Fear, Greed, and Loyalty: The Easiest Way To Make a Commission

Paul Winkler: Welcome. This is “The Investor Coaching Show.” I am Paul Winkler. I talk money and investing, financial planning.

The Investment Industry Is Broken

I had some fun this week. I say fun. Some people are like, “You have a really weird idea of fun, Paul.”

But I did. I had to write. I did some writing, some academic writing, and what I wanted to do is I wanted to see what peer-reviewed research there was out there.

Anytime you’re doing academic writing, it’s got to be peer reviewed. That’s typically what you’re shooting for. Academic journals, those types of things.

But I wanted to just see what peer-reviewed research there was out there, because this show, let me just tell you, the whole premise of this show has always been this: the investment industry is broken. Listen to the commercials for investment firms, and you don’t have to go any further.

Some of it’s they’re offering insurance products. A lot of them is financial planning. They’ll talk only about financial planning.

And often they’ll use that as the lead-in to sell, because you walk into a financial planning office and then all of a sudden they get into product recommendations, and you’re like, “I don’t know if this is good or not good,” but the person’s nice, and that’s how people are brought in. They really don’t know, necessarily, a whole lot about what they’re doing or why they’re doing it.

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But the industry has been really good at selling people on the idea that they know exactly what’s going on. 

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And I started off in the industry working for big investment firms, worked for a huge insurance company. Got really frustrated with that. The way you solve a problem is you don’t like working for the insurance company, so you just go, “Maybe I’ll just go to another insurance company. It’ll be different there.”

Not exactly. It wasn’t at all. It was the same junk, different day.

And then I went and worked for a brokerage firm. I thought, Well, maybe if you don’t work for the insurance company, but you work for a brokerage firm that represents a lot of different insurance companies, and also you have a broker-dealer, so you have an investment provider, and you get a list of different funds and different investments you can recommend to the public.

And I did that, and I was like, “This still isn’t the answer.” So I got really super, super frustrated as a result.

And then of course, at one point, I was at a meeting and the guy goes, “Hey, you know what? You’re pretty inquisitive.” And I am. I’m always asking questions.

“There’s these guys, researchers that are actually teaching around the country. Go just hear what they have to say.” And that’s exactly what I did.

So I went and started understanding that investing, there was a whole lot of logic, and it made sense. And clients could be actually educated to the point where they’re not blindly trusting anymore, which is a pretty cool thing.

Where Investors Get Information

So I’m writing this paper and I said, “I want to know if there was any peer-reviewed research that the majority of investors’ information is shaped or delivered by the investment industry,” and of course, there was. There was a tremendous amount of evidence about that.

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I found one thing that said that investors rely heavily on supplied or commercial sources of information. 

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So when you go to, let’s say, a mutual fund company, let’s say that a mutual fund company runs your 401(k). Now, the person who is signing you up for your 401(k) works for, yes, the mutual fund company or the insurance company, because sometimes you’ll see that there’ll be variable annuities and those types of things. And it might be group annuities, not the ones that you always hear me talk about variable annuities and annuities as being like, “Just stay away, stay away.”

I mean, they have their use every once in a while, but there is way, way too much use of these products because there are expenses, commissions, all kinds of conflicts of interest. So I’m not a real big fan.

But there can be group annuities, which is where an insurance company puts together a whole bunch of mutual funds. And back when I was in the 401(k) business, what I would do is I would often use these products.

And I asked somebody, “Well, why do we use these products? Why do you want me to recommend these things?”

I asked somebody that one time, and he said, “Well, because you have a responsibility to the company that you’re actually representing, their 401(k). You can pass off some of the responsibility to the insurance company because the insurance company chooses the underlying investments, and that way you get rid of some liability that way or potential liability.”

And I said, “Oh, that’s kind of interesting.” So that is why often we would do that.

Beating the Market

Now, there was some expense because the insurance company had to make money as well, so you don’t see that as much anymore. I don’t see that very often anymore.

Typically we’ll see mutual fund companies. So the person works for the mutual fund company. A person works for an investment firm and they’re given a certain group of investments to recommend. Big brokerage firms, they have investment management departments, and of course, their product is the absolute best product ever, right?

And my contention is that so often, investments are sold based on historic performance or short-term past performance. And when I say short-term, 10, 20 years is still short-term when it really gets down to it.

You can have a period of time. I think about Legg Mason, the value fund. There was a guy named Bill Miller. Bill Miller beat the market, as I recall, it was like 15 years in a row, and he was lauded as being this incredibly brilliant investment manager.

And I remember when I was doing this show, he was still on that run, and I made the comment, I said, “Don’t count on this lasting forever, folks. You can’t bet on this side. This is this person’s past performance. It’s random.”

You have tens of thousands and you have a lot of people trying to beat the market, probably millions, of people trying to beat the market. The odds that you’re going to not have one person that does it would be infinitesimally low. You’re going to have somebody that does it. We just didn’t know ahead of time it was going to be Bill Miller.

And of course, what happens is tremendous negative performance going forward. Not that I predicted it.

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I knew that the odds are incredibly low that somebody’s going to continue that hot streak. 

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And then of course you have Fidelity Magellan Fund, and that fund beat the market 11 out of 13 years. Again, can it happen? Yeah, it can happen. Highly unlikely.

Using Index Funds Actively

Then what happens is that if people say, “Hey, our investment department’s really great and we do really great stuff,” and then increasingly they start using index funds or ETFs, because the idea is you don’t have stock picking or market timing inside the index fund. And of course, what happens? The investment industry can’t get out of their own way.

Research recently shows that they’re using index funds increasingly actively. So they’re moving money around, and the whole idea was that you don’t do that, but investment managers are doing that, and people don’t even realize it’s happening.

So the frustration is that so often we’re getting information, and I thought, Hey, if we could just somehow, some way, if we could get people to just understand what am I doing, why am I doing it, how do things work, where do returns come from, I think we could keep investors a lot more disciplined. I think the investment industry would do better, which is odd. They would do better if they would stop this junk.

But here’s what happens. It’s a combination of the short-term focus of the investment industry. “We’ve got to get new business.” Hey, what’s the easiest way to get new business?

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The easiest way to get new business is to focus on your instincts — my desire to go toward pleasure, my desire to go away from paying.

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So I will look at something and go, “Wow, hey, really, how have you done? What have your returns been in the past 10, 15 years? Oh, you guys have done really well. I think I’ll go with you.”

And the client, not knowing that they’re asking a bad question, you don’t want to look at that. It’s not that returns don’t matter. It’s just that when you diversify, think about it this way.

I love one of my clients. He’s a rocket scientist and a brilliant guy, of course, and he sends me an article one day, and I still refer to it to this day because it was so good. He said, “Diversification means always having to say you’re sorry.”

Well, the investment industry doesn’t want to say that they’re sorry. They don’t want to say, “Hey, I put you in something that didn’t do well.”

But the reality of it is, when you’re diversified, you’ll have stuff that does really great and stuff that doesn’t do as well, and you are in competition with other investment managers. It is a lot easier if you just focus on your winners. And if you happen to be in an area of the market that happened to do better and you had more of your money that happened to be in that area, you’ve got a leg up on any competition.

The Low Bar for Investing Advisors

So what happens is people get their information from people that are competing in this particular manner and investment firms that are competing in this manner, and then they’re just like, “I don’t know what to do. Calgon, take me away.”

So what I think needs to happen is investors need to get a better idea or better teaching on how investment markets work, what diversification really is, and how you measure diversification. And you think, Well, that’s a big hill to climb, getting people to understand that.

And I made the comment, I said, “No, I think it’s not that hard. I think you can get it.” Because too often, if we’re getting information from these really compromised sources or they’re conflicted sources, you’ll never get to the point where investors really feel confident.

So what I was doing is I was looking at some of the evidence that these problems are out there, and one of the comments I made was something I’ve made here on the radio show, is that you’ll have, for example, the Texas thing that happened. There was an article I covered here on the show recently about a decision.

And I say it’s a decision. The reality was that the Department of Labor, who is responsible for 401(k)s, retirement plans, you’ve heard before people talk about being fiduciary, fiduciary, and that’s meaningless.

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I’m not a big fan of the idea of the fiduciary standard. I haven’t been because it was too easy to skirt around it, number one.

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Number two, the other point I would make, is this. If I said to you, “Hey, Doctor,” let’s say we’re talking about a doctor, “you have to do what’s in your patient’s best interest,” but let’s say that you had no training. You are a witch doctor.

You had no training in any medicine that was evidence-based in any way, shape, or form. You wouldn’t really know what was in somebody’s best interest. It wasn’t that you’re evil, but you just don’t know what’s in the best interest of the person.

A point that I made in the paper was that you get people that go through the Series 65. And I’ve got a guy that works with me, and I don’t let people that actually only have a Series 65 or even just a couple financial … I want somebody to have a lot of education before they deal with the public.

But the problem was that he passed that exam in three weeks and you go, “Well, wait a minute. I can call myself a financial advisor after just a few weeks of study?” Yeah, that’s the problem. So in effect, the investing public doesn’t realize quite often that the bar is that low, and hence we have the issue.

Our Decisions Are Emotional

They did this thing in Texas that I’m going to go back to that for a second, and basically, the Department of Labor doesn’t even show up for this hearing. So the insurance industry, they’re excited as they can be.

“Wow, you mean we don’t have to be fiduciaries anymore? This is great. We can sell it.”

And the way they put it was something like this: “Oh, the public is going to be served better because they can deal with the financial advisor of their choice.” Well, how did the financial advisor get chosen? It was a friend of the family. It was a nice person.

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There was one study that showed almost — and I would say it probably is — 100% of our decisions are emotional in nature.

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When we make decisions, it’s not necessarily that we’re making decisions using the left side of our brain, the logical, literal, language, and we call it the L’s, the left side of the brain. It’s being made based on instincts, emotions, fear, greed, trust, loyalty, things that we don’t even really think about, that we’re not even considering that that’s what is driving our decision, but let’s face it. That’s what’s driving our decision so often.

Then what I did is I found this one article, and I love the title of it. I don’t have it in front of me, but it was something to the effect that the evidence-based research, the academic research out there, they were questioning, with a lot of evidence, whether the investing public was even benefiting at all from this research.

And they were making all the points that I make on this show. The investing research goes ignored by an industry that doesn’t implement it because it’s easier to sell, it’s more effective to sell, based on past performance, based on trying to convince people that you have greater insights than somebody else, based on you have instincts and emotions, and those two things go together.

I plus E, as I always like to say, is greater than the C, which is the cognitive part of the mind. It’s a lot easier to sell based on that, and the media plays off of that.

Relative Losses

There was another article, as a matter of fact, now I’m thinking about it. This article was looking at online investing, and it was looking at where people were getting information. And the title of the actual research study was that they’re getting really bad results.

And it doesn’t mean that they’re losing money. Don’t get me wrong. It doesn’t mean that the investing public is losing money investing in this manner.

You often have what are called relative losses. That means that you lose relative to what you should have made had you captured market returns.

And that, my friends, is the problem that we’re dealing with in the investing industry so often. I’m going to give a couple examples of that. I’m going to go to a break, but I’m going to give some examples of how this actually plays out and the stuff that we see on TV, when we watch programs, the things that we hear, and it helps arm people against this type of information.

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That’s my goal. The more I can arm you to understand when you’re getting a sales pitch versus getting good information, makes you a better investor.

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So often, people will actually hear somebody talking about some investment product and it sounds really good. I would love to have an investment that gives me a 10% rate of return and there’s no risk, for example.

I’d love to have an investment product that when the market goes up, it goes up in value and it’s like a ratchet. When the market goes down, it doesn’t go down. That sounds really good.

I had an investment advisor come up to me at a radio station event. He said, “Paul, how could you possibly not like this particular product? It has a 100% participation rate in the upside of the market, blah, blah, blah.”

He’s going on and on. I wasn’t familiar with the product, but I was sitting there going, “You have to be born at night, and maybe even last night, to believe that’s possible.”

And of course, what I did the very next week on the radio show — probably didn’t make a big fan out of him because he was another investment guy — but I actually went in, and I found where the Department of Insurance, the regulators, were actually picking on the product. There was a regulator that tore it up on how misleading it was.

Because they were actually able to issue the product with this claim of a 100% participation rate. In other words, if the market goes up 10, you go up 10. If the market goes up 20, you go up 20, and there’s no cap on it. They were actually claiming that in the brochures, but they would change the product once the policy was issued, and it was just smoke and mirrors.

This is the investment industry, folks. You gotta watch it. You can’t blindly trust people, and it’s not because they’re trying to mislead you. A lot of times, the advisors themselves are misled, and that is a point I make all the time.

Pre-Tax Investment Vehicles

Yeah, so I’m going to throw just a little bit of financial planning stuff at you right here. I had a meeting with a couple, and they were just as excited as they could be. It’s retirement time. They were a hoot.

I was just fired up. It was like, “Okay, I’m going to cut grass with a pair of scissors. I’m going to have so much time on my hands.” He’s just looking forward to that.

It was really funny. But one of the things that we talked about, and this is something to think about when you’re preparing for retirement:

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When you are putting money away, quite often I will have people do things in pre-tax type of investment vehicles. 

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So the way our tax system works, your first income that you earn is taxed to zero. Then you have some income that might be taxed at 10 and then 12.

And as your income goes up, your percentage goes up 22, 24, on up to 37. So when I put money in pre-tax and I am in a higher tax bracket, I’m avoiding taxes.

Now, let’s say if I put $10,000 away into an IRA and I’m a 22% tax bracket, it will only affect my take-home payment if I’m in a 22% by $7,800. So 22% below, 100% is 10,000. And then 22% below that’s 7,800.

So if I did something with an after-tax type of investment, like a Roth IRA or let’s say an investment account, I probably wouldn’t do a savings account for retirement money. But if I had an investment account, I would only have $7,800 to do something with.

So a lot of times people will go pre-tax, because they have more that goes in there. And money that would have been sent to the government would actually stay in the account.

Now, as time goes on, not only does the $7,800, but the $2,200 that would have been paid in taxes continues to grow. And so, if we invest it well, it continues to grow.

And at some point in the future, we pull that money out. Now we do have to pay taxes when we pull it out, but we have some income, it’s at zero and some at 10 and some at 12.

And so, you have a situation where it’s at a lower percentage than when you put it in there, and let’s say that it’s 10%. Let’s say the money didn’t grow, just to keep it simple.

So let’s say it was 10,000 went in and you pull it back out at 10%. Well, you saved $2,200 when you put it in there. When you pull it back out later on, if the rate of return was zero, you pull it out and there’s 10%, which is $1,000.

Your taxes are lower as a percentage. Now, of course, you’re not likely to have 0% rate of return unless you’re just really doing a bad job when it comes to investing, but that’s the idea behind it.

Living Off Retirement Funds

Now, what happens is sometimes people will build up money, and this is what these people did, is they had a lot of money sitting in cash on the sidelines. And they had been paying off debt, getting all of the debt rid of.

So a lot of their expenditures, their mortgage payments, debt payments, and those types of things, were out of the way. So their budget had come way down, because they were used to, and I love this when people do this, they pay off debt like crazy before retirement, and they get used to living on a lower amount of money, because they’ve been making those debt payments.

And just when they retire, their budget is lower and they’re used to living on that lower amount. Now, they have a bunch, and these people also did this thing where they saved money on the side and they had cash.

Some people will sell their house and they’ll downsize, and they end up with a bunch of cash, or they’ll sell businesses, or they’ll have other things that they’ll get rid of in order to come up with a bunch of cash. Now that cash is after-tax money, sitting in an account someplace.

And in their first year of retirement and first couple of years of retirement, they can spend the cash. They can pull that money out and they can live off of that.

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Then, while they’re living off of that, what’s their tax rate? Well, they don’t have income from work anymore. So they have a bunch of income.

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It’s over 30,000 now for married filing jointly. And you even have additional ones for certain groups. And I’m not going to get into all that, because it varies based on your age, but you have a significant amount of money that you pay no taxes on.

Then you have some money that you pay 10% and 12%. Well, now what you can do is take some of that pre-tax money, which you avoided a 22% rate on or 24%, or even higher, and you convert it to Roth IRAs at lower rates. And the lower rates are because you’re in retirement, you’re not earning income, and you’re living off of that cash.

What About Social Security?

So it’s one of those strategies, and quite often you just have to look at these types of things, how it affects Social Security if you’re taking Social Security. If you’re putting off Social Security like these people are, you can defer the benefit.

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You don’t have to retire and take Social Security at the same time. You can push it off in the future, which can be really good for your benefit. 

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And in this particular case, the spouse had a significantly lower Social Security benefit, less than half of the other spouse’s. So they may take their benefit early, but they just don’t get the spousal benefit, which is the additional amount of money.

And the example I gave was, let’s say that you have a $2,000 benefit from Social Security, let’s say one person, and the other person has a $300 benefit, because they didn’t work outside of the house a whole lot. Well, if they both take their benefit at age 67, let’s say that’s their full retirement age, the one gets the $2,000, the other one gets their $300, but they get an additional $700 spousal benefit to bring them up to half of the first spouse’s benefit.

So they get the $2,000 plus another $1,000 made up of the $300 and the $700 supplement, which is what is called the spousal benefit. Well, in this particular case, the person was going to wait on their Social Security benefit, the $2,000 one. And you have the other one who is younger take their benefit, and they were going to take their benefit at 62.

So they get the $300, but they get it reduced. It’s reduced, because you take it early and you have a reduction. Now, in that particular situation, you have a benefit that is reduced for life, but your spousal benefit, when the other spouse does apply, you get that spousal benefit unreduced as long as you take that on time.

Now, it gets a little complicated. And if you really want to understand this stuff in detail, go to my website, paulwinkler.com. There is a tab on there and the whole tab, it’s just webinars or I think that’s what the title is, paulwinkler.com, and you go to webinars and you can watch all these presentations.

And I have a good presentation on Social Security, how it works, how the system actually works, and you can check that out. But it’s just cool that you can have these strategies.

Sometimes I see them misused, because the tax law is misexplained. I remember working with one guy, and he was teaching all of these financial advisors how the tax system works, and he taught them wrong. And it just made me crazy.

You’ve got to understand the graduated nature of it. And a lot of times, we’re having to use really sophisticated software programs to make these calculations and determine what the best strategy is going forward. It’s just good to know that some of this stuff is available out there.

Advisory services offered through Paul Winkler, Inc an SEC registered investment advisor. The opinions voiced and information provided in this material are for general informational purposes only and not intended to provide specific advice or recommendations for any individual. To determine what investments are appropriate for you, please consult with a financial advisor. PWI does not provide tax or legal advice. Please consult your tax or legal advisor regarding your particular situation.