Half The Story

One of my biggest pet peeves is when someone makes a point but only uses some of the evidence to justify their position. When you know more about a topic than someone else, it's easy to prey upon that knowledge gap for your own benefit. Here are three real examples of experts disclosing only half the financial story, which could end up hurting you.

THE ANNUITY STORY

I wrote a financial plan for some new clients that came on board last year. After the data gathering process, I noticed something odd. They each held an annuity inside their respective Roth IRAs. Specifically, they each owned an Indexed Annuity. Normally, I wouldn't expect to find these specific annuity products inside a Roth. Before I tell you why, a bit of background.

Indexed annuities are always sold the same way; you get to participate in market appreciation but you're guaranteed not to lose your principal. Good deal, right? FYI: as a rule of thumb, whenever you sense an investment is too good to be true, just remember that there is no such thing as a free lunch and walk away.

The financial salesperson that sold my clients these products likely saw a commission check long before she even bothered considering better alternatives. Sticking an annuity inside a Roth wasn't the worst tactic, but it wasn't even close to the best. A financial advisor should aim to place investments with the highest expected returns inside the most tax advantaged accounts such as Roths. Based on the cost structure and several other mechanics that influence the rate of return on their indexed annuities, the average expected return is lower than the average expected return in a balanced portfolio of mutual funds. Not only that, but a guaranteed income rider that they didn't even need was attached to their annuities. These riders aren't free, and it will rob them to the tune of 0.75% annually over the 10-year period that they're stuck with these products.

Considering all relevant information per this client's financial situation, any rational advisor would have concluded that an index annuity does not belong in their Roths. Because of this oversight, the clients are worse off than they could have been because only half the story was considered. They'll be just fine based on all the work I've done with them, but they could've had a little bit more. As investors, we can't feel bad about mistakes like this (you don't know what you don't know, right?) as long as we learn from them.

THE LONG TERM CARE RIDER IN LIFE INSURANCE POLICIES

The November 2017 issue of Financial Advisor magazine included an article titled How To Pay For Long Term Care. This is a big issue in financial planning circles. Unfortunately, there is no easy solution to transfer future risk to an insurer without giving up something (such as money in the form of policy premiums). I felt that the article portrayed sticking a long term care (LTC) rider into a life insurance policy as a magic bullet. I'm a trained skeptic, so maybe I'm off base. But...

In my opinion, the article focused too heavily on using a life insurance policy to solve an investor's LTC need. The way this hypothetically works is via a rider specifically designed so the policyholder may reduce their death benefit and apply that offset as payment for LTC. According to the article, it's easier to qualify for this "hybrid" policy than a conventional LTC policy, and "whatever benefits they don't spend remain in the death benefit.".

OMG NO... For so many reasons.

Here's the single biggest one. A hybrid policy requires the insured to maintain the policy until they die. That's an extremely expensive proposition. The vast majority of Americans do not need life insurance beyond their working years. A central tenet straight from the CFP Board is that an investor should only buy insurance to the extent its needed. Never pay for something unnecessary and expensive just to achieve an ancillary benefit*. That's like buying a house for the sole purpose of receiving a tax deduction on the interest paid, which of course is stupid thinking.

I'll concede that the article does mention near its conclusion that "some industry watchers insist it's important to determine if the client actually needs (or still needs) the life policy.". Some watchers? How about you should ALWAYS ask this question right away, not as the weak afterthought as it was written in the article. C'mon Financial Advisor mag, focus on the whole story without extra credence to a product centric narrative! Maybe we should start calling it Financial Product magazine...

SUZE ORMAN'S BAD ADVICE

My wife and I have a Costco membership. Each month we receive their Connection magazine. In the January 2018 issue, Suze Orman answers financial questions based on emails from readers. One of her answers was so bonkers it prompted this whole blog post.

A reader asked "What are the advantages of paying off a mortgage loan in 15 versus 30 years?". Technically, her responses are correct; you save interest costs (true), you build financial security faster (depends on the rest of your finances, but ok sure), and you get a lower interest rate (usually, yes). Everything she mentioned are in fact advantages. But shouldn't the next logical question address disadvantages? I believe her immediate and appropriate followup should have been to consider the cumulative long term effect on net worth.

In her defense, she does acknowledge that the reader should first have an emergency fund, no credit card debt, and maintain retirement savings. This is all sage advice. But, she should have discussed the opportunity cost of lost savings associated with a higher mortgage payment on the 15 year loan.

If every subscriber acted on her "advice", millions of people would now be locked into a detrimental 15-year mortgage based on a half-assed response. Let me drop some math on the reader's question to finish the story properly.

A $300K mortgage at 4% interest over 30 years equals a $1,432.25 monthly principal & interest payment.

The same $300K mortgage at 3.5% interest over 15 years equals a $2,144.65 monthly principal & interest payment.

The 30-year mortgage ends up costing $129,571.93 in additional interest, but the 15-year mortgage payment is an extra $712.40/month. If you went with the 30-year mortgage and invested that $712.40/month at an 8% return, you'd have $1,061,732.07 after 30 years.

If you went with the 15-year mortgage, you no longer have the extra $712.40 to invest each month, but after 15 years you have the full $2,144.65 to invest at the same 8%. That nets you $742,130.87 after 15 years, i.e., over the 2nd half of a 30-year mortgage scenario. That's still a nice sum but not nearly as much as you would've had under the 30-year scenario.

Even though you saved $129,571.93 in interest using the 15-year mortgage, your investment activity over the 30-year mortgage scenario earned you an extra $319,601.20 in your brokerage account. In other words, the interest savings ($129,571.93) on the 15-year mortgage was not enough to overcome what was gained from investing under the 30-year mortgage scenario ($319,601.20).

That difference is $190,029.27 (minus some capital gains taxes at 15%, but still way better), which is what Suze Orman's bad advice would've cost this reader assuming a $300K mortgage.

THE MORAL OF THE STORY IS

When I tell you not to pay off your house early (or any other money tradeoff style question), it's not because

I believe it'll be better for you. It's because of the numbers. Everyone is entitled to their own beliefs, but not their own facts. It's the consideration of all relevant facts whether you like them or not that should guide your decisions.

If you work with a financial professional who can't show their work, doesn't clearly articulate their thought process, and never discusses viable alternatives, you're doing business with someone's beliefs, which is inherently biased. My advice is to thank them for their time and walk. It's easy to see why. They are likely just taking the easy road of preying on your knowledge gap to sell you something not in your best interest. Another way to find out if you're getting played is to ask for a 2nd opinion and be open to what they actually say! There's no guarantee that the 2nd opinion isn't also playing to their own agenda, but at least you did some due diligence.

The absolute best way to increase the likelihood you're receiving advice in your best interest is to hire a "fee-only" financial planner (Google it or just click HERE). By design, fee-only planners don't earn commissions. This removes the incentive to sell you something for their personal gain. When a financial professional gets paid exclusively via fees that come directly from you, they no longer care if you buy that expensive hybrid insurance policy from their firm or not. Said another way, their incentives to sell you garbage have been removed.

Fee-only planners have the freedom to seek out and recommend the best products available based on your financial situation, and that's the whole story.

* Disclaimer: if an investor can't qualify for standalone LTC insurance then yes, look into a hybrid policy as a possible alternative.