Thursday, July 16, 2015

Six Ways to Tell You Need a New Financial Advisor

The US Treasury
Your adviser says you should "own your age in bonds"

This is one of the most common allocation rules from the "old school". It suggests that if you're, say, 65 years old your portfolio should be 65% bonds and 35% stock.

Why it's bogus:

With real bond returns at 0.82% this is a good way to become a cat food connoisseur.

To be fair, bonds can produce solid returns during major market sell-offs so they certainly have a place in your portfolio. But 65%? No where near. People like Jeremy Siegel (the kind who actually understand the numbers) demonstrate nearly the exact opposite is true. In chapter 6 of Stocks For The Long Run Siegel analyses portfolio risk for a number of holding periods. The results show that for 20 to 30 year periods (a reasonable time frame for retirement) the lowest portfolio risk comes with 58% to 68% invested in stocks.

Your Adviser Asks if You're Worried About XXX
(where XXX is some vaguely defined "big event")

It's a sales pitch based on fear: "social security is going broke" (it's not), "inflation will accelerate" (it hasn't yet in spite of almost 7 years of near zero short term rates). The dollar will collapse because (inflation, China, deficit, debt, etc...). It won't. The market will crash (it might, and then it will advance to new highs in a few years).

This one pops up in those free seminars has-been actors and right wing commentators tout on late night TV. The individual giving the seminar is promising a way to "survive" some event or events with your finances intact. He's really there to sell suckers his DVDs and books by scaring them with a bunch of hand waving and unverifiable claims and how something must happen (and soon). If he gets lucky he'll also sell a few financial products from which he earns high commissions.

Why It's Bogus

There are no secrets in the financial world. Everything that's in those expensive DVDs and books is available free on the internet or from your bank or broker. When you hear phrases like "your income goes up with the market" that's all you need to know. You're being sold an Equity Indexed Annuity. It's one of the best products in the world - for the salesman. You? Not so much. See below for more on annuities.

Not My House
Your Adviser Suggests a Reverse Mortgage

You've seen these advertised on TV, probably in the same commercial break as the "free seminar". They promise guaranteed income as long as you live in your home and meet other requirements.

Why It's Bogus

See that phrase "as long you live in your home and meet other requirements"? That's the key. And there are lots of ways an elderly person can run afoul of that gotcha:
  • Miss a property tax payment? Oops, you didn't meet the requirements.
  • Let the insurance lapse by accident? Oops, you didn't meet the requirements.
  • Can't keep the weeds under control? What about that busted gutter?  Oops, you didn't meet the requirements.
  • Spend 13 months in a nursing home while you rehab after you break your hip? Sorry, you didn't "live in your home". 
You better believe the lender is going to come for that house.

There's another trick married couples need to watch out for: putting only the older person on the paperwork. It's easy to fall for - the shorter life expectancy results in higher monthly payments. If the person on the paperwork dies first? Somebody's going to be looking for a place to live.

A reverse mortgage might be appropriate for a very old (say 85+) individual who owns her home outright and has enough income to cover the normal upkeep and insurance required by the HECM. Otherwise - forget it.

Bill "4%" Bengen's Allocation

Your Adviser Mentions the 4% Rule

Back in 1994 a smart guy named William Bengen, based on some very good research, suggested that by withdrawing about 4% of one's retirement fund annually could allow the fund to last longer than the owner. His paper is here.

Why it's bogus:

Bengen's study was based on the assumption of a return from bonds of 5.2% and from stocks of 10.3% (before inflation) in an evenly balanced portfolio.

Today real bond returns are at historic lows with the 10 year Treasury yielding 2.42% and inflation running about 1.6% last year. From 1994 through June of 2015 the S&P 500 has had an average annual return of 7.08%. That's real returns at roughly 0.82% and 5.48% respectively.  See the problem?

A very low risk free interest rate coupled with low income & capital appreciation from stocks pretty much dooms the 4% rule. Despite rumblings from the FOMC (we might raise short term rates from 0.01% to 0.25% sometime, when the data indicate it's needed, maybe...) and the squeals of the lunatic fringe about out of control inflation, rates are going to stay low for the foreseeable future.

For a fully worked out discussion this article from 2013 is the place to start. (Executive summary: You have a 57% chance of running out of money before you die if you use the 4% rule.)

Don't Buy These
Your Adviser Mentions Gold

This will  inevitable come with a pitch involving "inflation" (non-existent), "hard currency" (how are you going to exchange a hunk of gold for a bunch of turnips or a gallon of gas?), and so forth. All that nonsense will be seasoned with a generous helping of "worry" (see above with a double dose of China).

Why It's Bogus

Gold is illiquid. If you need to turn it into cash you're at the mercy of whatever the current spot price is minus sales commissions and other fees, especially if you're trying to convert the physical metal. And if everything does collapse... how are you going to trade a hunk of shiny (but useless) metal for that bunch of turnips?

Gold is not a hedge against inflation. At most gold prices increase at approximately the rate of inflation. Right now inflation is about 1.6% and gold is dropping in price. Here's an article from 2013 on what started to happen (and continues to this day) when fear fell out of the equation. In the meantime that so called "hard currency" is earning no interest and pays out no dividends.

If you want some pretty coins for your grand kids to play with, fine. Just don't expect gold to save your retirement.

I Should Have Bought Stocks

Your Adviser Suggests an Annuity

You've probably seen these advertised right after the reverse mortgage commercials and in much the same way: "guaranteed payments for life", "your payment can never go down", etc. If you have a good relationship with your insurance agent (as we do) he or she will almost certainly bring up annuities since they are typically originated by... insurance companies.

Why It's Bogus

OK, annuities are not necessarily completely bogus. But they are lifetime contracts that lock up your money while promising a steady payment. Some have the ability to increase the payments depending on market conditions (see below). But here's the big problem: annuity payouts are based on current interest rates. Remember why the 4% rule is bogus? An annuity ties up a big pile of money while providing a very low return - a return that's guaranteed to decline in purchasing power.

If you have a lot of cash going into retirement an annuity may be part of comprehensive retirement plan.  Immediate annuities (which consume dividends and principal) can provide a reasonable income stream if you have predictable needs and remember to adjust them for inflation. You can use the free calculator here to model the amounts you might need.

That's for simple immediate annuities. Unfortunately there are a bunch of more complex ones. The one you'll hear about most is technically called an Equity-Indexed Annuity. These are the ones that you'll see advertised on TV with claims like "your income goes up with the market" and "you'll never lose money". These are extremely complex products that are sold with high commissions and fees. That's bad enough but many allow the company selling the product to change the rules whenever they want to.  If you don't read and understand the fine print you'll be in a world of hurt.

For a complete discussion of EIAs, check out what the Financial Industry Regulatory Authority has to say.

So What Should You Do? 

Honestly? I don't really care. What I will do is explain what I've been doing in this blog and give you pointers to resources that will help you decide if you might want to do something similar.

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