Objective information about financial planning, investments, and retirement plans

Reverse Churning Are You a Victim?

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One of the best things about being a freelance financial writer and blogger is that I often learn new things in the course of my writing. A reader left a comment on a post here on the blog and mentioned reverse churning. Until that time, I had never heard this term, but after a bit of research I found that its’s one more thing that clients of stock brokers and registered reps need to be aware of.

The issue of reverse churning is one that will come to the forefront as the initial implementation of the DOL fiduciary rules commences next week. Here’s what you need to know about reverse churning to protect yourself and to make a good decision if your broker proposes a fee-based account.

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What is churning?

Investopedia defines churning as “Excessive trading by a broker in a client’s account largely to generate commissions. Churning is an illegal and unethical practice that violates SEC rules and securities laws.”

Churning conjures images such as the boiler room in the movie Glengarry Glen Ross (actually they sold real estate) or the iconic 2002 ad by Charles Schwab (SCHW) in which a brokerage house manager is depicted as telling the brokers, “Let’s put some lipstick on this pig” in reference to a sub-par stock he wants them to pitch to clients.

What is reverse churning?

A 2014 piece by Daisy Maxey in The Wall Street Journal describes reverse churning as follows:

“The Securities and Exchange Commission says the practice of so-called “reverse churning”–putting investors in accounts that pay a fixed fee but generate little or no activity to justify that fee–is on its radar. Regulators will be watching for signs of double-dipping by advisers who generate significant commissions within a client’s brokerage account, then move that client into an advisory account and collect additional fees.”

This occurs in brokerage accounts that at one point generated significant commissions for the broker from the purchase and sale of individual stocks or other commission generating transactions. If the activity in the account tails off the broker makes little or nothing from this client.

As a way to generate ongoing fees from this type of client, the broker may suggest moving to a fee-based advisory account, often called a wrap account.

Under this arrangement there is an ongoing fee based upon the assets in the account plus often trailing commissions in the form of 12b-1 fees from the mutual funds usually offered in this type of account. These generally include proprietary mutual funds offered by the brokerage firm, or at the very least costly actively managed funds from other fund families in share classes geared to offering broker compensation.

Fee-based is not fee-only

Fee-based is often confused with fee-only. I suspect the brokerage industry likes it this way.

Fee-only compensation means that the financial advisor earns no compensation from the sale of financial products including trailing fees and commissions. Their fees come from their clients. These can be hourly, a flat-fee or as a percentage of the assets under management.

Fee-based compensation, also called fee and commission, is a mix of the two forms of advisor compensation. A common form of the fee-based model entails the client paying the advisor to do a financial plan and then if the client chooses to have the financial advisor implement their recommendations this will often be via the sale of commission-based products.

The version with fee-based advisory accounts associated with reverse churning by brokers and registered reps arose out of a 2007 rule that prohibits the charging of fees in brokerage accounts. Many broker-dealers have a registered investment advisor (RIA) arm which runs these accounts.

The fiduciary rule

The new fiduciary rules make fee-based accounts more desirable for brokers and other fee-based advisors. These types of accounts will become even more prevalent with the disclosures required for retirement accounts under the new rules.

There has been a movement towards fee-based accounts in the brokerage world for several years now, likely in anticipation of the eventual issuance of these rules. This movement should accelerate in IRAs. In some cases, this will be a good thing as clients will fully know what they are paying in terms of fees.

In other cases, clients will find themselves paying 100 basis points or more in wrap fees for accounts where they were formerly trading infrequently on a commissioned basis. Whether the fee-based account will be a better deal will vary.

If all they are getting is an expensive managed account filled with bad to mediocre mutual funds that charge high fees on top of the wrap fee, this is not a good deal. If the advisor does little more than collect a fee, this sounds like the definition of reverse churning based on my understanding of the term. Much will depend upon the level and types of advice clients receive for the fees they will now be paying.

Buyer beware 

If you are working with a stock broker or registered rep and they propose moving to a fee-based or wrap account, you should take a hard look at what you are being offered. What is the wrap fee? What types of investments are used in the account? Are they expensive actively managed mutual funds that throw off 12b-1 fees in addition to wrap fees? What is the track record of the manager of the account that the advisor is proposing? What types of advice and service will you receive for the fees you will paying?

The Bottom Line 

I can’t recall hearing about a case of churning in recent years. Reverse churning is a new term to me, but from the perspective of a broker or registered rep, fee-based advisory accounts make a ton of sense. They provide ongoing fee income and frankly require little attention from them. If your broker proposes a wrap account, make sure you understand how this arrangement benefits you the client.

Approaching retirement and want another opinion on where you stand? Has your broker proposed a fee-based option and you aren’t sure if this is the right option for you? Check out my Financial Review/Second Opinion for Individuals service.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner. Don’t miss any future posts, please subscribe via email. Please check out the Hire Me tab to learn more about my freelance financial writing and financial consulting services. 

 

How is My Financial Advisor Compensated?

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Many investors do not understand how their financial advisor is compensated. With the initial implementation of the new DOL Fiduciary Rules mandating that advisors put their client’s interests first when working with their retirement accounts upon us, the issue of financial advisor compensation will be front and center. It is important that all clients fully understand how their financial advisor is compensated and how much this relationship is truly costing them.

The three basic compensation models 

Commissions: The advisor is compensated for the sale of investments, insurance, or other financial products. Compensation is paid by the firm that provides the financial product, usually a mutual fund or an insurance company. This may be in the form of an up-front charge, trailing (ongoing) fees or a combination of both. Other names for commissions include front-end loads (A share mutual funds are an example), 12b-1 fees that serve as trailing commissions on some mutual funds and commissions paid to advisors for the sale of insurance products.

Fee-based: Typically the advisor will charge a fee for putting together a financial plan for you. If you chose to implement the recommendations in the plan, such as the purchase of insurance, an annuity, or investments, the implementation will typically be done via the sale of commissioned products.

How is My Financial Advisor Compensated?

Fee-based has taken on a whole new significance in light of the new DOL fiduciary rules. Many firms have moved clients to fee-based or brokerage wrap accounts. The fee part arises from the wrap fee (typically a percentage of assets) charged to the client. Many of these accounts use mutual funds that throw off 12b-1 fees or other types of revenue sharing to the brokerage firm.

Fee-only: The advisor charges a fee for the services rendered. This can be one-time or ongoing based upon the nature of your relationship and the services rendered. Fees may be hourly, flat or retainer based, or based upon a percentage of the assets under advisement.

Why should you care how your advisor is paid? Because his/her compensation can impact the choice of the products recommended to you and your return from those products.

An advisor who is paid via commissions will likely recommend those products that offer him a commission or sales load. Sales people generally sell what they are compensated to sell. Commissions can therefore result in a huge conflict of interest for your advisor. Does she suggest the very best and lowest cost products or does she suggest those products that pay her the highest commission?

Fee-only advisors do not have this inherent conflict of interest because they are paid by the client, not the financial product provider. They are free to suggest the best investment vehicles and financial products for each client’s individual situation.

Should compensation be the only metric used to select a financial advisor?

Of course not, but the advisor’s compensation should be made crystal clear to you. When interviewing an advisor ask very direct questions.

Ask them to detail ALL sources of compensation. These might include up-front commissions or sales loads; deferred or trailing commissions; surrender charges if you opt out of the mutual fund or annuity too early; a wrap fee on your overall investment account; or a myriad of other fees and charges in various combinations.

This extends to fee-only advisors as well. Be sure to understand how much you will be paying for their advice and what types of investing costs you can expect to incur.

While you will not be writing a check for any commissions or product-based fees, make no mistake you are paying the freight. Excessive commissions or expenses serve to directly reduce your return on investment.

Once the new fiduciary rules go into effect, you may be asked to sign a form called a Best Interest Contract Exemption or BICE. The BICE form is used when the advisor seeks to use commissioned-based products, collect other types of revenue sharing or otherwise work with you in a fashion that is outside of the new fiduciary rules. Be sure to read this agreement carefully and to ask questions before signing it.

Approaching retirement and want another opinion on where you stand? Not sure if you are invested properly for your situation? Check out my Financial Review/Second Opinion for Individuals service.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner. Don’t miss any future posts, please subscribe via email. Please check out the Hire Me tab to learn more about my freelance financial writing and financial consulting services.  

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Selecting the Right Financial Advisor

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Several years ago finance blogger extraordinaire Barbara Friedberg wrote this guest post for Happy Simple Living entitled Financial Advisors Who Get Paid To Sell Products Bother Me.  What she said in that post still resonates as true today as it did then.

While there are many excellent financial advisors who are compensated all or in part via commissions, an advisor who is compensated from the sale of financial products has a built-in conflict of interest when providing clients with advice.Finance

Ask a lot of questions

With the introduction of the new Department of Labor Fiduciary rules, financial advisors will be required to put their client’s interests first when providing advice on their retirement accounts.

Conflicts of interests must be disclosed. A financial advisor who already acts in a fiduciary capacity towards their clients likely has a leg up under these new rules.  They already run their practice from the perspective of putting the interests of their clients above all else.

As Barbara indicated in the title of her post, how an advisor is compensated is critical.

In short, selecting the right financial advisor for you involves asking a lot of questions and understanding how they do business.  

  • How are they compensated?
  • Do they have experience working with clients whose situation is similar to yours?
  • Are there conflicts of interest that will impact the quality of the advice they provide?
  • What qualifications does the advisor have?
  • How and how often will they communicate with you?

If the prospective financial advisor can’t or won’t answer these and other questions to your satisfaction ask yourself if this is someone to whom you want entrust your financial future.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner. Don’t miss any future posts, please subscribe via email. Please check out our resources page as well.  

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Why Should I Care if My Financial Advisor is a Fiduciary?

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House Financial Services committee members sit...

The Department of Labor recently released its final draft of their fiduciary rules mandating that financial advisors place their client’s best interests first when offering advice on their retirement accounts. Here is a post I wrote just before the release. DOL Fiduciary Rules – What Do They Mean For You?

Much has been written of late, and more will be written (including on this site), about the issue of financial advisors as fiduciaries under the new DOL fiduciary rules.  The phase-in of the new rules begins in April of 2017, with full implementation on January 1, 2018.

At the end of the day, however, why should you as an investor care if your financial advisor is a fiduciary?

Definition of a Fiduciary

fi•du•ci•ar•yA financial advisor held to a Fiduciary Standard occupies a position of special trust and confidence when working with a client. As a Fiduciary, the financial advisor is required to act with undivided loyalty to the client. This includes disclosure of how the financial advisor is to be compensated and any corresponding conflicts of interest.

This is the definition of Fiduciary used by NAPFA (National Association of Personal Financial Advisors) the largest professional organization of fee-only financial advisors in the United States.

Why should you care if your financial advisor is a fiduciary?

Stock brokers are regulated by FINRA, who required them to make recommendations that are suitable for their clients. I’ve never come across a good definition of what suitable really means. Here is one definition I did find several years ago on the website of Clausen Miller a law firm with offices in major U.S. and international cities:

The suitability rule provides that when a financial representative recommends to an investor the purchase, sale or exchange of any security, a financial representative shall have reasonable grounds for believing that the recommendation is suitable for such investor upon the basis of the facts, if any, disclosed by such investor as to his or her other security holdings and as to his or her financial situation and needs.

This really doesn’t specify anything about loyalty to the client, disclosure or anything else. The word reasonable is quite vague at best.

This brings me to the reason that clients should care if their financial advisor is a fiduciary. As a client I would want to know that my financial advisor is acting with my best interests at heart, that he or she is making recommendations to me that are in my best interest. In fact, as you receive disclosures telling you that your broker, financial advisor or registered rep is now a fiduciary acting in your best interests a logical question is, “Weren’t you doing this in the past?”

Several years ago Charles Schwab ran an ad depicting a brokerage office pushing the stock of the day and used the phrase “…let’s put lipstick on this pig…” While humorous (and perhaps exaggerated) I fear that it did reflect the mentality of many product pushing sales people calling themselves financial advisors.

Many investors don’t understand

The worst part is that most of the investing public doesn’t really understand all of this. Many financial advisors who were previously subject to the suitability rules are competent and concerned with the welfare of their clients. They make recommendations that are in line with the best interests of their clients. Unfortunately, there are others who don’t and were not required to under the vagaries of the suitability rules.

While the final fiduciary rules were watered down a bit from prior draft versions, they none the less will change the landscape for financial advisors and their clients. Pay attention to any and all disclosures that you might receive from your financial advisor. Ask questions and don’t settle for half-baked answers.

Approaching retirement and want another opinion on where you stand? Not sure if you are invested properly for your situation? Check out my Financial Review/Second Opinion for Individuals service.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner. Don’t miss any future posts, please subscribe via email. Please check out the Hire Me tab to learn more about my freelance financial writing and financial consulting services.  

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6 Investment Expenses You Need to Understand

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Investment expenses reduce your investment returns. While nobody should expect investment managers, financial advisors or other service providers to offer their services for free, investors should understand all costs and fees involved and work to reduce investment expenses to the greatest extent possible.

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Here are 6 investment expenses you need to understand in order to maximize your returns.

Mutual fund and ETF expense ratios

All mutual fund and ETFs have expense ratios. These fees cover such things as trading costs, compensation for fund managers and support staff and the fund firm’s profit. Expense ratios matter and investors shouldn’t pay more than they need to.

Vanguard’s site, as you might expect, deals with this topic at length. In one example, it shows the impact of differing levels of fees on a hypothetical $100,000 initial account balance over 30 years with a yearly return of 6%. After 30 years the balance in the account would be:

$574,349 with no investment cost

$532,899 with an investment cost of 25 basis points

$438,976 with an investment cost of 90 basis points

These numbers clearly illustrate the impact of fund fees on an investor’s returns and their ability to accumulate assets for financial goals like retirement and funding their children’s college educations.

Mutual fund expense ratios are an example of where paying more doesn’t get you more. Case in point, Vanguard Growth Index Adm (VIGAX) has an expense ratio of 0.09%. The Morningstar category average for the large cap growth asset class is 1.21%. For the three years ending January 31, 2016 the fund ranked in the top 32% of all of the funds in the category; for the trailing five years the fund placed in the 19% and for the trailing ten years the top 17% in terms of investment performance.

Sales loads and 12b-1 fees

Front-end sales loads are an upfront payment to a financial advisor or registered rep. Front-end sales loads reduce the amount of your initial investment that actually goes to work for you. For example, if a rep suggests investing in a mutual fund like the American Funds EuroPacific Growth A (AEPGX) for every $10,000 the investor wants to invest, $575 or 5.75% will be deducted from their initial investment balance to cover the sales load. Over time this will reduce the investor’s return versus another version of the same fund with a similar expense ratio that doesn’t charge a sales load.

Some will argue that this load is a one-time payment to the advisor and their firm for their advice. This strikes me as dubious at best, but investors need to decide for themselves whether the advice received in exchange for paying a sales load warrants this drain on their initial and subsequent investments. This share class has an expense ratio of 0.89% which includes a 12b-1 fee of 0.21% (see more on 12b-1 fees below).

Deferred sales loads associated with B shares are largely a thing of the past. Carrying the American Funds example forward, the EuroPacific Growth B (AEGBX) which has been closed to new investors since 2009, was purchased at NAV with a deferred sales charge of 5%. The fund carried a surrender charge over a period of years whereby if the investor sold the fund during this time they would be assessed a surrender charge (see below for more on surrender charges) on a declining basis. In order to compensate the advisor for not receiving an upfront sales commission the fund’s expense ratio is 1.69% which includes a 0.99% 12b-1 fee which compensates the advisor. After a set period of time B shares are supposed to convert to the lower cost A shares. If you are still in a B share of any fund you should aggressively ask why this is and demand to have the shares converted to A shares if eligible.

Level loads are associated with C shares. The American Funds EuroPacific Growth C (AEPCX) fund has a level load of 1% in the form of a 12b-1 fee and an overall expense ratio of 1.61%. Brokers and registered reps love these as the level load stays in place for eight years until the funds convert to a no load share class of the fund. There is a 1% surrender charge if the fund is redeemed within the first year of ownership.

12b-1 fees are a part of the mutual fund’s expense ratio and were originally designated to be marketing costs. They are now used as trialing compensation for financial advisors and reps who earn compensation from selling investment products. They can also be used to provide revenue-sharing in a 401(k) plan. While 12b-1 fees don’t increase expenses as they are part of the fund’s expense ratio, typically funds with a 12b-1 fee will have a higher expense ratio than those that don’t in my experience.

401(k) expenses

For many of us our 401(k) plan is our primary retirement savings vehicle. Beyond the expense ratios of the mutual funds or other investments offered, there are costs for an outside investment advisor (or perhaps a registered rep or broker who sold the plan) plus recordkeeping and administration among other things. If your employer has these costs paid by the plan they are coming out of your account and reducing the return on your investment.

Add to this mutual funds that may be more expensive than needed to compensate a brokerage firm or insurance company and all of a sudden the expenses associated with your 401(k) plan are a real drag on your investment returns.

Financial advice fees

Fees for financial advice will vary depending upon the type of financial advisor you work with.

Fee-only financial advisors will charge fees for their advice only and not tied to any financial products they recommend. Fees might be charged on an hourly basis, on a project basis for a specific task like a financial plan, based on assets under management or a flat retainer fee. The latter two options would generally pertain to an ongoing relationship with the financial advisor.

Fee-based or fee and commission financial advisors will typically charge a fee for and initial financial plan and then sell you financial products from which they earn some sort of commission if you choose to implement their recommendations. Another version of this model might have the advisor charging a fee for investment management services, perhaps via a brokerage wrap account, and receiving commissions for selling any insurance or annuity products. They also would likely receive any trailing 12b-1 fees from the mutual funds used in the wrap account or from the sale of loaded mutual funds.

Commissions arise from the sale of financial and insurance products including mutual funds, annuities, life insurance policies and others. The financial advisor is compensated from the sale of the product and in one way or another you pay for this in the form of higher expenses and/or a lower net return on your investment. Additionally, financial sales types are incentivized to sell you products for which they are compensated, it is highly unlikely they will push a low-cost Vanguard index fund.

Investors need to understand these fees and what they are getting in return. In fact, a great question to ask any prospective financial advisor is to have them disclose all sources of compensation that they will receive from their relationship with you.

Surrender charges

Surrender charges are common with annuities and some mutual funds. There will be a period of time where if the investor tries to sell the contract or the fund they will be hit with a surrender charge. I’ve seen surrender periods on some annuities that range out to ten years or more. If you decide the annuity is not for you or you find a better annuity the penalty to leave is onerous and costly.

Taxes 

Taxes are a fact of life and come into play with your investments. Investments held in taxable accounts will be taxed as either long or short-term when capital gains are realized. You may also be subject to taxes from distributions from mutual funds and ETF for dividends and capital gains as well.

Investments held in a tax-deferred account such as a 401(k) or an IRA will not be taxed while held in the account but will be subject to taxes when distributions are taken.

Tax planning to minimize the impact of taxes on your investment returns can help, but investment decisions should not be made solely for tax reasons.

The Bottom Line

Fees and expenses can take a big bite out of your investment returns and your ability to accumulate a sufficient amount to achieve your financial goals. Investors should understand the expenses listed above and others and take steps to minimize these costs.

Not sure if you are invested properly for your situation? Do you wonder if your investment expenses are too high? Check out my Financial Review/Second Opinion for Individuals service.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner. Don’t miss any future posts, please subscribe via email. Please check out the Hire Me tab to learn more about my freelance financial writing and financial consulting services.  

3 Financial Planning Lessons from the Cincinnati Bengals

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Long-time readers of The Chicago Financial Planner know that I am a die-hard football fan and avid supporter of the Green Bay Packers. Come playoff time, I try catch all of the games as they are often memorable. The game this past Saturday between the Pittsburgh Steelers and the Cincinnati Bengals was memorable for the wrong reasons if you are a Bengals fan.

Rarely, if ever, in my 50 years of watching NFL games have I ever seen a team give away a game (especially a playoff game) in such a bonehead fashion as did the Bengals. Besides some just plain dumb moves, the level of dirty play and bad sportsmanship was disgusting.

What can we learn from the Bengals about financial planning? Here are 3 financial planning lessons from the Cincinnati Bengals.

Protect your downside 

The Bengals had gained the lead in the final quarter after being held scoreless for the first three quarters of the game. On what should have been a routine running play, (in the Steelers end no less) to try to run the clock out, the Bengals’ running back fumbled. In this situation ball security should have been his first priority, not gaining any yardage.

Unless you are very young, most investors are wise to diversify their portfolios in order to dampen the impact of market declines like the financial crisis or even the market volatility that we’ve seen since the start of the new year.

Keep your emotions in check 

Cincinnati linebacker Vontaz Burfict made a key interception that looked like it might seal an improbable comeback win for the Bengals. After the fumble mentioned above, he proceeded to make one of the absolute dumbest and dirtiest hits to the head of a Steelers receiver resulting in a key 15-yard penalty.

His teammate (and I’m sure fellow Mensa member) Adam Pacman Jones then garnered another 15-yard penalty for shoving a Pittsburgh assistant coach during an on-field altercation that set-up a chip-shot game winning field goal for the Steelers.

Burfict is known as a loose cannon and has been fined in the past and Jones is not a choir boy either. Both personal fouls can be attributed to a combination of bad judgment and a failure to keep their emotions in check in a key situation.

Investors need to stay calm during periods of upheaval in the economy and the financial markets. So far 2016 has started off with roughly a 5% loss in some the major market averages.

Back in 2008 and early 2009 the financial press was filled with stories of investors who panicked and sold out of their stock holdings, including mutual funds and ETFs, at or near the bottom of the market. Many of these investors stayed out missing all or most of the six plus year rally we’ve seen since the lows of March 9, 2009. Sadly, for those who were near retirement they booked substantial losses and never gave their portfolios a chance to recover.

Investors need to stay calm. One way to help in this area is to have a plan. Have an asset allocation that that reflects your situation including your time horizon for the money and your risk tolerance. Review your portfolio at regular intervals and rebalance as needed. A plan does not eliminate market volatility or the stress that it can bring, but it can help to prevent you from acting on your emotions, usually to your detriment. 

Build a team that you can depend on 

While both Burfict and Jones are talented players, both have a history of issues. Jones has been in trouble with the NFL for off-field activities and has been suspended by the league in the past. Burfict was suspended for this hit and has been fined for prior transgressions. He was undrafted, many say as a result of a reputation for being hard to deal with.

As a viewer of the game I would say these two players let their teammates and fans down at the most critical point in the most important game of the season. The Bengals have not won a playoff game since 1991 and their comeback to take the lead and put themselves into a position to win was heroic, only to be destroyed by the lack of self-control of these two.

In the course of accumulating money for goals such as retirement and college for your kids, many of you will seek advice along the way. In doing so it is important to build a team of advisors and partners that you can trust.

If a financial advisor is needed be sure to choose a fee-only advisor. This isn’t to say that one who derives some or all of their compensation from the sale of financial products isn’t competent, but someone who doesn’t have the conflict of interest inherent in the sale of financial products starts out as more objective.

Find an investment custodian who has reasonable fees and offers the types of investments and accounts that meet your needs. Free ETF platforms are nice, but who cares if the ETFs on the platform are not the ones that are right for you.

Other advisors might include a CPA or an attorney to handle estate planning matters.

In all cases don’t be afraid to ask questions. In the case of a financial advisor it is important to understand if they have worked with clients in similar situations as you and to understand what you will receive for the fees paid.

The Bottom Line 

As I’ve written here in the past, football and the world of financial planning and investing have some similarities. Learn from the Cincinnati Bengals and be sure to protect your financial downside, keep your emotions in check and build a team that you can trust. These steps will put you on track towards achieving your financial goals.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner. Don’t miss any future posts, please subscribe via email.

Reader Question: Do I Really Need a Financial Advisor?

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This question came from a reader who is around 60, works for a major corporation and has retirement assets in neighborhood of $1 million.  He indicated he is looking to either retire or be able to retire in the near future.  His question was in response to my recent request for story ideas and I appreciate this suggestion.  I will address this question largely from the perspective of this person’s situation as this is the type of client I am quite familiar with.

Do I really need a financial advisor? 

Do I really need a financial advisor? The only answer of course is that it depends.  There are many factors to consider.  Let’s take a look at a few of them.

How comfortable are you managing your own investments and financial planning issues? 

This is one of the main factors to consider.  The reader raised the point that the typical fees for ongoing advice on a portfolio of his size would likely be $8,000-$10,000 per year and wondered if the fee is worth it.

Certainly there is the issue of managing his portfolio.  It sounds like he has a significant 401(k) plan balance.  This will involve a decision whether to leave that money at his soon to be former employer or roll it to an IRA.  Beyond this decision is the issue of managing his investments on an ongoing basis.  And taking it a step further the fee level mentioned previously should include ongoing comprehensive financial planning advice not just investment advice.

Since it is likely that his 401(k) contains company stock (based upon who he works for) he has the option of electing the Net Unrealized Appreciation (NUA) treatment of this stock as opposed to rolling the dollars over to an IRA. This is a tactic that can save a lot in taxes but is a bit complex.

Can you be objective in making financial decisions? 

The value of having someone look at your finances with a detached third-party perspective is valuable.  During the 2008-09 stock market down turn did you panic and sell some or all of your stock holdings at or near the bottom of the market?  Perhaps a financial advisor could have talked you off of the ledge.

I’ve seen many investors who could not take a loss on an investment and move on.  They want to at least break-even.  Sometimes taking a loss and redeploying that money elsewhere is the better decision for your portfolio.

Can you sell your winners when needed and rebalance your portfolio back to your target allocation when needed?

Do you enjoy managing your own investments and finances?

This is important.  If don’t enjoy doing this yourself will you spend the time needed not only to monitor your investments but also to stay current with the knowledge needed to do this effectively?

In the case of this reader I suggested he consider whether this is something that he wanted to be doing in retirement.

What happens if you die or become incapacitated?

This is an issue for anyone.  Often in this age bracket a client who is married may have a spouse who is not comfortable managing the family finances.  If the client who is interested and capable in this area dies or becomes incapacitated who will help the spouse who is now thrust into this unwanted role?

Not an all or nothing decision

Certainly if you are comfortable (and capable) of being your own financial advisor at retirement or any stage of life you should do it.  This is not an irreversible decision nor is there anything that says you can’t get help as needed.

For example you might hire a financial planner to help you do a financial plan and an overall review of your situation.  You might then do most of the day to day work and engage their services for a periodic review.  There are also financial planners who work on an hourly as needed basis for specific issues.

Whatever decision that you do make, try to be as objective as possible.  Have you done a good job with this in the past?  Will the benefits of the advice outweigh the fees involved?  Are you capable of doing this? 

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner. Don’t miss any future posts, please subscribe via email. Please check out our resources page as well.  

Robo Advisors – A Brave New World?

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The piece below is written by Doug Dahmer and originally appeared under the title “Robo-Advisors” – rise of the machines on Jon Chevreau’s site Financial Independence Hub.  Jon is at the forefront of a movement he calls “Findependence.”  This is essentially looking at becoming financially independent so that you can pursue the lifestyle of your choosing.   Jon is a Canadian author and journalist, check out his book Findependence Day.  Jon has contributed several prior posts here as well. 

I know Isaac Asimov’s Three Laws of Robotics, I read Arthur C. Clarke’s 2001: A Space Odyssey and I love the Terminator movies (I’ll be back!).

From all this I know three things: Robots are very smart. Robots always start off to help you. Robots have a tendency to turn on you.

One of the newest crazes and buzzwords in personal finance is: “Robo-Adviser.” If you’re not familiar with the term, it refers to investment management by algorithm in the absence of human input.

With a “Robo” you are asked to complete an on-line risk assessment questionnaire. Your responses determines the prescribed portfolio of ETFs (Exchange-Traded Funds) with a built-in asset allocation best suited to your needs. Once a year the portfolio is rebalanced to this prescribed asset allocation recipe. 

Dynamics change as shift from Saving to Spending

The “Robo” approach relies heavily upon a basic “buy/hold/rebalance” investment strategy. This passive strategy can work to your advantage during your accumulation years. These are the years when time is your friend, and dollar cost averaging through market cycles offers the opportunity to give your returns a boost.

However, as we get older and begin to prepare for and transition into our spending years, things change. Unfortunately, too few people realize that the investment strategies that served us well during our savings years turn on their head and work to our disadvantage as the flow of funds reverses and savings turns to spending. 

Dollar Cost Ravaging

Suddenly time changes from friend to foe where “dollar cost averaging” turns to “dollar cost ravaging” or what we call, the Mathematics of Catastrophe. (More about which in our next Hub blog). During the second half of your life the simplistic money management approach followed by “Robo- Advisers” can start to look like a “deed of the devil.”

Another concern is that “Robos” are unable to deal with the reality of expense variability. If you believe that in retirement, a fixed, annual withdrawal rate from a diversified portfolio will address your income needs I can with confidence suggest you are at best short-changing yourself and at worst setting yourself up for a cataclysmic financial failure.

I have been in this business a long time and know beyond a shadow of a doubt that a properly constructed life plan is very important in the second half of your life. It is only when you know what you want to do, when you want to do it and what it will cost to do it, that you can start to build the financial framework to make it happen.

Only through your life plan are you able to anticipate years of surplus and years of deficits and take the steps to bend them to your benefit. You need to bring together cash flow optimization, tax management and pension style investment management to make it happen and in the process add hundreds of thousands of dollars to your lifetime assets and cash flow. 

Robos ill equipped to link life to investment plan

Linking your life plan to your investment plan is the secret to success, but “robo investing” is not equipped to handle the nuances of that linkage. A Retirement Income Specialist knows that the type of money management you need is much more complex where the cash-flow demands outlined in your life plan need are linked to your investment plan. Tax planning, income optimization and risk mitigation means it is dangerous to leave your investment management running on auto-pilot.

Isaac Asimov’s first law of robotics holds that: A robot may not injure a human being or, through inaction, allow a human being to come to harm.

“Robo-adviser” firms would do well to review this law. When it comes to investors heading into the second half of their lives, “Robo Advisers” may well be about to break it. 

Doug Dahmer, CFP, is founder and CEO of Emeritus Retirement Income Specialists. With offices in Toronto and Burlington, Emeritus’ C3 process is one of the industry’s most comprehensive retirement planning processes. 

Online financial advisors or Robo Advisors are popping up all over the place and if you believe the financial press they are the future of financial advice.  In part I believe they are or will at least shape the future of financial advice.  I weighed in on this topic recently via  Is An Online Financial Advisor Right For You? for Investopedia.

Please feel free to contact me with your questions.  

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