETFs can be very wisely and properly utilized in a diversified investment strategy.  But you’d better fully understand what you’re buying.  Much like a mutual fund, an exchange traded fund is a single investment representing a basket of securities.  For example, you can purchase an ETF that will track the S&P 500 index or commodities like gold or oil.  But the question remains, what exactly is inside of the ETF?  Sometimes it is actual investments, (like stocks in gold mining companies, for instance) but often the underlying properties in an ETF are derivatives—options or futures—and subject to market forces beyond the commodity or index itself.  If you don’t understand how the investment is built, you may be in for a surprise when you see how it actually reacts to market stimuli.

There are many other examples out there, and I’d love to hear what you’ve run into in your financial journey.  Please share your good or bad experience, or ask any questions, in the comments section!


[i] Why so passionate, you ask?  These products have some of the biggest commissions in the business.  Up to and over 12%!

[ii] I worked with one agent in a prior professional life who regularly pitched a “Roth Look-A-Like,” an alternate retirement savings vehicle designed to give you all the tax advantage of a Roth IRA, and more…except that it was nothing more than a whole life insurance policy.  I saw one unfortunate 20-something guy who wasn’t even married and had no dependents buy a look-a-like when his money would’ve been better served in a true Roth.

The Economic Bias of Financial Advisors

After a great September of guest posts from internationally recognized bloggers and authors[i], I’m going to spend the month of October turning a constructively critical eye toward the very business of which I’m a part—the realm of financial planners and advisors.

I’ll be tackling this territory in 90 Second style, beginning with an examination of the three primary compensation models into which nearly every financial advisor fits.  And in keeping with my 2011 resolution, I can pledge that each of these video snippets DOES fall within my prescribed 90 second timeframe!

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[i] If you missed any of the guest posts, check them out: musical philanthropist/author,Derek Sivers; travel-hacker/life blogger, Chris Guillebeau; personal finance blogging pioneer, J.D. Roth; and financial artist/industry agitator, Carl Richards.

What the #@$% is going on?

Unless you live under a rock (check out this Geico commercial referencing under-rock living if you haven’t seen it), you have picked up the message that volatile markets and bumbling economies have again captured the global consciousness.  If you looked at the headlines any of the last several days, you may very well have concluded that the sky is falling and the financial crisis of 2008 is returning.  A great article in the Wall Street Journal explained “Why This Crisis Differs From the 2008 Version,” but that still leaves us with the nagging question, “What the #@$% IS going on?”  (I’m not promoting profanity, only acknowledging that times like these have a tendency to inspire it.)

Strangely, the majority of the talking heads on television render their contrary opinions on what’s going to happen in the future—tomorrow, next week or next month—spending very little time educating us on what the underlying reasons are for our current crisis.  In the spirit of the Freakonomics team, who, in a recent podcast demonstrated “Why we are so bad at predicting the future,” I’ll avoid attempts at prognostication and seek instead to explain what IS and what ISN’T going on in the global economy at present, followed by a couple suggested action steps:

Debt ceiling?  S&P downgrade?

The big news of the last few weeks has been debate over the debt ceiling and the seemingly corresponding S&P downgrade of the United States government.  The market has been expecting this downgrade, regardless of what happened with the debt ceiling, for quite some time now—it wasn’t a surprise.  Besides, S&P’s ineptitude regarding the accuracy of their ratings, most notably demonstrated by their maintenance of top ratings on the junk that helped cause our financial collapse in 2008, has justifiably rendered their guidance nearly impotent.  It was suggested that if the debt ceiling was not raised, the U.S. would not be able to pay its bills for the first time in history and that could lead to a financial collapse.  Well, the debt ceiling WAS lifted, but the market responded by crashing.  How do we explain that?  The problem we’re experiencing now has little to do with the debt ceiling, but a lot to do with debt, in general.

So what is happening?

The U.S. certainly has its own debt problems to contend with, but while the U.S. media got narcissistically wrapped up in our own debt ceiling and S&P downgrade, it obscured the more imminent problem—major European countries threatening default.  We’ve all heard about the financial troubles of Greece, Ireland and Iceland—each of which required financial assistance to stay afloat—but following those three countries are Italy and Spain.  They’re much bigger economies, and their failure may not be sustained by the European Union (EU) and the International Monetary Fund (IMF).  And just within the last couple days, one of the stronger European countries’ banks, France, is sending warning signs pointing to another potential crisis there.

Deja vu?  (Not really)

In the Great Depression, we basically allowed the natural free-market system to run its course.  That resulted in the pain of 25% unemployment and a stock market decline of over 90%. The silver lining, however, was that after the economy recovered from its sickness, we got back on the path towards financial health and prosperity.  This time around, the government took unprecedented action to keep us from experiencing Depression-like immediate pain, but many suggest they just deferred the problem and that we’ll be dealing with it for many years into the future.

So the United States and other countries around the world started “printing money” to create growth in their economies, in the hope that increased money supply would pull us out of a recession headed towards depression.  But while it can’t (yet) be said that the U.S. is again dipping back into a recession (the dreaded “double dip”), some major European countries are headed quickly in that direction, and that contagion could spread around the world.  Again.  Governments have already started responded with measures similar to those utilized in the 2008/2009 financial crisis; doing whatever they can to create monetary liquidity they hope will spur growth.  This could result in a boost for economies and markets in the coming weeks and months, but it’s certainly no guarantee.

So, what can you do?

You shouldn’t make wholesale buying or selling decisions in your investments based on what a market does in a day or a week, but this current calamity should prompt you to return to your portfolio and take a long, hard look at what you own and why.  Whether you are a strict buy-and-hold asset allocator or an active investor, your strategy must recognize and contend with the possibility of times like these.  You—and your financial advisor—must be accountable to articulate why you own what you own and how you intend to react depending on further developments in this scary story.  I’m not recommending you buy, sell or “stay the course;” I’m recommending you educate yourself and then act accordingly, not out of impulse.  There is no bliss in ignorance.

*This post will also be featured on TheStreet.com.

Bad Advice for Younger Generations

Young couple I read a Wall Street Journal article recently written by a reporter for whom I have a great deal of respect, but who acted as a conduit for a fundamentally flawed (supposed) majority opinion on the part of some financial advisors—that risk taking in investing and financial planning naturally leads to reward.  The article is entitled, “Take some chances, Gen X,” and chides 30-somethings for making capital preservation an investment priority, warehousing cash in defense of a job loss and eyeing debt elimination as a goal.

Hmmm.

I’m not denying the relationship between risk and return.  But while it is true that higher returns are accompanied by a greater degree of risk, the inverse is not promised.  It’s a classic investing blunder to presume taking higher risks will naturally result in a higher rate of return.

Is it possible that while the boomer advisors were pining over outdated investment “science” and Monte Carlo retirement simulations, they missed the simple math their younger clients discovered—that it’s easier to lose money in the market than it is to make it?  If you’ve lost 10% in your portfolio, it will take 11% to get back to where you started.  If you’ve lost 20%, you’ll need to make a 25% rate of return.  If you, however, get slammed by a 50% loss, you need to make a 100% rate of return to recover your losses.  Is it possible that youth and a stomach for losses isn’t actually the optimal investing posture?

The article wisely captures the reasoning behind the financial common sense of younger generations—“Many Generation X and Y investors have watched plunging financial markets destroy their parents’ retirement plans.”  That sounds eerily similar to words spoken by Gen X’s grandparents, the Depression Babies.  While it certainly is true that the intense, deep pain of the Great Depression may have created a syndrome in which some were too conservative, the Greatest Generation’s aversion to debt, skepticism of equity-heavy investing and penchant for emergency cash reserves may be exactly the foundation young investors need for a fruitful future.

The apparent concern of the "advisors"?  (And I’m sure it has nothing to do with the fact that they can’t charge fees and commissions on cash stored for emergency reserves or used to pay down debt…) They’re “…concerned that the low risk tolerance of some of these investors may ruin their retirements too, by leaving them short of funds when they get there.”  Again, the advisors miss the mark.  The point of financial planning and investing is not to retire, but to live a better life now and in the future.  Gen Xers, realizing they may be working indefinitely, thanks to companies and a federal government that raided their retirement promises (pensions and Social Security), are choosing jobs they love over those that pay the very most and seeking the nuanced balance between saving for the future and the present and everything in between.

Maybe the article should have been headlined, “Generation X shows more financial wisdom than financial advisors.”

Tim Maurer, CFP®

Financial Planner and Gen Xer

90 Second Finance…Don’t Panic!

In 2010, I released a series of videos with the help of my friend and audio/visual enthusiast, Ben Lewis, entitled Finance in 90 Seconds or Less.  The attempt was to force me to encapsulate meaningful and substantive lessons in personal finance with the aid of a whiteboard in 90 seconds or less.  I FAILED!  We released 14 of these 90 Second Finance videos and I think no more than two of them fell under the 90 second allotment.  Educational they may have been, but I called myself on false advertising.

So I’ve made a resolution in 2011 to continue the series, BUT to only release those videos that are, indeed, 90 seconds or less.  (We’ll continue to produce some longer “feature” videos, like Making Financial Music, but the 90 Second series will carry this mandate.)  So far, so good.  We’ve recorded three videos and I’m batting a thousand!  Here’s the first with three actions you can take to avoid panicking, even when market or economic news seems to call for it.

Defense Wins Championships

The fall is, without a doubt, my favorite time of year. And a not-so-insignificant element of that is the joy that fills my heart when huddled around my parents’ television on a Sunday afternoon with my family, a belly full of “linner” (a lunch big enough to be dinner) and the smell of apple pie wafting over a group of adults and children yelling in unison at the images of modern day gladiators chasing around an odd-shaped leather ball.  Football is philosophy… and some of that philosophy translates especially well in our personal finances.

IRAs Are Boring…in 90 Seconds or Less!

IRA is the most often used acronym  in all of personal finance, but what the heck is it (Individual Retirement Account)?  And when should I use a Traditional IRA or a Roth IRA?  And, by the way, what is the difference between the two?  The answer: