investment advisor Archives - Bankers Anonymous

October 28, 2019November 20, 2019

FIRE Part I – Taxonomy of Early Retirement

Up until now I’ve mostly ignored the Millennial FIRE movement, which stands for Financial Independence, Retire Early.

My buddy Justin S. introduced me to some retirement planning strategies I’d never heard of recently, strategies that he is considering using in the next few years as part of his FIRE plan. FIRE is the aspiration of many 20 and 30-somethings, who hope to quit their jobs by age 40 or so. It would be easy – as with all trends involving Millennials – to exaggerate and strawman-ify the FIRE movement.

Justin, a software engineer at a large financial services company in San Antonio, is 39 years young. He hopes to be able to retire within the next five years.

Justin’s FIRE journey began 1.5 years ago when he and his wife began to really examine what role paid work should, and should not, play in their lives. It was at that point that they got serious about trying to accumulate savings enough to let them walk away from work within ten years.

He says his wife had always been a natural saver, whereas he had enjoyed buying nice cars and a motorcycle. In an earlier phase of life he’d bought a condo at the worst time and place (Central Florida, 2007), an experience that left him with wrecked credit and a searing fear of being stuck financially, living paycheck-to-paycheck.

Says Justin, “My primary driver is to not be in a position like that again. Anything can happen at work, anything can happen with houses.”

He’s gotten deep into FIRE-oriented blogs, retirement strategies, and tracks his progress on a free website.

with numerous retirement calculators. His ultimate goal is to have enough saved that he could choose more hands-on work. He seeks something more tangible than software, something that would give him a more tangible sense of accomplishment.

Justin explained to me the many variations on FIRE. To save you some time navigating Reddit threads, finance blogs and YouTube channels, here’s your guide to different FIRE flavors.

Lean FIRE – This is Justin’s plan. This means figuring out the bare minimum income you need to survive on annually, usually by making choices to downsize a home and car, location, and lifestyle. If Justin and his wife can figure out a way to live on $35,000 per year total, for example, and assume a 5% annual withdrawal rate, then theoretically they would only need $700,000 in a nest egg to call it quits in five years. (These are my numbers, not theirs, and just reflects a starting point for planning)

Obviously they (or we) can tweak some assumption about tax rates, rates of return, inflation, and their ability to eat only rice and beans forever, but you can sort of see the initial plan start to come together.

Inherent in Justin’s Lean FIRE planning, he says, is a commitment to live cheaply enough that work isn’t necessary. If that means living in a lower-cost state, or even a lower-cost country, he’s ok with that. Their reward will be freedom from having to work in an office or depend on a paycheck in the future.

Fat FIRE – This is for folks who make a high enough income that they can build a hefty nest egg for later. Generally this also means sacrificing current wants to ensure future luxury. Or as Justin says, Fat FIRE adherents want to live middle class today in order to live upper class in the future. Of course, part of the goal is to build that nest egg as quickly as possible in order to still retire early. A Fat FIRE pile of savings is by definition far higher than a lean FIRE pile of savings.

Barista FIRE – This is for current corporate drones who dream of giving up a career advancement and responsibility and who have seek to have enough money in the bank to just work a minimum wage job with good benefits. Since healthcare costs naturally represent a major barrier to early retirement, the “Barista FIRE” enthusiast may sign up to work for a company like Starbucks, post-retirement, for the generous benefits rather than for the paycheck. FIRE in this case doesn’t mean a full retirement but rather the independence from work that requires long-term responsibility, career, and those jerks from headquarters requesting you come in to finish those TPS reports on Saturdays.

Coast FIRE – This is for folks who have made their “number” for financial independence but don’t actually have an incentive to quit yet. Maybe their spouse isn’t ready to retire early, so it’s worth hanging on to a job. But they can ‘coast’ for a while without the pressure to actually work to pay one’s bills.

All in all, of course, you can criticize and exaggerate these different versions of financial independence and retiring early. Assumptions may strike us as unrealistic. The goal may seem overly materialistic, or not materialistic enough. Personally, my main objection to seeking to retire early is that work is what gives us meaning. If we don’t like work and seek an early retirement, maybe the solution is to seek different work that better suits our skills and interests?

Older barista may be totally financially secure, just doing it for the healthcare.

And yet, every responsible financial planner would ask her client to set forth a future plan, make realistic assumptions about savings and investment to get there, and then ask what the client is willing to give up to make the future a reality. That’s what the FIRE adherents are doing. Financial independence always requires some version of these steps, even if some FIRE enthusiasts take it to the extreme.

At the extreme, of course, even the financial independence aspect of FIRE can be overdone. Just as body dysmorphia pushes even the thinnest people to cut calories, so can the FIRE movement lead to penny-pinching absurdity. Justin is not in that problematic category, but you don’t have to look hard online to see people maximizing their savings to an extreme that doesn’t make a ton of sense.

What about those specific FIRE retirement account strategies Justin mentioned that I hadn’t heard of before? I looked into them. They aren’t exactly universally recommended – nor is FIRE for that matter – but I’ll describe them in more detail in an upcoming column.

Please see related posts:

FIRE Part II – Some Complex Techniques

FIRE Part III – On the Benefits of Frugality

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May 13, 2015

Audio Interview with Wendy Kowalik Part III – Happiness, Pyschology, and Gender

Podcast: Play in new window | Download

Please see Part I with Wendy Kowalik, on fees, and Part II with Wendy Kowalik, on Insurance and Getting Rich Slowly

Michael: Hi, my name is Michael and I used to be a banker.

Wendy: Hi, Michael. My name is Wendy Kowalik, I founded Predico Partners. We’re a financial consulting firm.

On Happiness

Michael: In your experience you’re dealing with both high net-worth folks and very moderate net-worth folks.

Tell me about are the rich really different from you and me? I mean specifically this idea of happiness. I think we know from popular culture, probably, that money doesn’t buy happiness. But I wondered in your experience are people different on the happiness scale if you have 10 or 50-million net worth?

Wendy: I don’t think that money buys happiness. What I’ve seen over the years of doing this is a lot of times it brings more complications that they weren’t expecting, especially when it shows up quickly. Then it’s a struggle between how much do you help your children, how much do you help family, how much do you help others versus how much do they need to survive. It brings into a lot of families struggles that they weren’t expecting, just from “where do I draw the line.”

The number-one thing people are concerned about is “I don’t want my children to feel entitled.” How do I make sure they understand the value of the dollar? How do I make sure that they’re going to be a benefit to society and really do something — not be everything you see on social media on trust-fund children? That’s a real struggle that people always say if I had money I wouldn’t worry about. But your children, you’re going to worry about whether you have money or don’t.

Michael: I differentiate in my life people I meet between — I have my prejudices, and one of them is – people who’ve made the money in their lifetime and people who simply inherited it. It’s perhaps an unfair divide, but it’s a quite American democratic divide that I make. Other people do this as well.

Do you find people who’ve made the money have a totally different perspective on the money than the people who have simply inherited the money?

Wendy: Absolutely, at the end of the day the people who have made the money have normally done it through struggles, especially if they’re business owners or they’ve earned it over time. They’ve had failures. The people who are second generation many times have not had the failures. They’ve just seen it as life is good. They’ve seen the cash coming in, and especially third generation, because they’ve never not had the money. Sometimes with first generation, because they didn’t have it early on, the kids maybe didn’t grow up the same way. But it is a very different situation when you’ve never failed, either in business or in money. That’s one of the greatest obstacles is how do you let kids fail when you have the opportunity to bail them out.

Michael: The deep mixture of psychology and money, which I also think is pretty interesting, fertile ground for discussion. My site, Bankers Anonymous is really all about me coming to terms with my business failure in a sense, and then being like “let’s talk openly about money” and maybe a bit of the psychology of money, and a focus on investing and that kind of thing, but also globally with a lot of other things. There’s an element where there’s a personal project.

I’m deeply interested in that topic, of people experiencing failure around that or experiencing deep psychological discomfort around that. I’m not sure this will make the cut of the podcast but for me that’s a really interesting set of topics.

On Role of Psychology in Investing

Michael: One of them relates to the role of the investment advisor, and I use a couple of phrases when I talk to my friends and acquaintances about money and managing money, and investment advisory advice. One of them is the role of an investment advisor is really deeply a psychological role. It’s to hold your hand at certain moments. I have recently written on one of my posts that probably the most important role is to hold the hand of the client when the market pukes, and then go “Don’t sell. This isn’t the moment to sell.” It’s a very deeply — has very little to do with market knowledge and everything to do with holding the hand of the person, and saying: “Remember, we talked about this, and I know you’re freaking out, but it’s a deeply psychological time. Just trust me, don’t sell.” Do you find yourself doing some version of hand holding or really being the psychological coach to your clients?

Wendy: It is absolutely probably one of the keys to psychology to this business. If you think about it, you’re asking people on a daily basis to do what is completely opposite of what they know and feel.

The best was in the ’90s. We had a client’s son called. He’d been in the 401(k) for about five years at that point. He called and said, “I need your help. We have to figure this out. I’m in a 401(k) and those accounts don’t go down. I need you to figure out what’s wrong, what did my company do, how did they mess this account up?” He’s been in the stock market in that period of time where it had never lost money. He really believed that it just completely kept going. If you put money in, this stuff went up. Not like everything else outside your 401(k).

Michael: Some magical pixie dust of your 401(k) that just made it go up. One of my mentors on Wall Street [famously] said to me as an aside, but I never forgot it. He said, “I love this job. It’s 5% bond math and 95% child psychology.” It’s true for Wall Street sales and true for I think investment advisory.

There’s an investment advisor I don’t know personally but I read his stuff. I’m on his newsletter that I mentioned to you in the past, David Hultstrom, who said, “Investment advisors make the mistake of thinking their job is to increase their client’s money or increase the size of the portfolio. But really, they increase the client’s happiness.” If you see it that way you have a totally different possibly set of ways in which you approach the client. Forget about making the money or increasing the portfolio. Make them happy. It seems like a wise, profound thing to say.

Wendy: It’s a very true statement.

Gender in Finance

Michael: What about being a woman in finance? On Wall Street there were plenty of women on the trading floor. On the other hand, they weren’t generally my bosses nor were they running the firms. There’s a glass ceiling there in those types of jobs. When you’re running your own company you’re running your own company, but do you find it is different for a woman than a man, still?

Wendy: It’s interesting. There’s definitely much fewer women. If you look at the insurance industry they’re almost non-existent in the insurance business. There’s definitely many more in the investment side of the business than there are in insurance. It is a difference in the way that women and men go about how they make decisions and how they talk to clients about things.

It’s been interesting to talk to clients over time about the differences in the way that women and men approach money and approach topics of money. It’s a fascinating difference as you sit across the table.

Michael: Is it harder, easier, better, worse?

Wendy: I don’t think it’s harder. I think it’s definitely different. I’m more question oriented so I have to dive down into details to get the ultimate facts. I can’t come to you and just talk off the top of my head if I don’t know it to be true, whereas I’ve found most of the men in the business are very comfortable that once they have a high level of knowledge they were ready to go forward with it. They dive down into the details after they got down the road. It was just that sense of confidence of knowing that I had all the answers first. There’s a good happy medium.

Michael: Men are better at bluffing their way to begin with?

Wendy: True, yes, they’ll jump out there sooner. The good side of it is they’ll move faster than most women will. The downside is maybe they don’t have all the facts to move faster. Those are complete generalities because I work with men and women on both sides of the table. I think after 20 years in the business all of us learn to adapt. I’ve learned to be willing to move forward without having to have every single piece to the puzzle. But I think you have men that sometimes need to slow down and probably not shoot from the hip.

Michael: Last week, a quick story about my nine-year-old daughter, she was selected to be the traffic patrol kid with a team of a dozen patrols. They get there early and stay late as kids come into school and cross the street. They put up and down the flag and fold it. So one of the honorary things is putting up and down the flag. The other day she and another boy, Shawn, were selected to be captains. It’s a great honor. Of the dozen or so in her cohort, Shawn and she are going to be captains. She said, “They’re going to teach me how to do the flag. Of course, Shawn’s already been taught the flag.” And my wife and I said why is that. She said, “Well, he just acts like a captain already so he just kind of hangs out there, and they taught him how to do the flag.”

safety_patrol — Not my actual daughter, just some randoms from Google Image

Wendy: That’s a perfect example.

Michael: I thought holy cow, that is life right there. The boy just kind of hangs out, I’m kind of a captain type, and they taught him. She’s a rule-following kind of cautious kid, so she’s going to wait until somebody invites her to be taught. I was just floored and thought that’s it in a nutshell.

Wendy: That nailed it.

Michael: I don’t know what we’re going to do. But it’s super typical. She just needs to know that sometimes you’ve got to fake it, hang out, and get taught how to put the flag up.

Wendy: That’s right.

Michael: but let’s end this call now. Then let’s keep talking. Thanks so much.

Wendy: Take care, bye.

Michael: Bye.

Please see related posts:

Do You Need An Investment Advisor – Why?

Talking to Children about Money – I still need to read Ron Lieber’s book

Book Review: Why Smart People Make Big Money Mistakes, by Gary Belsky and Thomas Gilovich

Stupid Smart People

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May 1, 2015May 1, 2015

Audio Interview Wendy Kowalik Part II – On Insurance And Getting Rich Slowly

Podcast: Play in new window | Download

Please see related discussion with Wendy Kowalik in Part One on investment advisory fees.

Michael: Hi, my name is Michael and I used to be a banker.

Wendy: Hi, Michael. Wendy Kowalik, I founded Predico Partners. We’re a financial consulting firm. I started my career with an insurance company and sold insurance for the same 17 years that we managed money.

Try to save your money from all these nice folks

On Insurance

Michael: That is my pet peeve, insurance. I think too many people who are engaging with insurance as if insurance was a form of investing make a deep error. I find when people buy insurance they’re being told that it’s some kind of good investment. You and I previously spoke about this guy Dave Ramsey, who for all his flaws, has told me the number one thing I need to know about insurance, which is: figure out what the risk transfer is. And that’s what insurance is for. It’s not for mixing with investments. I deeply believe that.

You came from a firm that did quite a bit of insurance. As we’ve spoken in the past, that’s not always how insurance is sold. Probably the majority of the time it is some kind of weird blend between a supposed investment in addition to a risk transfer. You’ve done it. I haven’t sold insurance or been involved in that, but what do you think about my ideas?

Wendy: “It depends,” is the worst answer, but globally you’re on the right track. You’re exactly right. And what I’ll tell you is if someone is walking through the door saying you should use it as an investment vehicle, you’re probably on the wrong track.

predico_partners — Interview with Wendy Kowalik of Predico Partners

Very seldom will you find that working well. The insurance industry’s argument on that side of it is it’s disciplined savings. It grows tax deferred. Well, so does your 401(k). Make sure you’re making that out first. That’s the first place you need to be saving, on that side.

The other argument is you can go in and take a loan out tax-free. Very true statement except for the fact that if the policy doesn’t last for the long term, then you pay taxes on every dollar you took out. That’s where it’s all the details within the insurance that many times make them not work as they were originally sold.

Yes, for globally, I would tell everybody that there’s only two reasons to purchase insurance.

To protect an income source if you’ve got a spouse that’s working and you need their income to make your monthly budget. You need to protect that.

The second side of the table is if you have estate taxes. You can use insurance to basically pay a lower dollar amount for you estate taxes. Outside of those two pieces of the puzzle, I don’t really see a huge need for life insurance.

Michael: The second part, the estate taxes, is going to be much more of a high net-worth problem than an ordinary investor problem. We’re talking up at the top 5%, 1% or .01%. It gets more plausible that they’re going to be able to have a tax savings and estate planning through insurance, right?

Wendy: Right, sitting here today, an estate over 10-million dollars for a married couple and an estate over 5-million dollars for a single individual.

Michael: What I tell people, and most of my ordinary acquaintances are not in that category, I just say “You need to focus on self-insuring” through trying to invest your money so that when it comes time where you can no longer work, or you choose to not work, you’re not worried about an income stream, and you’ve self-insured though actual investments, rather than this expensive version, which is paying an insurance company to be this mix of asset protection, asset building, and income replacement.

Wendy: That’s exactly right. You should have two different pieces of the puzzle. You should have term insurance if you’re protecting an income stream for a period of time. And use your savings separate from that.

Michael: Right. I just don’t trust that most insurance sales people in the industry is parsing that out for people to say “If you’re got a risk of loss of income, you need term for the period of time in which you’re worried about that, and then use the savings to put that in the market.”

This is what I always tell people — without knowing — having not worked in the insurance industry that just seems to be the right thing.

Wendy: Right.

Michael: For most people, with obvious exceptions. If you’ve got a ten-million-dollar estate it’s a whole different situation and you probably need different set of advice, which I’m not qualified to give. We’ve got term insurance in my family related to how old my kids are, when they are going to be no longer under my protection, and can fend for themselves in a sense. But it’s super-duper cheap to get that, for a certain number of years, and a certain amount of money, not a huge amount, but sufficient to not leave them in a lurch.

Wendy: That’s the biggest struggle on the insurance side, is figuring out what that number is.

Michael: Tight.Certainly back to your two reasons to have insurance. One is replacing income stream, and the second is estate planning and possible tax reduction. The folks for whom that second part is relevant, estate planning — the first part seems to me to be totally irrelevant. You’re either in one or the other. You’re probably not in both because if you have ten million somewhere in assets, you don’t really need to ensure further a loss of income stream. You’re probably going to be able to feed and clothe yourself now. Or am I not thinking about that right?

Wendy: Yes, no you’re right. Could they self-insure? Absolutely. What you’ll find a lot of times, though, is you’ve got people in that situation that have purchased property or they’ve got a family-owned business that makes that up. Then it becomes a liquidity event. Do I really want to unload Pepsi to pay the estate taxes? Or do I want to have to sell at that point or do I want to buy some time? It still may not be this massive convoluted structure, but I may be that I want to purchase an amount to give me time to figure out what I want to do with the asset.

On Budgeting, and Getting Rich Slow

Michael: So, any other topics you think we should get onto the podcast?

Wendy: The other thing you put on there was budgeting. How do people come up with a budget.

Michael: Oh yeah, let’s talk about that.

Wendy: I do think that is a big piece of the puzzle. The number-one side we run through is no matter how much money you have, you’ve got to understand how much you spend that’s fixed expenses and will not change, no matter what you do right now, unless you actually make radical lifestyle changes, such as selling your home, changing your cars, that type of thing. Or is it just discretionary, and to me that is such a big piece of the puzzle, is understanding exactly what you’ve got that’s fixed, what you’ve got that’s discretionary, because that’s the only way you can determine can I really cut back and make some changes, and start saving more, because we don’t need to eat out as much or go do this as much. Or is it that we’ve extended beyond what we can truly afford either in a home, or cars, or things such as that, and we need to change lifestyles more dramatically than just not going out to eat on Friday nights.

Michael: I’ve taken to saying to people, my friends, or peers, or people that ask my advice that nobody has any extra money at the end of the month. Whether you make 350,000 bucks a year or you make 35,000 bucks a year. There’s no extra money. Your lifestyle builds to whatever you’ve gotten comfortable with, and I tell people you basically have to trick yourself into creating little streams of savings and investments. This isn’t true for everybody and to bring up my nine-year-old daughter, she’s basically a hoarder. Her babysitter basically said early on she’s going to be on the hoarder TV show. She never throws anything away, so if you give her some money — there’s a few people like that, who save all their pennies, nuts, and squirrel them away.

But for most people there is no money. There’s no salary that’s enough to make sure you have extra money. If you move up from the Honda to the Audi, then you have to get the Jaguar. You’re still just buying a car, but somehow if you make 350,000 dollars. It’s not hard to go bankrupt on 400,000 dollars a year. Mike Tyson went bankrupt after earning 300-million dollars in his life. There isn’t any real money…[that’s sufficient.] You have to figure out tricks and ways to get the excesses.

Then you have these weird stories of the person who never made more than 40,000 dollars in their life, and they have huge investment accounts, relatively speaking, at the end of their life. They were able to do it.

Wendy: My favorite was we had a client referred to us in my former firm. That was exactly it. He had been a civil service employee, never made over 40,000 dollars for many years, and finally topped out at 65,000 dollars. She was in her early 80s, late 70s, and her investment account was worth 15 million dollars. She purchased with every extra few dollars, at the end of the month, she’d say this is what we’re going to set aside for savings. He would purchase bank stocks because he decided that it paid a little bit in dividends, and that was what he followed. He did financial stocks and he purchased six stocks, followed them. He never once sold a dollar of them. He never cashed them in for anything, and just added to those same six. That’s what it grew to. It was absolutely incredible.

Michael: That is incredible. If you have 60 years of doing that, there’s the compound returns of equity exposure to a couple of good stocks or six different bank stocks over a certain period of time. That’s incredible, yet mathematically very plausible when you look at it, how much you could put away, and if you let it ride for 40 to 60 years. It’s totally doable. It doesn’t feel like that until holy cow, 30 years later suddenly it’s grown.

Wendy: Right.

Michael: I feel like that message doesn’t get out to enough people or it gets out when you turn 62 and you’re like huh, so I should have been starting 40 years ago? Now you tell me?

Wendy: That’s right. And I think it’s hard to withstand, and I think what many people strive for is they keep trying to find a better way to get to the investment returns. They’re looking for that — there’s some trick to get there. A lot of it is just hard work and discipline.

Michael: I think automatic deductions from paychecks or your checking account, so you never see it — just like investment advisors are going to secretly, stealthily take out 1% or 1.5% per year. If you can get your 401(k) and then your brokerage account to sneakily take out a few hundred and then a few thousand dollars per pay period, it works out in the long run.

Wendy: Exactly. You’re right.

Michael: It’s hard to make the affirmative choice to do it, but if just sneakily happens by default you can build up wealth, I think.

Wendy: I completely agree. We tell everybody if you take it and send it to a brokerage account that’s not in your bank, leave it in cash for 90 days, that way you know can you really make it without that money, without having to go back and take it back. You normally won’t call the brokerage account and ask them to send you a check. You really do need it if you’re doing that. So then at the end of 90 days put it to work. See if you can increase it and put away more in the next pay period.

Michael: I think that method works. GET RICH SLOW. It’s hard to get rich quick.

Wendy: Very true.

Michael: Thank you for discussing all these things. I think there’s lots of interesting ideas here that people should be paying attention to.

wendy kowalik pic 2 — Wendy Kowalik, President of Predico Partners

Please see related posts:

Interview with Mint.com – I give ALL the answers

On Insurance – Use for Risk Transfer Only

On Insurance as an Investment

401Ks are awesome but should be simpler

Guest Post from Lars Kroijer: Don’t buy too much insurance

On Longevity Insurance: Do You Feel Lucky?

Audio Interview Part I with Wendy Kowalik – On Fees

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April 30, 2015April 11, 2017

Audio Interview with Wendy Kowalik, Part I – On Fees

Podcast: Play in new window | Download

Here’s Part I of my interview with an investment consultant who charges advisory fees in an unusually (admirably!) transparent way. Click on Part II and Part III to hear Wendy and I discuss the uses of insurance, the psychology of savings, and how to get rich slow. You can read the transcript but as always I recommend the audio version highly!

Michael: Hi, my name is Michael and I used to be a banker.

Wendy: Hi, Michael. Wendy Kowalik, I founded Predico Partners. We’re a financial consulting firm.

Michael: Wendy, thanks so much for talking about that. There’s lots of different interesting things to say about your business, but I wanted to start with costs, because I think cost is one of those topics people don’t know that the most important thing to ask your investment advisor, in my opinion, is “how do you get paid?”
You have a different cost structure than most investment advisors. Can you tell me about that? and then I may jump in as well about that.

Wendy: Absolutely. What we found over the years is that most typical cost structures are built where someone brings you assets, and you’re going to charge a fee to oversee them, and invest them, and that’s how everyone gets paid. There’s a thousand different pieces of the puzzle beneath that.
What we decided to do at Predico is to go about life a bit differently. We decided we’d do an hourly charge for clients because it didn’t matter how much money you had; it was more about the time we were spending to either help you find someone to manage your money, or help you find some place to take care of it from there.
We do it based on a project fee or hourly fee.
In 2008 we had a client that had lost a lot of money, when we were in the former investment management business. And one of the things they sat back and asked was: “Do you get paid to keep me in the market or do you really believe that if I get out of the market that you could still make money and help me out?”
We decided we wanted a conflict-free answer to that question. And as we also looked at it, we had clients asking us “If our value went from 10 million to 20 million dollars are you really doing that much work for me than you were doing when it was at ten?”
The answer was no, from our perspective.

Michael: That is the main question. It’s basically as much effort to manage somebody who’s got 100,000 dollars, a million dollars, or 10 or 100 million dollars. As a manager, the scalability of charging fees on assets is so freaking amazing that it’s really unusual that someone would say I’m going to charge — you’re charging analogous to an attorney or a CPA, who would say charge me for the project by the hour, not on percentage of assets. It’s very unusual.

Wendy: Correct.

Michael: It’s almost to the point of you’ve chosen the hardest way to try to run your business, versus the scalability of “Hey, if I get a couple clients who have ten-million bucks I’m pretty much in business and I’m good.” As an investment advisor, it’s a very scalable business that way.

investment_advisor_fees — What should be on every investment advisor’s wall

Wendy: That’s a very true statement. I tell clients that all the time. If you look at investment advisors they have two ways of making money. The first way is the way they’re going to market to you, which is “I make money if you make money. I grow my practice by growing your assets. That’s why we should do it this way.”
The other way is the way that most of the investment business works is I make money by getting as much assets under management as possible, so even if a market goes down, if I picked up four more clients with assets, my income has still gone up this year.

Michael: And you haven’t chosen either of these awesome ways to make money!

Wendy: for 17 years of my career I did, and I did that, and we made a really good living by managing peoples’ money, and selling them insurance. I found it wasn’t a comfortable model for me. I was uncomfortable that I was either overpaid for my time for certain clients, and underpaid at other times. I decided I just wanted to get paid for my time, in a manner that both of us could see clearly the only person writing me a check was the client. And yeah, it’s definitely a much tougher model to track your hours, but I think it’s the fairest model, and I can sleep at night when I put my head on my pillow.

Michael: A client writing a check, versus what everybody else does in the investment management world, which is I just quietly slip out a portion of your money on an annual or quarterly basis, and you never even feel the pain of losing that money. When somebody has to write a check upfront for advice they’re given, it’s just a much higher hurdle.
I think it’s sort of magical the way that most investment advisors sort of slip the money out quietly, and you never notice it.

Wendy: Very true statement.

Michael: It’s magical little part of the compensation scheme that we call investment advisory, and you’re not doing it.

Wendy: And what they teach you over time when you’re in the investment management business is “It’s going to be just like gym-membership fees. Everyone signed on to the gym, they never go, and the gym keeps collecting it.” Same thing with an investment advisor.

Michael: Neglect is a key part of a lot of business strategies, gym fees, and a lot of insurance is built around the idea of neglect. You’re not going to re-check.
On a side note, my wife and I were looking at her mutual fund choices this week, and I noticed she’s got a bunch that are fine choices in terms of risk, but they’re probably five times the fees as probably she needs. It’s been going on for ten years. I looked at it and I said, “Oh my gosh, I can’t believe you have these high-cost mutual fund fees.” She said, “You’re the one who told me to do it.” I was like “That’s right, ten years ago.” I’ve neglected for ten years to check whether she’s still in these high-cost mutual funds. There’s a lot of money involved, even at our scale, that over time those mutual-fund managers have earned, simply from neglect. I just forgot to check.
Meanwhile, I’m out there pounding the gavel for people “You’ve got to be in index funds, or lower your costs, and don’t overpay these managers.” Meanwhile, my wife’s retirement account is paying a lot of fees, and I’m the one to blame, as she pointed out correctly.

Wendy: “It is the cobbler’s kids” [“that go barefoot,” I guess] That is a very true statement It is amazing how easy it is to ignore, and it makes you realize how tough it is for clients to do it. There are many times clients say “I can’t believe I’ve let this go on. I’m so embarrassed I haven’t looked at this, or I didn’t know.” We all run into the same point. You’re busy making money for the company’s bottom line. The last thing you look at is your own bottom line.

Michael: It’s hard. I know you know — I don’t, but you’ve done this; it’s hard to get somebody to say pay me money now, upfront, for some future benefit, rather than “I will keep getting paid on a renewable, quiet, stealthy fee, year after year after year.” I admire it. I’m amazed, actually.
Wendy: Thank you. It was definitely — I was very concerned about it when I launched the model because that was what most people told me. I just don’t know that I’d be comfortable, but I found people really like the fact I have no conflict, that I can sit in a room with an investment advisor and help them interview, and ask the questions because we did sell it for 17 years. I really do know why they’re being shown a certain thing or why not. It is fascinating to see all the things that are second nature, after you’ve been in the business, that you wouldn’t even think to tell a client, and watching that evolution come out.

Michael: Somebody comes in to you and they have a modest 50,000 or 100,000-dollar portfolio versus somebody else comes in and they say “I just inherited 15 million,” are you charging essentially very similar amounts for the same service?

Wendy: As I tell everybody, we charge $250 an hour and we’ll sit down and estimate the number of hours to get you an ideal project fee. So, yeah, in answer to that question. If you want us to go through, the only difference should be if you only have 50,000 dollars and two managers, helping you review it and ask some of the questions is a lot less hours, so it should be a lot less charge than it would be if I’ve got 32 accounts.

Michael: Somebody comes to you and you’re going to put together a plan. They may certainly end up paying mutual-fund or hedge fund management fees, and then they may end up paying fees to an insurance solution on top of what they paid you. They’re not eliminating that. It’s just they’re getting that presumably without the conflict of your caring, in a sense, about who they go to. Is that accurately said?

Wendy: Right, we do not manage money so once they actually decide they want to go put that money to work, we’ll help them find somebody if they need help or we’ll review what their current investment advisor is proposing. But yes, they’re going to end up paying some form of fee. The goal is we’ve helped them negotiate those fees down as low as possible, or we help them find somebody that they feel very comfortable, and trusting that they’re in good hands if they’ve never done this before.

Please see related posts:

Do you need an Investment Advisor? And Why?

Management fees – My Hyundai Elantra analogy

Book Review – A Random Walk Down Wall Street, by Burton Malkiel

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December 1, 2014

Ask an Ex-Banker: What Are Discretionary Accounts?

NOTE: A version of this post appeared earlier in the San Antonio Express News

Dear Mike,

I wanted to report on my meeting with JPMorgan today. They were very nice, very polished. They handle private accounts and were confident that we could easily transfer my money over to them. They told me that they have analysts all over the world working on this, but they are personally watching the money to insure we get the best deals.

Then I started asking questions and found out a key point: All JPMorgan accounts are “discretionary accounts” (actively managed) and they explained why that was really important and helpful.

So my question is this: What is a discretionary investment account? What are the other alternatives? And what would you recommend a novice investor use? I think I remember my old banker advising me to stay away from discretionary account management, but I am not sure.

Thanks,

Sophie in Boulder, Colorado

————-

Dear Sophie,

“Discretionary” means someone else — not you, someone at the bank — makes decisions about your money. That works for people who totally trust their banker, I guess.

Personally, I would never do that, but probably not for the reasons you would think. Let me define a few terms to explain my thoughts.

As so often happens with money management, the way you pay fees determines everything.

A discretionary “brokerage” relationship is probably what your old banker advised you against. That kind of relationship is one in which the firm and your main advisor make money only when you buy or sell a product, basically from brokerage commissions. This has the pernicious effect of encouraging your broker — because they have discretion or control over your account — to trade more often than might be prudent. That’s how a discretionary brokerage account works, and that’s something to avoid.

A discretionary “fiduciary” account, by contrast, is one in which the bank and your financial advisor get paid through regular quarterly or annual fees, usually as a percentage of your money that they manage. This has at least three advantages:

The broker does not make more money by trading frequently, which can be deathly to a person’s net worth;
If you as the client have more money, the advisor gets paid more, so in general the broker’s incentives line up a bit better with your best financial interests; and
A discretionary fiduciary relationship typically carries with it an expectation that the broker must act in the client’s best interest, and a regulatory regime exists to try to punish bad actors who fail to act as prudent fiduciaries.

Now, there’s no guarantee that the broker with discretion will always do that.

I say that not particularly because I think JPMorgan Chase will rip you off. While that’s possible, I would consider it highly unlikely to happen with JPMorgan Chase — or any other giant brokerage firm. I’m not naïve about the possibility of bad apples at JP Morgan Chase, but I trust in the power of lawyers going after big Wall Street firms. JPMorgan Chase and other huge brokerages are big fat targets in a highly litigious world. Many class-action or investor-protection lawyers would like nothing better than to take you on as a client if you got treated badly by a big brokerage company. That’s a massive payday all around for you and your attorney.

So I’m not primarily worried about fraud per se with your discretionary fiduciary account.

What I am more worried about with a discretionary account is the likelihood that JPMorgan Chase will provide higher-cost solutions than you really need.

I worked on Wall Street, and we always got paid better for putting clients into higher-cost, rather than lower-cost, solutions. Since that’s how we got paid, that’s where the conversations tended to turn. It’s really hard to avoid. When you give your broker discretionary power, mostly you run that risk. Since you are a novice investor, this is a particularly important risk to think about.

As for whether a discretionary account is standard at JPMorgan, as your prospective brokers claimed: It seems impossible to me that “everyone” has that kind of account. Those two brokers in Boulder, Colorado, may have every one of their clients with that deal, but I have no doubt that JPMorgan allows some clients to control their own money.

How do I know that? Here’s how I know. Many, many, many rich people want to control their own money, and JPMorgan Chase wants to make rich people happy. Therefore, JPMorgan Chase must open non-discretionary accounts.

A buddy of mine in San Antonio who works for a competitor of JPMorgan explained to me that he and his colleagues often prefer to set up clients with a discretionary fiduciary account. But the choice ultimately rests with the client.

Now, those JPMorgan financial advisors — or any other brokerage firm — may not want your account if they can’t have discretion over it, which is their own choice. But the JPMorgan investment advisors’ claim that “everybody” has that type of account is really a description of their own particular business model of those investment advisors within their office, rather than a universal rule of JPMorgan.

My buddy the investment advisor and I respectfully disagree somewhat on the issue of whether your discretionary fiduciary account will lead to higher cost solutions. He argues that because he makes more money when his clients make more money, he has both a fiduciary duty as well as a financial incentive to make his clients more money. For that reason, he argues, he will certainly choose a lower-cost investment product if that’s better for his client, or he will consider other options if that’s better for his client. Since he has set up his financial advisor practice so that he cannot benefit directly from higher-cost products, he feels confident he will protect clients from high-cost products that don’t serve them best.

I remain skeptical, and we’ve talked about this difference, because my experience tells me that investment advisors have a wide variety of incentives, and some of them go beyond the purely fiduciary. What if financial advisors get treated to a delightful luncheon at the best restaurant in town by the fund manager and their analysts? What about access, and information? What about a sense of belonging? Or brand loyalty — that goes beyond the precise “best practice” for the client?

My buddy says good investment advisors set themselves up to be client-oriented and safe from these competing incentives. I say that even with the best of intentions we’re all human and we have mixed motives. The more discretion you give your advisor, the less you can control those motives.

As for JPMorgan Chase’s claim that they are “watching your money to make sure you get the best deal,” I guess this is the kind of thing one says these days to justify higher fees.

The key to Wall Street — as always — is to convince clients that the broker or bank provides some extraordinary service to justify extraordinary costs, when in reality the service is typically very ordinary.

I know you are concerned about what to do next.

I’ve thrown a bunch of skeptical ideas at you that do not solve the problem for you.

The long run solution is to invest enough time in understanding your investments to the point where you will no longer see giving a bank or brokerage discretion as a good thing. The short run solution is to keep shopping around for a bank or brokerage that wants you to gain that understanding, rather than to make decisions for you.

Please see related post: Do You Need An Investment Advisor? If So, What For?

Please see related book review: Simple Wealth, Inevitable Wealth by Nick Murray

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October 13, 2014October 20, 2014

Do You Need An Investment Advisor? And Why?

A version of this post previously appeared in the San Antonio Express News.

Some friends of mine recently opened up investment accounts with a guy who is a salesman at a national insurance company. My friends also hired a “fiduciary” to review their investment plans. Finally, they consulted me, for free, on what to do with their investments because I’m a friend.

They seek answers to something nobody ever bothers to teach. They need financial advice. Who doesn’t?
Among the three sources they recently contacted, they will certainly hear quite a bit of possibly contradictory advice. In the long run, I got to thinking, do they also need to hire an investment advisor?
“Do you need an investment advisor?” is one of those evergreen questions for people who have managed to accumulate some investments.

The short, albeit possibly contradictory answer — given that I do not have an investment advisor myself — is: “Yes, probably.”
Following on the heels of that question, if the answer to the first question is yes, is: “What do I need an investment advisor for?”

I’m so glad you asked. And you’re not going to believe this, but I have very strong opinions on this question.
A good investment advisor should do two — and only two — things, and then stop.

Number one thing: Set up an investment plan for the client that has a reasonable chance for success at meeting the client’s goals, taking into account the client’s ability to save and invest. The plan should be so simple that all parts can be understood clearly by the client. The plan should run on auto-pilot (probably involving automatic paycheck or bank account deductions), and should rebalance on a low-frequency cycle (probably through new purchases, rather than sales).
All of this should be accomplished within two visits with the investment advisor.

Number two thing: When the market crashes — by the way, the only 100-percent guaranty in an investing life is that the market will crash, probably more than once, in a client’s 30-year investment cycle — the investment advisor is there to prevent the client from selling after the crash. Because when things get cheap you’re supposed to buy more, not sell.
Psychologically speaking, few of us can stomach the nausea of actually buying after the crash.

Ahem. Now, would all those reading this who made stock purchases in March 2009 please raise your hand?
Oh, really? All of you with your hands up are liars.
While we rarely have the sense to buy at the lowest point in the market, realistically a good investment advisor reminds us at least not to sell after the crash happens. The good advisor reminds us that we knew a crash would happen a couple of times in our 30-year investment cycle.
After the crash comes you don’t sell — you just keep on doing what you’re doing. If the advisor can prevent the panicked sale after the crash, the advisor is worth all the money paid to her over the years.

And that’s it. Anything else that an investment advisor does is probably too much, and the client may suffer as a result.

“But, but, but…..” I can already hear all of the investment advisors out there protesting.

But what about tax planning? And estate planning?
What about insurance products? Have you considered whole life versus term life insurance. Or can I interest you in a variable annuity?
But shouldn’t an advisor pre-screen some hedge funds and venture capital funds?
Want to hear about oil & gas leases? Master limited partnerships?
I’m pretty sure there’s real estate and mortgage refinancing to be done, no?
What about picking great stocks for a client?

financial_advisor — If your financial advisor was a stock-photo robot, he should look like this

But what should I know about precious metals, agricultural commodity futures, and that new project finance deal in Ghana?
I also once read something about sector rotation? And then there’s value vs. growth? And biotech, and countercyclical consumer products!
What about anticipating the Fed, trading ahead of new data releases, getting in early on the next hot trend, or black-box trading and currency hedging?
Look, I agree — finance can be endlessly fun and interesting, and these are all great areas for a broker or investment advisor to get into because they produce wonderful opportunities for additional fees, commissions, portfolio churn and opacity. In most cases, however, they just don’t happen to produce wonderful results for clients.
If you need insurance or tax planning, by all means hire an expert. But a good investment advisor does not necessarily serve her client by brokering all these products.

To sum up:
Do you know how to set up what I describe above as “the number one thing” all on your own? If not, you probably need an investment advisor.
Second, do you know — beyond a shadow of a doubt — what you will do when the market crashes? Are you sure? If not, you probably need an investment advisor to hold your hand — that itchy-to-sell trigger-finger hand — to prevent you from selling.