Paul Winkler: Welcome to “The Investor Coaching Show.” I am Paul Winkler, talking about money and investing. I am of the opinion that nowadays, you actually have to have a lot more of the academic behind the investing information that you’re actually sharing.
Financial Planning Designations
I’ll just tell you my story about this. I worked for a big investment firm and they said, “Paul, you really need to go become a charter financial consultant.” That was the designation that they wanted. There is certified financial planner, and then there are additional courses that make up the charter financial consultant and that happen to be oriented a lot more toward risk management.
But, what I did is I went and became a Life Underwriter Training Council fellow. I wanted to learn more about risk management. Then I picked up retirement income, certified professionals, and another designation. Then, I went and became a Chartered Advisor for senior living and an Accredited Asset Management Specialist and a registered financial consultant and a wealth management certified professional.
So you don’t see a lot of that out there. But the reason that I wanted the additional designations is, because I just felt like each one there was more to know. Since I was primarily focusing on asset management, I really wanted the in depth on that because I thought that was super important.
Well, what I found as I was going to school and learning more was that a lot of the things I had learned going through the financial planning education weren’t quite the same. And I was like, “Well, wait a minute. That’s not what…”
And then I started to realize that much of what I had been learning, there were some of the academics in it, but a lot of the academic research was being glossed over or underemphasized because the groups that were sending the students, myself included, to go get the education were concerned that the person would learn something that would tell them that the things that they were selling at the investment firm weren’t necessarily good things to be selling.
So, if you hear things that sound a little bit different on this show, it is because of that.
Our focus is a little bit different than others and proudly so.
I was reading the disclosures for an investment firm, a big local investment firm. They were talking about how they use tactical asset allocation. They use fundamental analysis. They look at the companies and the fundamentals of the companies to determine which companies they ought to be investing in and what they ought to be staying away from.
Disclosures
Technical analysis is in their disclosures. Now, the vast majority of people reading that would go, “Well, of course that’s what I want the financial advisor to do.” I want you to look at the company’s fundamentals and the investment fundamentals and look at the companies before we invest in them. Make sure that they’re good sound investments, things that we should be investing in.
But what they don’t recognize is that academic research shows that that’s a big waste of time. What fundamentals the companies have and what we know about is already factored into market prices. And what you’re doing when you’re looking at that information, is you’re assuming that whatever information that is out there is wrong, and that we can buy the stock for this price and it’s really worth more and we can make more money.
The research shows that when people engage in the process of fundamentals, it actually hurts returns.
It doesn’t help returns. It can increase risk too. And you think about it, what is the worst thing you ought to do for an investor? Decrease returns and increase the risk? If you could set up for something and say, “Hey, let’s do something that really messes investors over, let’s do those two things.”
And yet, that was literally in their disclosures and saying, here’s what we do, proudly. Here’s what we do as an investment firm. So I’m telling you folks, read the ADV of the firm that you’re working with, if they have an ADV. If you’re working with a mutual fund company, you’re not going to see that. If you’re working with a mutual fund company, read the prospectus.
Now you may be out there saying, “Paul, I’m not going to do either one of those things.” Well good, just bring it to us then. We’ll read it for you and we’ll show you what’s going on. But I’m telling you, you could be doing yourself a huge disservice if you blindly trust the investment firm is going to do what is in your best interest.
There was a question that came in that was related to that. It was about Babe Ruth earning $300,000 in yearly retirement income during the Great Depression without stock market risk.
Using Fear to Sell
It said something like, “If you have a portfolio of $500,000 and $2 million, grab your popcorn because what I’m about to share may be able to save you from the inevitable wrecking ball hurling towards your retirement portfolio in the next 12 to 24 months.”
So, number one, first off, they’re stepping out there, and they are trying to predict the future. What’s going to happen in the market in the next 12 to 24 months? They don’t have a clue. I don’t care how well you understand your company, you just don’t have a clue how bad it’s going to be.
Using fear to sell is very effective, so watch out.
So they’re talking about how it all started back in 1923, like many professional athletes, Babe Ruth was blowing through the Yankee salary, like a drunken pirate, blah, blah, blah, blah.
He met this personal financial advisor, and this guy changed his life. And here it goes through different people that owned whole life insurance and permanent life insurance. Well, back in those days, a lot of people did own life insurance. And the insurance companies, what they do is they’re just an intermediary between where when you put your money in an insurance company, they reinvest it someplace and they are going to take a cut between what you earn versus what those products pay.
So they’re an intermediary, so they’re a go between, so to speak. You hear people talk about buying flooring and buy it directly from them instead of going through a middle person, all of that. Well, that’s what an insurance company is, a middle person.
So right off the bat, you’re going to get a cut in return, because the insurance company and the commission that is involved in the insurance is going to take some of that return off the table. So you keep that in mind.
What happened was that the data started coming and they started realizing what a lousy investment it actually was. The insurance company would start to shift, because people got wind of that it was a lousy investment. People started to get the idea that buying life insurance as an investment isn’t such a great deal.
“The No Risk Investment”
So what they did is, they started doing what any self-respecting marketer would do, change the name of it, instead of calling it life insurance, call it something, anything other than that. What they called it here in this thing is “The No Risk Investment.”
They have this video, why hasn’t my financial advisor told me about this. You can earn 30 to 40 times more interest than a regular bank account. You want to make something look good, compared to something that’s really bad and really not a good investment for retirement. You can pull the money back out just like that.
Life insurance is locked up, it’s illiquid. The insurance company is buying longer term bonds, and therefore the interest rate better be just a little bit higher, because of those liquidity issues. Now, in the fine print, of course, they say that past performance is no guarantee of future results, you could incur loss and you need to consider your objective.
The big print gives and the fine print takes away.
And by the way, it says here that we’re not fiduciaries. We don’t have to keep your best interest first when we make all these recommendations and make all these promises. But the problem with life insurance as an investment is that you have insurance costs.
Now, with Whole Life, it’s what we call a bundled approach. What I mean by a bundled approach is that we have the insurance costs, you don’t really see the working parts of the life insurance policy. You don’t really see what’s going on.
What happens when you pay a premium, part of it’s going for the life insurance cost and the unbundled approach, which is universal life, which is easier to see what’s actually going on. If you look at the difference between whole life and universal life, there is not big difference between them. They are both permanent insurance policies, just one, you see the working parts, the other one you don’t.
With universal life, the insurance cost comes out of the premium, then the money goes into the investment account. Now, it’s variable life insurance, it’s mutual funds and mutual fund type investments, I should say. They’re not technically called mutual funds.
Hidden Risks and Costs
They actually have mortality costs and in higher expenses typically, in those products, those mutual funds that are off to the side. I say typically, I can’t remember a situation where I didn’t see much higher expenses in the investments.
Well, so just when you get to the point when you’re at retirement and you want to take this income from your investment portfolio, the life insurance cost is very, very high.
The cash that you built up in the policy, which is literally whatever you paid into it, didn’t go toward the life insurance when you were younger, the life insurance cost, because remember, that’s going to be an expense. It’s going to be an additional expense. Then you have the mutual fund expense, and then you have the mortality cost as part of that.
And then what happens is that as time goes on, that expense goes up. And when you’re at retirement, they say that it’s tax-free, because technically the way life insurance works. When you pull money out, you’re getting back the premium that you paid first, which is tax-free.
The cost of life insurance goes up and up and up as you age.
Well, what happens is you switch to loans. Now they’re charging you interest, they credit some interest. Some policies work differently on how they do this, but they credit back interest, as if the money were still there, because it’s technically an advance on your death benefit. Because death benefits are tax-free, you can say that your distribution is tax-free for retirement income.
Problem is, if you run the policy down to zero and there’s no cash left, you don’t have anything to pay the life insurance premium, remember, it is still coming out. And then the policy lapses and then you get a big tax bill, because any gain that you happen to have is now a taxable gain. Now, they didn’t tell you that part.
A lot of times what happens after 10 years in a life insurance policy, your cash value isn’t any more than what you put in. So it’s not great. This is not that great. And if you look at the returns, historically of these products, it’s pretty abysmal, but yet, they try to make it out to be this great thing.
Making Money in Commissions
Why? Because it is one of the highest commission type vehicles out there to be sold by agents. It’s one of the few areas where they can make a ton of money in commissions. Now, is it illegal? No. Well, they say, “No, this is perfectly legal.” Now, you’re right. It is. It’s perfectly legal. It’s perfectly legal and bad for you. But that never stops them.
So the answer to this person, do I know about it? Am I familiar with it? Absolutely. Run, don’t walk. And they even talk about do you qualify? Why do they say, do you qualify in this thing? Because you have to go through underwriting. That’s why.
Another thing that you’ll see out there is structured notes. This is why, as an investor, I want you educated because if you don’t know these things, then what happens is it’s easy to take advantage of you. The problem is professional investment advisors make the same mistakes with their own money that they make with clients’ money, so I don’t think that you can just blindly trust the investing industry.
There was this thing about structured notes that I was reading, and one of the things that they’re doing you need to be aware of. Their focus is that investment firms can sell whatever they want, but it is up to you, the investor, to read and consider the firm’s objectives, read the prospectus, read the disclosures, read all of these things.
How many of us don’t do that? We don’t listen to what the regulators say and actually go read this stuff. Now, one of the things that they say in the Securities and Exchange Commission website regarding structure notes is, and I read, “You should take the time to understand the manner in which the return of the structure note is calculated.”
They tell you to do that. That’s what the regulators want to make sure that you do. They’re not writing this to the investment advisor. They’re writing this to you.
Fully understand the manner in which your return is calculated.
Number one, that ought to be daunting, that’s your responsibility, right? Market risk. Some structured notes provide for repayment of the principle of maturity that’s often referred to as principle protection.
Principle Protection
Well, right there is how they get you from a marketing perspective. You have principle protection, but they say that this principle protection is subject to the credit risk of the issuing institution. In other words, if that institution goes down, bye-bye money.
For structured notes that do not offer principle protection, the performance of the linked asset or index may cause you to lose some or all of your principle, but still the principle protection is dependent upon the firm. If that firm goes under, bye-bye money. Keep that in mind.
Your ability to trade or sell the structured notes in a secondary market, in other words, primary market is when you buy it, secondary market is when you try to sell it to somebody else, is often very limited as structured notes and other exchange traded notes, known ATNs, are not listed for trading on securities exchanges. Guess what? If you can’t find somebody to buy it, well, good luck.
There are people who come and buy things for a song and dance because they know you can’t sell it anywhere else.
Structure notes may have complicated payoff structures that can make it difficult for you to accurately assess their value, so you look at your statement and go, “What’s my investment valued?” I don’t know. I can’t calculate it.
Payoff structures may be leveraged. Inverse leverage. You may have loans and that’s how people lost everything here. That great depression is leveraged. They would borrow money to buy stocks, which may result in larger returns or losses for you.
As I often say, you can magnify the gains and losses. Many times, it’s the losses you end up with. They’ll promise the world, and from my experience in this, those promises don’t come to fruition. You should carefully read the prospectus they say for the structured note to fully understand it.
Well, that’s all good. They write it down, the regulators write it down, and I’m not faulting the regulators here. I’m faulting the financial advisors. They should know this stuff. They shouldn’t be selling these types of things. Look at the ADVs, look at the disclosures of these companies, these investment firms out there. Look at your statement to see if this stuff is in there.
Good and Bad Diversification
I’m shocked how often I do see this in somebody’s investment portfolio. If you don’t know how to find it, like I said, this is something that we’d be glad to look at. They’ll have participation rates. You only participate in so much of the market move.
If the market goes up 20%, you get 10% of it. Well, that sounds all well and good, but the problem is you’re knocking off the top side of the return, which drops the return of the investment down to more something like you’d see in bonds with lots of risk. I don’t want bond returns with lots of risk.
Capped maximum returns is something else the Security and Exchange Commission says here. In other words, they’ll cap it. If the market goes up, you only get so much of the upside. Now, I’m not going to go on with that.
They issued these things, dead obligations and embedded derivatives in their value of the derivatives derived from the underlying asset. Investment banks claim that structured notes offer asset diversification. That’s what they do. That’s how they sell you.
They sell you on the idea, “Oh, you need to do this because it’ll make you more diversified.” Well, there’s good diversification and there’s bad diversification. It’s like there’s a good witch and there’s a bad witch.
Some diversification actually isn’t such a great idea.
I don’t want to diversify in some areas. There are some like mid-cap stocks, for example. Mid-caps have a problem with diversification. There’s too much similar movement with other areas in the market. Somebody was telling me that they were saying that the investment firm was saying, “We complicate things too much here.” I laughed when I heard that.
Complicated or Simpler Than You Might Think?
It’s not complicated. It’s actually more simplified. If you get into these products, you talk about complexity. There’s complexity and there’s the Securities and Exchange Commission saying that it’s stinking complex. It’s way too complex.
I’ll never forget working for an investment firm. The guy that ran the firm tried to confuse the daylights out of us, as advisors. He made his presentation so complicated that it was a challenge to keep up with. He said, “That’s the glazed over look I want to see in your client’s eyes because that makes them potty in your hands.”
That is not a compliment to say that it’s oversimplified.
You need to understand that you can understand this stuff.
If you don’t understand this stuff, you are a mark for an investment person that probably doesn’t understand it either, quite frankly, because they usually don’t have that much experience.
Now, it doesn’t mean that I don’t have certified financial planners that work in here, that haven’t been in the industry for a long time, but they are not making the end decisions because you have to have experience, in my humble opinion, because there are too many things out there like this that, quite frankly, the advisors don’t even understand.
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.
