Tag: Insurance, Financial Planning

Why Broker-Dealers Launching Robo-Advisors Are Missing The #FinTech Point

Why Broker-Dealers Launching Robo-Advisors Are Missing The #FinTech Point

Executive Summary

Broker-dealers launching their own “robo-advisor-for-advisors” solutions for their reps has been a growing and accelerating trend. From prior announcements like the LPL deal with FutureAdvisor after Blackrock bought them, to Voya stating that they are looking to acquire a robo-advisor solution, and this week Kestra Financial announcing that it is working on a robo solution in the coming year as well. Yet the irony is that even as broker-dealers increasingly hop onto the “robo tools” bandwagon, they may actually be the worst positioned to capitalize on the trend, especially if their goal is to increase their volume of next-generation Millennial clients for their reps!

In this week’s post we discuss why broker-dealers are missing the point by launching “robo” solutions, how broker-dealers will struggle to gain any traction with Millennials – even with a robo-advisor – because of their digital marketing woes, and why broker-dealers should really be framing “robo solutions” as simply an upgrade to their entire technology stack instead!

Given the popular notion that “robo-advisors” are an effective means to grow a Millennial client base, it’s certainly understandable that broker-dealers want to pursue “robo” solutions. After all, the reality is that while the average advisor may simply be able to keep working with affluent retirees until the advisor themselves retires, broker-dealers are going-concern businesses that must focus on the long run – and recognize that eventually, the coming shift in generational wealth (as Baby Boomers pass away and bequeath assets to their Millennial children) means that they must find a way to grow their Millennial client base. And for the average broker-dealer rep who struggles to efficiently serve small accounts, who wouldn’t want a “robo” solutions where clients can come to the broker’s website and sign up and onboard themselves?

Yet the truth is that robo-advisor tools don’t actually attract Millennial clients. At best, they’re a highly efficient means to onboard and manage a Millennial client’s account, but the firm must still figure out how to market and attract Millennial clients in the first place. Which has been a challenge even for the most established robo-advisors, as companies like Betterment and Wealthfront have only averaged $1B to $2B per year in net new asset flows (and even then at “just” a 25bps price point!), and even the more eye-popping growth of Schwab Intelligent and Vanguard Personal Advisor Services has been driven primarily by clients who already had their assets with those brands, and simply moved them to their new “robo” offerings. And in point of fact, Vanguard’s solution wasn’t even the rollout of a robo-advisor, but the addition of human financial planners to clients who already worked with Vanguard digitally – a “cyborg” (tech-augmented human CFP professional) solution that is taking over the industry, with Personal Capital, Schwab, and even Betterment now offering tech-augmented human CFP advisors (and not just a robo solution alone).

In fact, when it comes to marketing to Millennials, even the robo-advisors have struggled with client acquisition costs, and they have entire companies (or at least entire divisions) with dedicated direct-to-consumer marketing, and the ability to leverage substantial existing brands (in the case of Schwab and Vanguard). By contrast, most broker-dealers have little brand recognition with consumers, a decentralized marketing process (where every rep is responsible for their own marketing and business development), and a cumbersome compliance process that makes it almost impossible to rapidly iterate the broker’s digital marketing efforts to attract Millennials online. Which means broker-dealers that launch “robo” initiatives are unlikely to see much of any asset flows whatsoever.

All this point said, it doesn’t mean that the “robo” tools themselves are bad for a broker-dealer to adopt. To the contrary, there are tremendous operational efficiencies to be gained with “robo” technology that expedites the process of onboarding clients and efficiently managing (model) portfolios. But again, that’s because robo tools are all about operational efficiencies… not marketing and business development! Which means broker-dealers announcing they are going to roll out “robo” tools will at best underdeliver on its promise of bringing in new young clients without needing to do any work – because it’s not a marketing solution for Millennials, it’s an operational solution after you do the marketing to Millennials yourself (which, most advisors don’t do well in the first place)! And at worst, brokers themselves just won’t adopt the tools, because they feel threatened by “robo” tools that imply the broker can be replaced (even if real advisors aren’t at risk of being replaced by robos). Instead, what broker-dealers should do is simply say “we’re upgrading our technology to make you more operationally efficient in opening and managing investment accounts.” Because that’s what it’s really about. And that’s the outcome that really matters!

Why Broker-Dealers And Their Reps Want A Robo-Advisor To Work

Now, I do get the appeal for a broker-dealer of launching a robo-advisor. First and foremost, I hear a number of broker-dealer reps asking for it, but not all because many are very happy with who they’re currently serving and what they’re doing. But instead, whether it’s an easier way to handle accommodation clients, those small clients where it’s hard to spend the time with them, or just the appeal of being able to have a robo-advisor button on your website to take on young millennial clients. There is a pain point, a valid pain point, for a lot of advisors in trying to work with small accounts that are time-consuming where a robo solution that automates it seems appealing.

I mean if the technology is entirely automated anyways, who wouldn’t want to put a button on their website that gets young people to open up small accounts that will grow with systematic contributions over time? And it takes no time from the advisor because they’re just clicking on a button. And from the broker-dealer’s perspective, ideally, this helps them address I think what’s actually a much broader issue, the coming generational shift of assets from baby boomers down to millennials.

For the individual advisor, however, I think the significance of this trend is grossly overstated. The average baby boomer is 62 years old. A retired couple at that age still has as joint life expectancy of about 25 years. The average age of a financial advisor is mid-50s, which means the average advisor will long since be retired themselves before their average baby boomer client start passing away and bequeathing assets to millennial children. Even a 40-something advisor will likely be retired before a material rotation of assets happens.

And of course, during retirement, although we talk about how clients are in a decumulation phase, the truth is retirees don’t actually withdraw that much at a 4% withdraw rate. Account balances actually tend to remain stable where you can grow when retirees are in their 60s and 70s because a 4% withdrawal is less than the long-term growth rate on a retirement portfolio.

But broker-dealers are corporate entities and they have a much longer time horizon. If you’re an advisor who in ten years is watching your client be slowly attritioned down due to the occasional death and ongoing withdrawals, and maybe you’re losing 3% to 5% a year in assets and revenue because of it, it’s not really that big of a deal. You’re probably already 50- or 60-something, you’re making good money anyways, your clients have been with you for a long time, they might not even be all that time-demanding anymore, and there are still 10,000 baby boomers turning 62 every day, so you can always find a few replacement clients if necessary. Simply put, the average advisor cruises it out.

But if you’re a broker-dealer that in the aggregate is losing 3% to 5% a year in assets in a decade from now, it’s a crisis because the advisors are going to retire soon and the broker-dealer still has a multi-decade open-ended timeframe as an ongoing business entity. There’s a difference in time horizons. And in point of fact, I think this is why we see broker-dealers, as well as RIA custodians, so obsessively beating the drum about advisors needing to focus more on younger clients. It’s not actually because we as advisors desperately need younger clients for our businesses to survive. It’s because they, the broker-dealers and RIA custodians, need us to get younger clients for them so their businesses survive and so they have younger clients after we’re gone and retired.

Now, from the broker-dealer’s perspective, if all the buzz is that millennials are pursuing robo-advisor solutions, then the broker-dealer wants to roll out a robo-advisor to get those younger clients.

Broker-Dealers Struggle With Digital Marketing

I get it, but here’s the problem with the strategy: robo-advisor solutions live and die by their ability to get clients online, and that’s not easy. Even Betterment is up to just 10 billion dollars of assets after 6 years. Wealthfront is at barely 6 billion total over that time period. Schwab has made news for $15 billion dollars of assets, but has actually noted that only about a third of that, maybe five billion dollars, was new assets. The rest were just existing Schwab clients that happened to switch to the robo solution. Vanguard now is over 60 billion dollars, but it’s rumored to have an even higher percentage of assets that were already at Vanguard. They were simply upsold to human advice because, remember, Vanguard already is direct-to-consumer through the Internet. Their solution, Vanguard Personal Advisor Services, wasn’t adding a robo. It was adding humans to what was already a robo-digital solution at Vanguard.

And even when you look at firms like Edelman Financial, they’ve struggled. A 15-plus billion dollar RIA working on building a national brand with centralized marketing and a huge digital presence launched Edelman online in early 2013, and after four years, they have barely a thousand clients and $62 million dollars of AUM, and their average robo client is actually a baby boomer anyways. In other words, even though leading robo-advisors are struggling to get millennials and are getting maybe one or two billion dollars a year in net new assets, which at 25basis point pricing, it’s a couple million dollars a year of gross revenue before the cost to build and service and support the robo technology for the broker-dealer itself, which means even for a mid-sized broker-dealer, that’s really small potatoes. And that’s based on what the growth is that the leaders in the robo movement are doing.

Even more to the point though, is how the leaders are doing it with platforms that are focused on building robo solutions with centralized marketing, but that’s not how it works in a broker-dealer environment where there are hundreds or thousands of reps, each of them have their own marketing plans, their own online marketing experience, or no online marketing experience, no digital marketing tools, and they have to get every digital initiative and every change on their website re-approved by compliance.

When you look at what robo-advisors do, their marketing is constantly iterating. They are running dozens of AB tests on their websites every day. Meanwhile, at a broker-dealer, I can’t even AB test whether it would be better for my robo-advisor to have a button that says, “Click here to open your account,” or to say, “Open your account now,” without getting compliance to pre-approve the change of the text on a little, tiny button. That is, to put it mildly, a very inhospitable environment to do rapid testing digital marketing to gain traction with a broker-dealer’s robo solution.

So what happens instead? The reality, again, the average advisor at a broker-dealer focuses on retirees. Their website probably shows pictures of couples walking on the beach towards a lighthouse, or maybe they’re sitting on Adirondack chairs, looking out over the ocean. So what exactly is this advisor supposed to do with a robo solution from the broker-dealer? Put a button on their website that says, “Millennials, open your robo account now,” right between the lighthouse and the Adirondack chairs? I mean does anybody really think a tech-savvy millennial is going to hit that button and transfer their life savings?

Simply put, the problem is robo-advisors don’t actually help advisors get millennial clients. Robo-advisors help advisors open millennial accounts after they successfully market to get millennial clients in the first place. And so until and unless broker-dealers figure out how to help their advisors get much, much savvier about digital marketing and how to actually attract and get millennial clients in the first place, and then use the robo tools to onboard and open the accounts, these broker-dealer robo initiatives are all doomed to fail.

It’s not an, “If you build it, they will come,” kind of asset gathering opportunity. I mean what we’ve actually found is the real blocking point of robo-advisors is the client acquisition cost, what it takes to market and get a young investor to invest on your platform. The robo-advisors were not only not a solution to client acquisition costs, they’ve been getting buried by client acquisition costs. It’s why we’ve been writing for the past two years that robo-advisor growth rates just keep slowing and slowing and slowing. Most of them have already sold and the ones that are left aren’t even really focusing on a robo strategy anymore.

Notwithstanding how it’s labeled, Vanguard is a human advisor service, hundreds and hundreds of CFPs that they’re hiring as quickly as they can. At best, it’s a cyborg solution, tech-augmented humans. Personal Capital is often branded as a robo, but it’s not. It hires CFPs in Denver. It’s a cyborg solution as well. Schwab pivoted from a pure robo solution to intelligent advisory which offers humans. And heck, even Betterment pivoted from a robo solution to offering human advisors this year. So, no one who’s actually succeeding at robo is doing it with a robo solution. They’re bringing in humans while broker-dealers are trying to roll out robo-advisors. This is not going to end well for them.

Robo-Technology Is About Back-Office Efficiency, Not Millennial Asset Growth

All that being said, I do want to point out that just because a robo-advisor solution to broker-dealer is doomed to fail at gathering millennial assets, it doesn’t actually mean the technology itself is worthless. To the contrary, there are tremendous operational efficiencies to be gained in a lot of robo technology.

After all, at its core, robo tools basically do two things incredibly well. They make client onboarding easier and faster, and then they make it much easier to manage model portfolios. And I think that’s part of why Betterment’s technology in particular was so shocking when it launched a couple of years ago.

You dial the clock back to 2012, as advisors, we’re mostly still opening new accounts by faxing physical paperwork with wedding signatures to do ACAT transfers, praying we don’t get any NIGOs, and that if things go well, maybe assets will show up in two weeks or so. And then Betterment launches and lets you e-sign everything from your smartphone to open the account, fund the account, and fully invest the account from your phone in about a half an hour. I mean just imagine how much operational administrative staff savings the average advisor could achieve if that was our account opening process.

Similarly, robo-advisors from the portfolio management end are really not much more than model management tools, what we in the industry would call rebalancing software, which we’ve already seen in the industry as tremendous efficiencies with billion-dollar advisory firms that manage all of their client accounts with one trader in a piece of software.

So I don’t want to be negative on the value of the technology, but the value of the technology is operational efficiency. It makes your back office staff leaner and more efficient. It speeds up transferring and managing assets. It reduces paperwork errors. It cuts down NIGOs. It reduces trade errors. It keeps clients from slipping off model or forgetting to have new cash invested. But it’s not a business development tool. The business development is still up to the advisor. The robo tools are just what you use to onboard the client and invest after the business development process.

And in fact, what I find is that usually once the average broker understands that, that just putting a robo-advisor on your site does not actually mean millennial money just starts automatically rolling over and you don’t have to do anything. They don’t even want a robo anymore. In fact, it frankly feels kind of threatening to most of us advisors. As though when you say, “We’re giving you robo-advisor tools,” we’re going to be replaced by robots.

As I’ve written repeatedly, we are not going to be replaced by robots because what robo-advisors do is fundamentally different than what we do as human advisors. But when a broker-dealer goes and says, “Hey, brokers, we’re working on a robo-advisor solution to help you,” it’s kind of like saying to a factory worker, “Hey, great news! We’re working on new automated machinery to help your job in the factory next year,” and then the following year, you find out you’re fired because you just installed the technology that eliminated your job.gain, I don’t see that’s how it actually plays out with robo-advisors and human advisors because they’re not actually winning business from human advisors now, but that is why it’s absurd for broker-dealers to tell their reps they’re rolling out robo-advisor tools. At best, it’s going to grossly under-deliver on its promise of bringing in new young clients without needing to do any work because it’s not a marketing solution for millennials. It’s an operational solution after you market to millennials, which advisors still don’t do well in the first place. But at worst, brokers just won’t adopt the tools and technology at all because they don’t see the value of the technology because it feels like they’re supposed to use something that threatens them.

Again, I don’t see that as how it actually plays out with robo-advisors and human advisors because they’re not actually winning business from human advisors now, but that is why it’s absurd for broker-dealers to tell their reps they’re rolling out robo-advisor tools. At best, it’s going to grossly under-deliver on its promise of bringing in new young clients without needing to do any work because it’s not a marketing solution for millennials. It’s an operational solution after you market to millennials, which advisors still don’t do well in the first place. But at worst, brokers just won’t adopt the tools and technology at all because they don’t see the value of the technology because it feels like they’re supposed to use something that threatens them.

Instead, what broker-dealers should really be doing is just saying, “We’re upgrading our technology to make you more operationally efficient in the opening and managing investment accounts with better onboarding tools and better portfolio management tools,” because that’s what it’s really about and that’s the outcome that matters.

I hope this is helpful as some food for thought.

So what do you think? Are broker-dealers missing the point of robo-advisor fintech? Will broker-dealers and their reps continue to struggle with digital marketing? How would you use robo-technology with your clients? Please share your thoughts in the comments below!

How To Avoid A Sudden Increase In Medicare Costs

How To Avoid A Sudden Increase In Medicare Costs

Most retirees pay their Medicare Part B premiums directly from their Social Security checks, and as a result benefit from the “hold harmless” rules that prevent Medicare premiums from ever rising faster than the annual dollar increase in their Social Security checks. However, for higher-income individuals, they are not only ineligible for the hold harmless rules, but can potentially face a substantial “income-related monthly adjustment amount” (IRMAA), which effectively applies a surcharge on Medicare Part B (and Part D) premiums based on Adjusted Gross Income from 2 years prior (i.e., 2017 Medicare premium surcharges are based on 2015 AGI). At the extreme, the surcharges can increase Medicare Part B premiums from $134/month to as high as $428.60/month (plus another $76.20/month surcharge on Part D) for individuals with more than $214,000 of AGI (or married couples over $428,000 of AGI). And notably, the income thresholds for IRMAA are “cliff” thresholds; in other words, with the first surcharge kicking in at $85,000 of AGI (for individuals; $170,000 for couples), the entire surcharge will apply as income reaches $85,001. As a result, strategies that manage AGI become very appealing for those nearing the IRMAA thresholds, especially if income can be manipulated to come in just below one of the tiers. Potential strategies to achieve this include: do partial Roth conversions up to (but not above) the first/next AGI threshold, to reduce potential taxation of IRAs (or taxable RMDs) in future years; complete Qualified Charitable Distributions (QCDs) to satisfy RMDs and have the RMD income entirely excluded from the tax return (which means it’s not included in AGI for IRMAA calculations); and purchase a non-qualified deferred annuity to limit annual exposure of taxable growth, and then control taxable liquidations to coincide with lower income years (and/or to fill up to but not beyond the next IRMAA threshold).

Five Biggest Mistakes Families Make with Life Insurance

Five Biggest Mistakes Families Make with Life Insurance

The month of September is Life Insurance Awareness Month.  While it’s still a few months away, it’s not too early to start protecting yourself today. Most families are getting tons of information thrown at them around the topic of investing, far too often I see families make major mistakes when it comes to life insurance.   I had a widow come to see me just a few months ago when her husband had a tragic accident.   He left her with three young children and a $500,000 insurance policy.   With hardly any other saved money, she was left bewildered on how she would be able to make her bills, pay for her kids’ college education, and then also take care of her retirement.   While $500,000 seemed like a lot money at the time they applied for the insurance, in reality it was barely enough to get by given all of the family goals.  Here are the five biggest mistakes that families make when it comes to life insurance.

  • Not Reviewing Beneficiaries – When individuals make a beneficiary designation, they often don’t realize it is a contract of law. No matter what your will says, this is where the money will be going.  Insurance policies allow for both a primary beneficiary and a contingent beneficiary which is highly recommended to be filled out.  As your life progresses and your family situation changes with new children or a divorce, it is important to update these beneficiaries.
  • Picking the Wrong Amount of Insurance – Insurance can generally be rented or owned, with term insurance being the insurance that you rent.  Midland National® Life Insurance Company is a strong and established life insurance company, and they provide affordable, temporary coverage with level term insurance in increments of 10 year, 15 year, 20 year, and 30 year levels.   The main issue is that most families often only buy enough term life insurance to pay off their debts.  You should be doing both a needs analysis and a human life value analysis to figure out exactly how much life insurance you need.  What will the cost of college be for your children?  How much money will your spouse need to maintain your family’s standard of living?  Will you pay off the mortgage?  All of these are important questions?
  • People Think They Will Be Healthy Forever – Most families only buy term insurance, but you should have a strong consideration to get some level of permanent insurance. Even though many term insurance policies are guaranteed renewable and non-cancelable, the cost for the new premium when your term renews might be incredibly expensive.   Permanent insurance comes in all sorts of flavors, including whole life insurance, universal life insurance, indexed universal life insurance, and variable universal life insurance. If you are looking to have insurance forever and build up money for college education, for example, check out this great video.  Remember, if your health changes in your 40’s or 50’s you may not be eligible to get permanent insurance down the road.
  • Only Using Insurance Through Work —Although it can be a very cost effective strategy to get your term life insurance at work, the main problem is that the life insurance isn’t generally portable if you leave work. This means if you change jobs or move to a new employer, the new employer may not have the same level of coverage you had at your old employer, and it is possible your health had changed since you joined your employer.  It is important to consider some level of term or permanent protection on your own.  Remember, the longer you wait, the more costly the proposition will be down the road.
  • Not Factoring Inflation — If you buy a $1,000,000 insurance policy when you are 35 years old, what is it worth when you are 55 years old? People often under-insure themselves when they are younger by not factoring in the silent killer of inflation.   Make sure as you get older or when you think about how you structure your insurance policies, you consider this factor in your overall financial plan.

These are absolute ‘musts’ to consider when picking life insurance. While not a necessity, it’s helpful to consider providers with informative resources and communities that openly discuss what’s best for families and individuals. Midland National maintains a strong, interactive network of customers.  You can find Midland National on Twitter as well as Midland National’s page on LinkedIn.  If you are on Facebook, you can connect with Midland National. Midland National Life Insurance Company, part of the Sammons Financial Group also provides a wide range of financial and life insurance related videos or you can follow along on the Midland National blog and keep up to date on all Midland National company updates that help customers learn more about financial products, financially-stable living, and gives transparency into its business.

DOL Fiduciary Rule Should Be Upheld—Just Not the Class-Action Part

DOL Fiduciary Rule Should Be Upheld—Just Not the Class-Action Part

Last summer, the U.S. Chamber of Commerce and SIFMA filed a lawsuit to block the Department of Labor’s fiduciary rule. Texas Chief Judge Barbara Lynn ultimately ruled in favor of the Department of Labor (and not to stay the rule), the case was appealed, and now the U.S. Justice Department has filed its 135-page court brief to defend itself in the Appeals Court. In its brief, the Federal government continues to stand behind the fiduciary rule, but explicitly stated that it would not defend the provision of the rule that requires Financial Institutions to allow consumers the right to file a class action lawsuit when advice is provided to rollover IRAs. The shift is consistent with President Trump’s recent positioning in a separate case, NLRB v. Murphy Oil USA (which is currently pending before the Supreme Court)… although if the Trump Administration loses, it could become even more difficult for fiduciaries (and even FINRA) to require mandatory arbitration at all. For the time being, though, and in the context of the DoL fiduciary rule, the unwillingness of the government to defend that section raises the possibility (though it does not ensure) that the court could agree with the plaintiffs and ultimately strike down the class action requirement of the BIC exemption (and allow Financial Institutions to once again force consumers into mandatory arbitration, even in cases of alleged fiduciary breach). Given the string of legal losses that fiduciary opponents have faced thus far, the fact that the Department of Justice has pledged to continue to defend the fiduciary rule makes it likely that it will remain. However, the potential that the class action provision even could be struck down in court raises serious concerns about the overall enforceability of the DoL fiduciary rule with respect to IRAs, given that the Department of Labor has the right to set fiduciary rules for IRAs but not enforce them, and without the risk of a class action suit looming, Financial Institutions may simply decide that occasionally losing one-off mandatory arbitration cases against individual brokers is an acceptable “cost of doing business” while pushing the line on the fiduciary rule. And of course, in the meantime, the Department of Labor has already separately begun the process of potential further changes to the fiduciary rule with its recent Request for Information, suggesting that while the rule may “stick”, there is still substantial uncertainty about exactly what will remain in the final version next year.

How Some RIAs Sell Life Insurance Through A BGA Without A B/D

How Some RIAs Sell Life Insurance Through A BGA Without A B/D

Executive Summary

One of the primary blocking points for those at a broker-dealer who want to transition to an RIA is how to handle insurance once they make the switch. Investment portfolios can be shifted from commission-based products with 12b-1 fees to institutional shares with an advisory fee… but there are still virtually no “no-load” insurance products (and few fee-based annuity products) available to RIAs. However, the reality is, RIAs actually can sell – and get paid for – many types of insurance and annuity products, without a broker-dealer relationship!

In this week’s discussion, we discuss how RIAs can leverage a relationship with a Brokerage General Agency (BGA) to get paid for implementing most insurance and annuity products, without a broker-dealer relationship!

The key is to understand the different types of investment and insurance licenses that exist. The Series 7 exam (to become a “General Securities Representative”) is actually only necessary to get paid a commission to sell “securities” – stocks and bonds, along with mutual funds, ETFs, and variable annuities and insurance. In turn, those with a Series 7 (or a Series 6) must have an affiliation to a broker-dealer, as technically it’s the broker-dealer that sells the product and collects a Gross Dealer Concession (GDC) commission, a portion of which is then remitted to the selling broker.

By contrast, in order to sell insurance products, it’s only necessary to have a life (and health) insurance license from the state, and to get appointed by the insurance company to sell their products. In some cases, there’s an overlap – given that products like variable annuities are both an annuity and a securities product. However, for those who just want to implement term life insurance, whole life insurance, or universal life insurance that is not variable, then the advisor simply needs a life insurance license… but not a Series 6 or 7, and thus the advisor does not need a broker-dealer, either!

Of course, this still raises the question of how an RIA gets appointed by a company to sell insurance in the first place, and manages product selection across a wide range of companies. If the goal is to sell fixed products, the solution is for an RIA to work with a Brokerage General Agency (BGA). Conceptually, a BGA is similar to a broker-dealer, except they only work in the realm of (fixed) insurance products. Fortunately, there are a lot of BGAs out there to choose from (some work nationally, many work regionally, and some simply operate locally), of which many will work with RIAs – for which the primary differentiators are the BGA’s service, breadth of products, and commission payouts (though notably because insurance commissions are standardized with the state insurance department, the products themselves will generally still be the same price to the client, regardless of the BGA).

But the bottom line is that if an RIA wants to sell fixed insurance products, then a broker-dealer relationship isn’t necessary, as the RIA can work through a BGA relationship instead. Though it’s important to remember that a BGA relationship must still be disclosed on Form ADV Part 2, and that CFP professionals at the RIA cannot call themselves “fee-only” if there are insurance commissions involved (even if paid to a separate-but-related entity)!

So with the DoL Fiduciary Rule taking effect, a lot of broker-dealers are changing right now. Everything from compliance policies to payouts to reps. In some cases, it’s really driven directly by DoL Fiduciary itself, which limits certain types of payouts and compensation that could be deemed an incentive to not act in the client’s best interest. In other cases, the truth is it’s just the change the broker-dealer wanted to make anyways and is doing it under the guise of the DoL Fiduciary.

But regardless of the cause, I’m hearing from a lot of advisors lately who are working at broker-dealers and are considering whether to shift and become and RIA instead, with the caveat that they don’t want to lose their ability to implement insurance and annuity products for certain clients who may need it. I want to talk about that for today’s “Office Hours,” and respond to a particular question that came in from…we’ll say her name is “Patti.” So Patti asked:

“Dear Michael, I formed a hybrid RIA, but I’m finding the BD part to be expensive. While I did it to keep my Series 7 active, I was mostly interested in being able to still sell insurance and annuities. Can an RIA still sell those solutions without being a hybrid? Depending on who I ask, I keep getting conflicting answers.”

Great question, Patti. Unfortunately, this is an area where I find there is a lot of confusion out there, which isn’t helped by the fact that most advisors ask their broker-dealer for guidance and their broker-dealer, frankly, doesn’t want to lose them because it’s profitable to keep them. And, as a result, broker-dealers don’t always give the clearest guidance. So let me try to help set the record straight.

When You Need A Series 7 License

The starting point for this is the Series 7. The Series 7 exam is called the General Securities Representative Examination because it’s meant to assess your competency to be a “General Securities Representative.” Now, in this context, security is a financial asset that’s sold or traded in financial markets. And so, having a general securities license means you’re licensed to sell virtually any type of security. That would include stocks and bonds, ETFs and mutual funds that hold stocks and bonds, and even variable annuities or variable life insurance which hold stocks and bonds.

But the key here is that a Series 7 exam is all about being able to sell securities investments (stocks, bonds, vehicles that hold stocks and bonds [including mutual funds], variable life, and variable annuity contracts). And so, if you want to get paid a commission on those products, you need a Series 7 license, or at least a Series 6, which covers all the “packaged” investment products like mutual funds, variable annuities, and variable life. Technically, the Series 7 just expands on that by allowing all the other “general” types of securities; individual stocks and bonds, options and derivatives, etc.

In addition to the Series 6 or Series 7 license, you need a broker-dealer to actually facilitate as the broker for those product sales. Because technically, the company brokers the transaction and you are the registered representative of the company. That’s why when the client buys a stock or a bond, the commission is paid to the broker-dealer which then shares a portion of their income with you because you’re the representative.

Similarly, that’s why when you sell a mutual fund, the commission is paid to the broker-dealer. It’s literally called a Gross Dealer Concession, or GDC. And then the broker-dealer pays out a portion of that to you as their representative. That’s the compensation for delivering the company’s brokerage services to the client. So, if you want to sell securities products, you need a Series 6 or a Series 7 license.

Now, this is different than getting paid an Assets Under Management (AUM) fee to provide ongoing investment advice or discretionary management of an account. That requires becoming a Registered Investment Advisor, or an RIA, so that you can actually get paid an advisory fee. That’s the separation; if we’re going to get paid a commission, we need a securities license with a broker-dealer. If we’re going to get paid an advisory fee, we operate as an investment advisor and register as an RIA. And the Series licenses are specifically about getting paid a commission or receiving a 12B-1 fee, which itself is a form of a commission.

When You Need A Life Insurance License [Time – 4:23]

By contrast, when you sell insurance products, you need a life insurance license from the state. Typically, that’s a life and health insurance license which permits you to get paid to sell life insurance, disability insurance, long-term care insurance, and, as the name implies, health insurance. Annuity products generally also fall under a life and health insurance license.

In addition, you have to get appointed with an insurance company if you’re actually going to sell and get paid to sell that particular company’s products. In some cases, there’s an overlap, because products like variable annuities are both an annuity and a securities product (because it’s a variable annuity where the client’s money will be invested in the underlying stocks and bonds through an annuity contract). And as a result, selling variable annuities or variable life insurance require both a life and health insurance license for the insurance or annuity wrapper and completing at least a Series 6 exam or the broader Series 7 license to get paid a commission for the fact that it’s a security product.

But the key point here is that’s a requirement only for selling variable insurance and annuity products. If you want to implement term insurance, whole life insurance, or universal life that is not variable – either a standard UL policy or an indexed universal life policy – then you need a life and health license, but not a Series 6 or a Series 7 unless you don’t actually need a broker-dealer either.

Similarly, if you just want to sell long-term care insurance or disability insurance, then you need a life and health insurance license, but no Series exam and no broker-dealer relationship. And even in the context of annuities, you can sell a fixed annuity, indexed annuity, or a lifetime immediate annuity with only a life and health license and no Series exam or broker-dealer relationship. It’s just the variable annuity and the variable life that actually requires the Series license and the broker-dealer.

Selling Life Insurance Under An RIA Through A BGA

The key question for Patti in all of this is whether she wants to sell fixed insurance annuities under her RIA or variable insurance annuities under her RIA? If the goal is to sell fixed products, a health insurance license is necessary, but a broker-dealer relationship is not. Patti would only need the broker-dealer relationship if she wanted to sell variable products, or at least have a desire to keep trails and maybe remain broker of record for existing variable insurance or annuity products.

It’s also worth noting that Patti would really just need the Series licenses and a broker-dealer relationship to get paid a commission on a variable product. With the rise of new fee-based variable annuities under DoL Fiduciary, Patti could even recommend variable annuities with only an insurance license and no broker-dealer. Because technically, you don’t need a BD relationship to recommend an annuity, you need it to get the commission. But if you’re going to recommend the variable annuity and charge a separate advisory fee for the advice, you can do that, once again, with the standard RIA and a standalone life and health insurance license.

For many, the practical question is how exactly do you get appointed with and work with an insurance company when you’re an RIA? And the answer to that is what’s called a Brokerage General Agency (BGA). In practice, you can think of a BGA as similar to a broker-dealer. It’s a couple networks with multiple products and provides support and assistance to those affiliated with them to sell the products. Except, while a broker-dealer is built to do securities products, a BGA is built to do insurance products.


So if Patti decides that she doesn’t want or need to do variable insurance or variable annuities but still wants to be able to sell fixed annuities and non-variable insurance – so term, whole life, UL, disability, long-term care insurance, etc. – then she doesn’t need a broker-dealer, but she does need a BGA relationship.

The good news is that there are a lot of BGAs out there. A few work nationally, many work regionally, and some simply operate locally for insurance agents in the area. If you’re searching for one, you may need to ask around to a lot of BGAs in your area to find one that’s willing to work with you as an RIA. Because, the reality is, many BGAs are used to working with career insurance agents who sell a high volume of insurance and may not necessarily want to work with an RIA that will only occasionally place insurance products with them. But there are definitely BGAs out there that will work with RIAs.

In fact, a few I know like working with RIAs because by the time we evaluate the client’s situation, do the financial planning, and make a recommendation, there’s a very high likelihood that the client follows through and buys the insurance, which is a good deal if you’re a BGA in the business of getting insurance sold. And a lot of RIAs work with people who, shall we say, have above-average net worth and affluence, and consequently tend to buy above-average-sized insurance and annuity policies.

In terms of choosing a BGA, most will ultimately compete on service – their ability to know the available products, help you navigate the marketplace, assist you with all the licensing and appointments, help you actually implement the policy, and make sure you get paid.

Beyond that, the reality is that larger BGAs that do a higher volume of insurance business may also potentially be able to pay slightly better commission payouts as well, but I find there’s not a ton of variability from one BGA to the next. Though, there can be some, because insurance is still a volume business and brokers – including Brokerage General Agencies – that put through a higher volume can get better deals.

But it’s important to know that every BGA is going to get the same product for your client. It’s not as though one BGA gets a long-term care policy or term insurance policy at a discount to the others. The consumer rates, the premiums, are standardized by the insurance company and filed with the state insurance department. Therefore larger BGAs with a higher volume might be able to negotiate better payouts on what you sell, but they’re generally not going to get cheaper pricing on the policies themselves. That’s not a lot of reason to shop amongst BGAs in most cases.

Disclosing An BGA Insurance Relationship On Form ADV Part 2

For advisors who are switching to an RIA and want to keep doing fixed insurance and annuity business (but are at least ready to let go of variable products and the investment commissions and walk away from old 12B-1 trails), the path is to form an RIA and then establish a relationship with a BGA (Brokerage General Agency).

It’s important to remember that if you do go this route, you still need to disclose the BGA relationship as an outside business activity and another source of compensation in your RIA’s Form ADV Part 2. This is absolutely a conflict of interest the SEC expects you to disclose. And, in addition, it’s worth noting having an insurance relationship with your RIA means you are not allowed to call yourself “fee-only.” Even if you create a separate company for your RIA to contract with the BGA to receive insurance commissions. If you, as the CFP certificant, will ultimately participate in the commissions through a company you own when you deliver the services to clients, then you’re receiving both fee and commission compensation and you have to disclose it.

I find this gets mixed up all the time. There was an incident a couple of years ago where CNBC named their top fee-only financial advisors, and nine out of ten got insurance commissions. They were an RIA, but they had insurance commissions. And this was a whole issue that arose with Jeff and Kim Camarda and the CFP Board. The Camardas had a “fee-only RIA” as standalone, and then a separate insurance company that they also owned that was receiving commissions from their clients. And the CFP Board publicly admonished them because, as CFPs, they were still receiving commissions. It was through a related party, but they were getting the compensation.

The Camardas fought the ruling, but ultimately, the judge held the decision for the CFP Board. And the latest proposed updates to the CFP Board’s Standards of Conduct would go even further in making it crystal clear that paying commissions to a related party entity in connection with your financial advice to clients, is still a commission to the CFP and it means you are not fee-only.

You can decide whether having the fee-only label is even useful to you or not. I’ve actually written more than once; I don’t think it’s actually a great marketing term. Being a fiduciary is very important. Marketing as fee-only, not necessarily. But I do want to warn you if you decide to participate in insurance commissions as an RIA, you are not fee-only anymore, so don’t market yourself that way. Even if your RIA only gets fees, commissions those clients pay that come to you directly or indirectly via your related entity is still a commission.

Obviously, a lot of RIAs just choose to outsource this altogether and let a third party firm implement the insurance and get the commission for the work they do to implement the policy. You don’t have to participate in the commission at all. I know a lot of advisors who have a background in insurance feel like it’s natural to do. But recognize, in financial planning, we regularly give tax guidance to clients, but we still refer preparing the tax return to the CPA. We talk about estate planning strategies with clients, but we still refer out the estate planning documents to an attorney. We may review automobile and homeowner insurance policies, but we still refer out the implementation to a P&C agent.

In the same manner, you can advise regarding insurance as part of your comprehensive plan and still refer out the implementation. There’s nothing sacred about implementing the insurance and, frankly, introducing the conflicts of interest that it entails. Especially when you look at all the other stuff we don’t implement but simply advise on, and then hand off to dedicated professionals that do that for a living.

As we wrap up, getting back to Patti’s original question about whether she still needs to be a hybrid RIA with an expensive broker-dealer relationship just to implement insurance and annuities with the clients, the answer is “It depends.” Because it depends on whether she wants to do variable life insurance and variable annuities, which do require a broker-dealer relationship, or whether she’s only looking to do fixed annuities and fixed forms of insurance like term, whole life, UL, disability, and long-term care insurance. Because, for the latter, you don’t actually need a broker-dealer. You just need a Brokerage General Agency (BGA) relationship. And even if you want to do variable annuities, if you use a fee-based product with no commissions and just charge a separate advisory fee, that’s still okay with just an RIA and a BGA relationship and no broker-dealer.

And while you do have to disclose it in your RIA’s Form ADV Part 2, it’s worth noting the BGA relationship really is separate. A hybrid broker-dealer is the broker-dealer often wants to do oversight on the RIA. With a BGA, they will not require compliance oversight of your RIA the way that a lot of broker-dealers do if you hybridize with them. The BGA is just going to live in their insurance realm, because that’s what they do.

It’s worth knowing as well that there are some RIAs even that split the difference. They’ll form a BGA relationship to still do fixed insurance and annuity business, but refer out the variable insurance annuity business (particularly if they don’t do a lot of variable business as it’s just easier to occasionally refer out than to introduce the hassle of a broker-dealer relationship if it’s going to be a very small portion of their business pie).

Although, again, with the rise of fee-based annuities that don’t pay commissions since the DoL Fiduciary Rule, I suspect we’re going to see more and more RIAs that just decide to do this with the BGA relationship, and terminate their hybrid broker-dealer relationships, since that BD is going to be less and less necessary in the future as more and more products go fee-based and fixed insurance doesn’t require the BD anyways.

So what do you think? Have you considered selling insurance through a BGA? Do you think more advisors will drop their hybrid structure and move to a BGA relationship after DoL Fiduciary?

Six Areas Where I Disagree with Dave Ramsey’s Retiring and Investing Advice

Six Areas Where I Disagree with Dave Ramsey’s Retiring and Investing Advice

“A good financial planner is going to do more than pick your funds.”
–Dave Ramsey

Recently, personal finance guru Dave Ramsey engaged in a very heated discussion on Twitter with several financial planners regarding the appropriateness of his investment and retirement withdrawal advice. The questions were (and are) very legitimate ones, namely:

Why does Dave Ramsey keep telling people to invest 100% in equities and that they can expect 12% returns?


Why does Dave Ramsey keep telling people that they can safely withdraw 8% of their net worth each year in retirement?

Dave Ramsey’s responses?

@BasonAsset @behaviorgap @CarolynMcC @DaveRamseyExemption from the CFP/ethical requirements due to journalist role?

The snobbery of some of the “Financial Pros” in not helping regular people is sickening.

@DaveRamsey You used to be an role model of mine until you lashed out at @CarolynMcC. Guess you have to change your hero at some point.

@davegrant82 //Why? She has attacked me continually. I just responded. Dont want to get bit by the big dog, stay off the porch.

Here’s what he has to say about people who question him.

Out of 387k followers I am amazed how many are postive they can win and how many are nit picking victims.

Instead of actually addressing the questions with a cogent, thoughtful, defensible response, he resorted to ad hominem attacks against financial planners who hold a fiduciary duty to their clients, Carolyn McClanahan and James Osborne.

I’m a fan of Mr. Ramsey’s debt advice. I regularly tell people to go to the local library and check out The Total Money Makeover if they’re deeply in debt because there’s no point in paying me to get the same advice that they can get for free by checking that book out of the library.

But, I have serious and deep concerns about the investment and retirement asset management advice that he gives to his listeners.

Six Areas Where I Disagree With Dave Ramsey’s Advice

There are six areas of disagreement I have with the investment and retirement advice that he provides to his listeners and to his readers.

Investment advice disagreement #1: You can expect a 12% average return

Even if the average returns of the market were 12%, which they’re not, he’s making a very simple, basic mathematical mistake. He is confusing average returns and compound returns. In average returns, the sequence of returns doesn’t matter. In compound returns, the sequence of returns does matter.

Let’s look at an example.

Say you invested $1,000 in Widgets, Inc. The first year, Widgets Inc. loses 10%. At the end of the year, you have $900 of Widgets, Inc. stock. The second year, Widgets Inc. gains 20%. At the end of year 2, you have $1,080 of Widgets, Inc. stock.

The average return during that two year period was 5%. But, applying an average 5% return over a two year period would mean that you should have $1,102.50 in Widgets, Inc. stock. You don’t. You only have $1,080 of Widgets, Inc. stock.

Your compound average growth rate (CAGR), or compounded annual return, was 3.92%.

If you report the average annual return, you get to say that you averaged 5% per year.

If you return the annual return that you see in your personal holdings, then you averaged 3.92% per year.

Compounded over time, that’s a big difference.

I don’t believe that Mr. Ramsey is trying to lead anyone down the garden path here. I think he really thinks that the average annual return is the correct number to report when it’s not.

He does argue two counterpoints to this issue. The first is that saving 15% per year during your working lifetime for retirement is more important than the returns that you’ll get. He’s right, but not by the wide margin that he tells his audience. Furthermore, his newsletters encourage working backwards from a 12% return rather than saving 15%. That advice is contradictory.

If an average family, earning $52,762 (the national average family income), saves 15% of their income every year for 40 years and receives the compounded average growth rate of the market, adjusted for inflation, which is 6.69%, that family will end up with $1,556,686.83. Using a 4% withdrawal rate (which contradicts his advice, a point we’ll address below), that provides the family with $62,267.47 per year. The family will be in good shape, but not in the shape that a 12% return assumption would lead them to believe – $6,799,510.70 versus $1,556,686,83 – a 77% difference.

The second counterpoint is that he uses 12% as an educational example and that he can point to mutual funds which have made 12% over a long period of time. We’ll deconstruct his picks further down, but using 12% as an “educational example” brushes over an important aspect of the differentiator between a “guru” (which he undoubtedly is and deserves the title) and an actual, fiduciarily bound advisor. He’s not bound by a fiduciary duty. It’s not investment advice. That’s why he won’t tell people which mutual funds to invest in. I can’t either, unless you’re a client, but I can certainly tell you which ones to avoid, such as mutual funds that have exorbitant loads. Again, more on this later.

If you think that you’re going to get a 12% average return, then you’ll simply plug 12% into your numbers each and every year, and that’s wrong. The market has ups and downs. To simply say 12% per year every year is naïve and can lead you to significantly overestimate the value that your nest egg will hold when it comes time to retire. It is possible to become anchored (to read how the anchoring bias affects your retirement decisions, read “The Difficulty of Predicting Your Retirement Number”) to the 12% return and not follow the 15% savings rule, and that will lead to serious repercussions when you reach retirement age if you save less because you think that you can get a higher return than you probably will.

Which leads me into the second area of disagreement.

Investment advice disagreement #2: Continuing to be invested completely in stocks in retirement

Once you retire, you’re basically trading sources of income from wages to money produced by the assets you’ve saved up and invested in. While some of you may plan on working part-time in retirement, it’s quite possible to expect that you may not be able to work once you’re in retirement. Furthermore, as you age, the probability that you can get back to work declines, both because of mental and physical frailties and because the absence from the workforce will make it increasingly difficult to get a job.

Thus, unless you’re the rare person who will work until age 103 and die at the desk, you’re going to have to rely on your nest egg and Social Security to support you. In most cases, Social Security will not be sufficient to allow you to maintain the lifestyle you had during your working years (and hopefully, many of you will be able to retire before Social Security starts), so you’re going to need an additional source of income.

That income will come from your assets.

Now, it’s possible that you may never need to purchase bonds in retirement, butyou will need some source of income. Relying solely on the dividends and capital gains provided by stocks is an extremely risky way of doing so unless your asset base and the dividends it produces far exceed your income needs.

It’s not wise to go completely in the other direction, either, and dump everything you have into CDs. If you choose that route, while you won’t lose money, you willlose purchasing power. Ultra-safe, income-generating investments like CDs and money markets do not beat inflation. This means that, over time, what you can buy for your money will decrease. Given that the biggest increase in expenses and the biggest inflationary cost in retirement is healthcare, this failure to match or beat inflation will mean that when you need more money to cover declining health or long term care, you won’t have the financial wherewithal to afford the care that you need.

That’s why I generally suggest that people aim to have 110 – age as a percentage of the portfolio to keep in equities and the remainder in income generating assets. If you are retired and have all of your investments in equities and the market tanks, then you’re going to be faced with a double whammy of a shrunken nest egg and having to withdraw from it when it’s been hit. Since bonds and equities usually are countercyclical, the impact of a down market year won’t be as bad.

While Dave Ramsey says that you can withdraw 8% per year from your portfolio in retirement based on a 12% rate of return and 4% inflation, the reasoning behind how he gets to that conclusion is where the advice causes me to disagree. First off, as I have pointed out, he uses incorrect calculations in determining 12%, but that’s not really the issue. The issue is that you won’t get 12% (or 15% or 3% or whatever rate of return you want to depend on) every single year. If that was the case, and your returns were steady every single year and at or above the rate of inflation, then you could withdraw the gains and not have to worry about depleting your nest egg.

The problem is that returns aren’t always going to be above the rate of inflation.The way that Dave Ramsey reaches the 8% withdrawal rate is outlined below. His newsletter outlines the example of a hypothetical couple who has saved $1.2 million for retirement.

Now, envision what retirement will look like for you by estimating the income your nest egg will bring. Using the example above, our couple’s $1.2 million will remain invested and growing at the long-term historical average. Estimating inflation at 4% means they can plan to live on an 8% income, or $96,000 a year ($1.2 million x 8% = $96,000).

This plan allows you to live off the growth of your savings rather than depleting it. With careful monitoring and some modest adjustments in years with low returns, you can be confident that your savings will last throughout your retirement.

This hypothetical couple lived off of $50,000 per year. Suddenly, they’re going tojump on the hedonic treadmill and start living on whatever above inflation their investments return.

Unfortunately, they still have minimum living expenses. They lived on $50,000 per year beforehand, and they were saving 15% per year, so their true living expenses were $42,500 per year. Therefore, in down years, they have to still eat and live, meaning that they need to eat into the nest egg to pay for food, shelter, clothing, and transportation.

Although I’m no fan of aftcasting, it is instructional to use historical stock market returns to give you an idea of how often this plan succeeds.

I set forth a couple of rules.

  • If the returns exceed the inflation adjusted annual expenses, then spend the returns. Do not deplete the nest egg.
  • If the returns do not exceed the inflation adjusted annual expenses, then spend the inflation adjusted annual expenses. Deplete the nest egg only to the extent necessary to meet minimum spending needs.

Using 3% as annual inflation (which would benefit the Ramsey approach, as that requires less money be spent in lean times), if I run the hypothetical retirees through 30 years of retirement for every year since 1926 using actual stock market returns, the retirees run out of money 49.1% of the time.

I don’t want to use a plan which has a slightly better than 50% chance of succeeding.

The reason that academics and practitioners promote 4% (or even less) as a safe withdrawal rate in retirement is that you need to reinvest excess gains in years with strong returns to give yourself enough buffer so that you don’t deplete your assets in years when returns are below the rate of inflation.

An improved solution in this situation is to set up a maximum cap of spending. If we set up an inflation-adjusted cap of $100,000 per year, then the plan has a 93% chance of succeeding.

There’s one problem with creating a solution that has such a broad range of spending. These retirees are going to experience some serious shocks and whiplash in their lifestyles. One year, they’re spending $106,090 and living fast and free, and the next year, they have to slam on the brakes and live on $46,440.90. The constant hedonic adaptation that one must undergo to constantly vacillate between salad and lean years is going to take an enormous psychic cost and will be a very difficult to live within.

The better approach is to work backwards from a retirement spending goal and a much smaller range and adjust it for annual inflation. Then apply a withdrawal rate such that the chances of running out of money before running out of heartbeats is minimal.

Investment advice disagreement #4: Recommending front-loaded mutual funds

On June 4, 2013, Mr. Ramsey invited a Motley Fool staff writer onto his showto discuss an article that was published at the Motley Fool website discrediting Ramsey’s assumed rate of returns. I’ll discuss more about that hour of the episode later, but for this disagreement, I want to pull out a particular piece of the discussion.

The crux of the hour-long dialogue was that Ramsey often quotes 12% as an average annual return, which is close to the S&P 500 average return (discussed in disagreement #1). Ramsey’s retort was that he has found funds which return more than the S&P 500 and have a history of doing so.

He cited two funds: Investment Company of America (AIVSX) and Growth Fund of America (AGTHX). He also encourages people to utilize loaded mutual funds on his website.

Both of the funds he cited have a 5.75% front load.

I’ve previously explained why loads on mutual funds destroy your nest egg. Let’s demonstrate how the 5.75% front load affects the returns for the hypothetical couple that we discussed above. As the example pointed out, this was a couple that made $50,000 per year and invested 15% of their earnings. How would they do with each of these mutual funds after paying a load?


Since the historical data from Yahoo Finance goes back to May 31, 1996, I’ll assume that this family invests 25% of their $7,500 per year, or $1,875 on May 31 of each year (or the first available trading date after May 31). They pay a front load varying from 5.75% down to 4.5% based on the breakpoints for loads in the fund (for which their salesman thanks them), and between $1,767.19 and $1,790.63 goes into the actual mutual fund. They will reinvest dividends and capital gains.

As of June 4, 2013, their investment would be worth $57,079.74. 17 years of contributions totaling $31,875 has gained them $25,204.74 in profit, for a 79.1% return. This is an average return of 4.65%, or an annualized return (CAGR) of 3.49%. They paid $1,818.75 in loads for this privilege.


Since the historical data from Yahoo Finance goes back to February 11, 1993, I’ll assume this family invests 25% of their $7,500 per year, or $1,875 on February 11 of each year (or the first available trading date after May 31). They pay a front load varying from 5.75% down to 4.5% based on the breakpoints for loads in the fund (causing glee in the salesman’s heart), and between $1,767.19 and $1,790.63 goes into the actual mutual fund. They will reinvest dividends and capital gains.

As of June 4, 2013, their portfolio would be worth $100,789.89. 20 years of contributions totaling $37,500 has gained them $63,298.89 in profit, for a 168.8% return. This is an average return of 8.44%, or an annualized return (CAGR) of 5.39%. They paid $2,001.56 in loads for this privilege.

Now, let’s compare how these two investments would perform versus their Vanguard Index counterparts.


The Investment Company of America’s fund invests in blue chip stocks, comparable to the S&P 500. Thus, an appropriate index fund comparison is the Vanguard 500 Index Fund (VFINX).

If the same family had purchased VFINX compared to AIVSX, they would have $57,696.02 as of June 4, 2013. That is $616.28, or 1.08% more.

To break even and erase the effects of the loads on performance, the family would have to contribute $1,999.94 per year, or $21.36 more to that fund.


The Growth Fund of America is a growth fund that invests in smaller capitalization stocks with the intent of gaining appreciation over time as these stocks grow. Thus, an appropriate index fund comparison is the Vanguard Small Cap Index Fund (NAESX).

If the same family had purchased NAESX compared to AGTHX, they would have $113,357.18 as of June 4, 2013. That is $12,558.29, or 12.5% more. To break even and erase the effect of loads and underperformance, the family would have to contribute $2,223.08 per year, or $244.50 more.

In the first case, the loads outweigh the outperformance of the fund. In the second case, even if you took away the load, the fund still underperforms its index counterpart.

Ramsey’s argument for loaded mutual funds is that purchasing a loaded mutual fund keeps you in the market when the market goes down and it prevents you from panic selling. This is an argument we’ve discussed before, but the simple counterargument is the best one.

If you’re taught to properly invest and understand the risks involved in jumping ship when the market declines, you’ll act correctly. It costs a whole lot less to get that training (and a full, comprehensive financial plan while you’re at it) than to rack up thousands of dollars in mutual fund loads.

Investment advice disagreement #5: Disregarding fees in investments

In his book Financial Peace Revisited, Dave Ramsey states the following:

The biggest mistake people make is putting too much emphasis on expenses as a criterion.

As I demonstrated in the above example, for disagreement #4, fees killed the returns in the VFINX versus AFINX horserace. Without fees, AFINX would have been a superior investment, but fees made the Vanguard counterpart a superior investment.

Investment advice disagreement #6: Promoting actively managed mutual funds

I have previously discussed how, in a time when information becomes more and more widespread, luck plays an increasing role in explaining extremes in performance. Since the highest skilled investors are, relatively speaking, only marginally better than the least skilled investors, the remaining differences in performance are generated by luck.

But, let’s say that you poo-poo the notion that you have to be lucky to get outsized returns in the market. Let’s assume that the mathematics are wrong and it doesn’t take up to 64 years to determine if you’re skillful. You can look at the past 20 years of returns, as Ramsey suggests, to determine whether or not you have a winner on your hands.

There are still risks involved in choosing an actively managed fund:

  • The manager’s retirement risk. Few people like to continue to work at picking stocks like Warren Buffett does. Even Benjamin Graham retired after a few years. What happens when a fund manager decides to hang up his boots and ride off into the sunset? You now get to start all over with a new fund manager and have to wait another 20 years before determining ifthat manager knows what he or she is doing.
  • Tax risk. Actively managed mutual funds, as is implied by the name, trade more often than index funds. Because of the increased trading, the investor must pay short-term and long-term capital gains taxes. If the funds are in a tax-deferred or tax-free retirement account, this is a moot point, but for investments in normal brokerage accounts outside of a tax shelter, this is important and reduces the after-tax returns of these investments.
  • Concentration risk. I don’t mean that the manager is going to daydream, but, rather, that you’ll be more concentrated in an actively managed fund when you will be in an index fund. The active manager should, by definition, be picking fewer stocks for the fund than the index counterpart, since he’s supposedly picking the best of the litter. This is great when his bets are right and disastrous when his bets are wrong.

The statistics simply are not on the side of actively managed mutual funds. First off, for the past five years, of all of the different mutual fund categories, active management underperforms the index counterparts in all but one: large-cap value funds, where 50.22% of actively managed funds outperformed their index counterparts. For the other 16 categories, index funds outperformed actively managed funds.

Secondly, even if you pick a high performing fund, there is little assurance that said high-performing fund will continue to do well. If you picked an actively managed mutual fund that was in the top 20% of performance over the previous five years, there was only a 0.18% chance that it would remain in the top 20% of performance over the next five years. If you were a little more lax in the standards and only picked a fund that was in the top half of performance (which would not guarantee that it outperformed its index counterpart) in the previous five years, there was a 4.46% chance that the fund would remain in the top half in the next five years.

The statistics simply are not in your favor if you choose actively managed funds and are investing for the long term; it is more likely than not that you will choose funds which underperform their index counterparts.

In the previously discussed June 4, 2013 show, Dave Ramsey categorized people who questioned his advice as one of two types of people:

  • Bitter people who say that they can’t win and they can’t be millionaires. I daresay that any casual reading of my body of work will disprove both of those notions.
  • Financial nerds who analyze and analyze (his emphasis, not mine) everything to the nth degree and don’t learn about what Dave Ramsey teaches. I’ve gone through the Financial Peace University course, read The Total Money Makeover, and listened to hundreds of his podcasts. I understand his advice, quoted his website (which he, in the show, admitted he doesn’t read everything which gets published there), and have applied analytical rigor to what he teaches. He also says that those financial nerds don’t have a business and are bored. I have a business, serve my readers, and am far from bored (oh, and I already built and sold another business). I just want people to get proper guidance, regardless of the source.

Dave Ramsey’s biggest argument during the discussion was “If they [his listeners and readers] follow all of my advice, they are not being harmed.” That is true. They should not be harmed, although his advice for withdrawing funds during retirement could be harmful for retirees; however, just because someone isn’t harmed doesn’t mean that the person can’t do better.

The lesson of all of this is to apply a critical eye to everything you hear or read. Just because information comes from a “guru” or from a website you like doesn’t mean it’s always going to be right. Don’t take things at face value. Think. Question. Ask yourself how something could go wrong. Determine what would happen to you if the assumptions you make about future outcomes don’t work the way you planned. Have a backup plan and a backup plan after that. Don’t just take it on blind faith that because someone told you that something would work a certain way that it well when it comes to planning for your retirement. Make sure that you understand what information and assumptions are being used to make your plan and how those affect the outcome.

Then, you might have financial peace.

What do you think? Am I wrong in disagreeing with the points that I do? Do you agree with him on those points? If so, why? What other advice, if any, do you disagree with? Let’s talk about it in the comments!

The 3 Big CPA Problems Financial Advisors Can Help With

The 3 Big CPA Problems Financial Advisors Can Help With

These scenarios to developing a relationship with the CPA work best if you already have a mutual client with the CPA. It’s the easiest way to connect with them to solve their problems, and start the relationship with a CPA.


From an advisor’s point of view, I’ll sum this up as lack of coordination between tax and investment.

It’s very common for clients to make big financial decisions during the year, and then be surprised come tax time when they find out that they owe more tax than they thought. A lot of times the CPA gets the shaft, because they are the ones that break the bad news to the client.

This is not a great feeling for the CPA, because the client ties the negative results directly to the CPA!  And what is the CPA thinking is “How am I supposed to magically know what you did last year? Why didn’t you or your advisor tell me about this ahead of time? This all could have been avoided.”

If we want to stand out from all the other advisors, we want to create an ongoing relationship with our client’s CPA. When you’re planning for your client throughout the year and there’s a possible event that could affect their taxes (ie, large capital gain/loss, Roth IRA conversion, etc.), we want to make sure we keep the CPA updated.

After getting approval from your client, a simple phone call to the CPA is the best method for starting the conversation. Both the client and the CPA will appreciate this effort to keep all parts of their financial life coordinated. (As you continue to read this post, you’re going to learn exactly what to say to start the conversation with your clients and their CPAs about this issue.)


A normal conversation at a CPA firm with a client during tax season goes like this:

CPA: I see that you had dividends from fund company last year but nothing this year for your taxes, did you get a 1099?

Client: No, I don’t remember getting one.

This will either result in incorrect info on the tax return and a letter from the IRS three months later, or it will hold up the CPA on completing the tax return for a few weeks. Both are an inconvenience for the CPA.

Since you know your client’s financial picture better than the CPA, you can clearly communicate to the CPA the correct answer. It’s very simple, but this one thing gives the CPA the ability to complete a tax return and move onto the next one, which is a big deal to them.

The best way to solve this problem for the CPA is to create a simple list of your client’s accounts. All that’s needed is the name of the custodian, the type of account, the last 3 digits of the account number, and whether the account has a 1099 for the year or not. (Of course, it’s very important that you first get client and compliance approval before communicating and sharing with their the CPA in this way.)

This simple exercise is going to save the CPA a lot of time. As the CPA goes through the client’s tax documents, they can use the list you provided to confirm that they have every 1099 from their client. If something is missing, they can ask you to get them a copy.

I’d recommend trying this out on only 10-20 of your clients. It’s a good way to test the process and make sure your client and CPA are getting benefit from the extra work you’re doing.


This is the most common problem that CPAs face. It usually happens during tax season while the CPA is working on the client’s tax return, and they see a $0 cost basis. They call the client to ask them about it, and the client will have no idea. And then begins a time-consuming process to try and figure out what the basis is. This is also the one thing where clients usually end up paying way more to the government than they have to.

All CPAs want is a number to put on the tax return and be done with it. If you can help them with this in the height of tax season, they’ll love you. They will at least say yes to meeting you for lunch after tax season.

If you were involved in the account throughout and actually have – or can get – the transaction history, calculate the total cost basis of the investment, or at least give the historical purchase details to the CPA, so he/she can get it done quickly.

Alternatively, if there’s no record of basis and you can’t calculate it yourself, try running a Morningstar Hypothetical that works backwards to estimate what the cost basis might have originally been.

If you can work the hypothetical to show a sale price that’s close to the total proceeds on the 1099, based on at least an estimate from the client of when the original purchase may have occurred, you’ll have a pretty good idea of what the cost basis was, and the total amount of dividends reinvested over that time period.

I usually tell the CPA that I’m sending them a hypothetical example and it shouldn’t be shared with the client, but it will provide you with some idea of what the cost basis would be for this example. It may not be perfect, but the CPA can use it to make a reasonable estimate of the cost basis, that is better than just assuming a cost basis of $0… and you save your clients a lot of money by communicating with their CPA on the problem! (Again, make sure to check with your compliance department to ensure this is permissible for you.)

By solving one or more of these 3 problems for a CPA, you’ve instantly been brought to the head of the crowd. You’ve relieved their pain and stress when it’s highest, and they’ll be grateful for your help. And you can turn that positive feeling the CPA has about you into a prospective referral relationship.