Beware

Financial planning versus investment advice:  Are you looking for overall financial planning guidance to objectively help you see the big picture, or are you just seeking investment advice?

The term “financial planner” is widely used without you as a consumer understanding that anyone can use that phrase.  Look for the Certified Financial Planner practitioner, or CFP® designation as a starting point when seeking objective guidance.

Investment advice is just one small piece of your overall financial picture. This focuses only on where you invest your money. Be sure you know the difference before you move forward.

Is your financial advisor properly qualified?

The best analogy is the medical profession.  When you choose a doctor, you trust they have the proper credentials, training and experience to give objective medical advice.  They must complete rigorous requirements to become a physician.

In the financial services industry, there’s no such standard.  All it takes is the time and effort to pass a couple tests for financial advisors to get their sales licenses for investment or insurance products.  In fact, I remember years ago when I worked at a bank, meeting another advisor who had been running a grocery store the prior year.  Getting their license just makes it legal for them to receive commisssions or fees.

Just as you trust your health to that doctor, you’re trusting your financial health and therefore the quality of your future to that financial advisor.

7 Questions to Ask an Advisor

1.  What credentials, NOT sales licenses, do you have?

2.  How many years have you been in the business?  (look for at least five years or longer, to understand the ups & downs of the markets)

3.  Why are you affiliated with this firm?

4. How do you make investment decisions on my behalf?

5.  How often do you meet with me during the year?

6.  If you were to leave this firm, do you have a non-compete that would prevent you from working with me in the future?

7.  Do you use an overall financial plan as the “blueprint” for your recommendations?  Why or why not?

The BIG QUESTION to ask any potential financial advisor:

“How are you paid?”

Going back to the physician analogy, how would you feel if you knew whenever your physician prescribed any medicine, he received a commission from that drug company? That’s often the case in our industry.  Hence, the question noted here.

Look for a clear, direct answer. They should clearly explain all fees you will pay to them, and all expenses you will pay associated with any insurance or investment product they recommend. You should see a red flag if they give vague answers, such as:   “my company pays me,” or “the money comes out of your insurance or investments.”

We know from experience, that even if they may want to do what’s best for you, they could easily have sales quotas or money management goals they have to meet. If they are with a Broker-Dealer, (be sure to ask them), then this scenario is very likely. You’ll see wording like this: ”Securities offered through xxxxx.  Member FINRA/SIPC” if they’re with a Broker-Dealer.

They’re really paid by that Broker-Dealer, not directly by you.

You can also just ask them up front if they have any sales quotas or new money they’re required to bring in during the year.

If they are paid directly by fees from you, as in the case of a      fee-only financial advisor, then they are more likely to be on your side.  They have no Broker-Dealer obligations to cloud their advice or pressure to use the insurance or investments their Broker- Dealer prefers them to use.

NOTE: We do know advisors that are very reputable, that are part of the Broker-Dealer world, and often part of the fee-only world as well.  Just be sure to ask the right questions, of which this is a primary one.

Peeve 1 – “Be Your Own Banker”

The majority of life insurance agents are reputable.

However, those who are dishonest have schemes to sell permanent life insurance. They are continuously devising new methods to disguise either themselves or the product; sometimes both at the same time; for example, calling themselves financial planners with no certifiable financial planning expertise. Or they call the insurance policy a “Private Pension Plan” and a “Super Roth”. “Be Your Own Banker” is another prevalent sales concept.

“Be Your Own Banker” is really just building a positive net worth. Net worth is defined as: Total Assets (what you own) minus Total Liabilities (what you owe.) $15,000 of assets and $10,000 of liabilities equals a positive net worth of $5,000. Conversely, assets of $10,000 and liabilities of $15,000 equal a $5,000 negative net worth.

There are many types of investments besides life insurance that can be used to build net worth. Cash and equivalents, bonds, individual stocks, pooled investment funds, annuities, real estate, collectibles, precious metals and gems, and life insurance. Each investment vehicle has unique characteristics.

Permanent life insurance does have one very unique characteristic. It is the only investment vehicle that creates wealth in the event of death or disability. The death benefit creates an instant estate. If you become disable, a total disability “waiver of premium,” usually added to your insurance policy, pays the premiums and builds your estate gradually just as if you were working and making the premium payments. In this situation, the cash value might be used as a living benefit for yourself. If the cash value is not needed, then the death benefit goes to your beneficiaries.

Permanent life insurance also offers tax benefits. The cash value grows tax-deferred and can be borrowed income-tax free.

On the other hand, there are negative characteristics that make permanent insurance unattractive as an investment.

First, there are the costs. The death benefit has mortality expenses that other investments do not have.

You can lose all your money if you have to cancel your cash value policy too soon.  It is front-loaded, high commission product that generates little or no value in the initial years. Second, only cash and equivalents earn a lower long term rate of return. Because of these two factors it will generally be in excess of 20 years before you could borrow from the policy without paying further premiums.

Remember this about life insurance. If you have to answer health questions and/or take a physical exam to qualify, you are investing in life insurance.

Only invest in life insurance if  1) you have loved ones that you care enough to provide for in the event of your death; and 2) they would suffer economic hardship.

The correct amount of death benefit is the most important consideration, not whether it is a permanent or term policy.

 Peeve 2 – “My Financial Planning Services Are Free”

Advisors often offer free financial planning services and seminars. In this arrangement there is no charge for analysis, advice or preparation of a financial plan. They’re paid solely from the sale of products purchased in order to implement financial planning recommendations. This is commonly referred to as a commission-only compensation arrangement.

How much does free financial planning cost me?

The cost depends upon the product.To keep it simple, let’s examine and compare mutual fund and variable annuity commissions on a $100,000 investment in each product.

The mutual fund prospectus explains the sales charges.

For example: “A” shares have an up-front sales charge of 3.5% on a $100,000 investment so the mutual fund company pays the Broker-Dealer, who pays the advisor, $3,500.

“B” and “C” shares do not have an initial sales charge but still pay the broker-dealer commissions of $4,000 and $1,000 respectively. The “C” share commission is smaller but is paid annually, not just in the first year like “A” and “B” shares.

Mutual fund commissions are easily identified. The “A” share commission is deducted from your account immediately and is itemized on your fund statement. The “B” and “C” share commissions are not deducted immediately. Those commissions are taken from the internal, annual fees in your account and are shown in the annual expense ratio. A comparison of the “A”, “B”, and “C” share expense ratios reveals the higher internal annual costs for the “B” and “C” shares.

Variable annuity commissions are significantly higher than mutual funds, less transparent, and do not offer breakpoint discounts as the investment amount increases. This has led to improper product sales and replacements and has drawn significant regulatory scrutiny leading to numerous fines and disciplinary actions.

Looking at our $100,000 example, a typical variable annuity pays a $5,000 to $7,000 sales commission. Some even pay a new commission at the end of the surrender period to discourage advisors from replacing them. These costs are taken from your money using Back End Sales Charges and internal expenses that are higher than mutual fund internal expenses.

What is a fair price for advice? This obviously varies by investor based upon their investments and the complexity of their situation. If the advisor is supplied with organized information and statements, and the investor thoughtfully answers a questionnaire prior to the first meeting, then a fee range of $500 to $1,500 would be reasonable depending on the complexity of the investments. A full financial plan including investment recommendations could be done for at least $1500.

Consumers have resisted paying for advice historically. Consumers are becoming more educated about costs and abuses, and the trend seems to be toward that of paying fees for advice instead of paying commissions for products. Hopefully this trend will continue.

College Planning Pet Peeves

There are often hidden agendas at Free Financial Aid Seminars

Many advisors will invite you to a “free” financial aid seminar. However, the advisor is often not very knowledgeable in the financial aid system. They have a hidden agenda. They simply want to sell insurance products under the premise that it will reduce the EFC for the family without doing actual analysis to see if the strategy is valid for the family. In reality, this could be one of the worst choices for the family. However, it puts lots of commission dollars in the advisor’s pockets.

Some life insurance agents will recommend insurance to help fund college expenses without analyzing the client’s situation.

Some agents are very quick to tell consumers to take out a home equity loan and invest the proceeds in a Universal Life Insurance Policy. The agents have just received a fat commission.  However, this often serves no purpose for the consumer, especially if you do not qualify for need-based aid. If you do qualify for need-based aid, home equity is only assessed by a very small percentage of colleges.

Some advisers and brokerage firms offer only one or a very limited number of 529 plans.

The options may not include your own state’s college savings plan which may offer a tax advantage to residents. Also, they many not provide the consumer the opportunity to invest in college savings plans issued by other states, even though those 529 plans may have lower sales loads or lower expenses.  Broker-sold plans often contain sales loads and higher fees and expenses than direct-sold plans. However, the bottom line is the rate of return you receive after fees and expenses.  Be sure to factor in the income tax deduction loss if you invest in an out-of-state plan.

Beware of scholarship scams

Unfortunately, many students and their families are falling prey to scholarship scams.  Beware of the following statements:

“This scholarship will cost some money”

“This scholarship is guaranteed or your money back”

“You can’t get this information anywhere else”

“I just need your credit card or bank account number to hold this

scholarship”

Scholarships are not guaranteed, and legitimate organizations that offer scholarships do not require payment to apply.

Beware of free grant money

Consumers receive a check in the mail referred to as free grant money. Along with the check are instructions regarding how to pay the processing fees for the award. This is merely check fraud. The grant checks are fraudulent, and the scammers get away with the processing fees that were paid by the consumers.