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Thursday, February 25, 2010

Myth- Fee-only advisers are always better. Part II

A client recently told me that his CPA was "suspicious" of investment advisers who also sell insurance and investments (in other words, me). I could understand that suspicion (that is, superstition) if the "product" were shampoo or pharmaceuticals, for example. But as my first post on this subject proved, the manner in which an adviser is compensated bears absolutely no relationship to the adviser's honesty, competence, or empathy, the three cornerstones of trust. Regardless of how a person is compensated by you, he can still be a crook, a dummy, or a sociopath. Without all three of those cornerstones an adviser is not deserving of your trust, no matter how she is paid. And regardless of how one is paid, there will always be biases and conflicts of interest. Is it fair for your stockbroker to earn $15,000/yr. on your million bucks (the average) while its value is declining? Is it fair for a fee-"only" adviser to recommend that you use that stockbroker because they have a cross-referral agreement?
Let's look at CPAs and tax preparers for example. Their bias- a substantial one -is to deliver the smallest legal tax bill for the current tax year. That's how they earn your love, one year at a time. But as a result, millions of Americans have created tax time-bombs which will blindside them at the most vulnerable time of their lives: retirement. You hear about wealthy retirees who pay little to no income tax. Wouldn't you prefer that? Naturally. But it takes a long term view, careful planning, and the acquisition of properly structured financial products.
So back to the Three Cornerstones of Trust. Let's use an example to see how these characteristics might play out in real life. Let's say you want advice on asset allocation in your TSA. Your nephew recently got securities licensed. He's thoroughly honest and empathetic. But is he competent? Probably not. So you turn to the adviser you know from church. He's been in the business 25 years and honest to a fault. But he's an egomaniac focused solely on raking in as much cash as possible; entirely legal and ethical under Wall Street rules. But just not very empathetic. Trust him? Finally, you tune in to the latest TV financial guru who is a genius and exhibits such deep caring about you. But looking back, if you had followed his advice two years ago you would have lost 40% of your money. Does he ever mention that on his show? No. Is that honest?
But this really is a moot point about the differences between commission, fee-based, and fee-only advisers. Registered Investment Advisers (RIAs), are held to a fiduciary standard no matter how we are compensated. That means we are legally obligated to diagnose your situation and then find the best solutions for you that we can. The key word there is solutions. The reason I also offer concrete solutions- products & investments -is that it's not enough to just arm someone with a list of great ideas. In that case, usually nothing gets done. The most brilliant solutions in the universe are useless if not implemented! I'm not the smartest guy in the room. That's why I always recommend that my clients get input on my recommendations from their CPAs, attorneys, even other advisers.  But I am biased towards action.
I am also biased toward minimizing taxes and fees over my clients' lifetimes.  If they choose to buy a commission-paying product through me then I give a corresponding refund of my fee.  It is a fact that sometimes the very best planning option involves a commission-paying product.  Would it be more ethical of me to charge my planning fee and then refer the client to a broker to buy the product?  Of course not.  It is the clients' choice.  Most choose to get the planning for free and let the product vendor pay me.  Because ultimately, I may be sitting on the witness stand explaining to a jury why I chose that particular product.  I never want to have to say, "Because it paid me the highest commission."

Thursday, February 11, 2010

Supreme Court Myth: Now my chickens can vote

I have already given you the history of how paper fictions- corporations -came to acquire human rights intended only for living, breathing human beings (see the 11/9/09 post). Now, in a radical departure from 100 years of legal precedent, the Supreme Court has given corporations and unions virtually unlimited power to interfere in elections. So now my chickens, or your car, or a forest, or even a bag of hammers can in effect "vote". All you have to do is place them in a corporate shell, dump in some cash, and go buy an election.

Tuesday, February 9, 2010

Myth: It's Always Best to Consolidate Your IRA Accounts to Lower Fees

Normally, that is true. Most- and I use that word accurately -investors create the illusion of asset diversification by having multiple fund companies or even multiple IRA custodians. But there is so much overlap that the whole shebang is at risk anyway: twenty virtually identical large cap funds held by 5 different fund families still leave you flapping in the breeze of Wall Street hot air. And those unnecessary duplicated fees add up, especially in down or flat markets. So, yes, usually it's a good idea to consolidate as much as possible to reduce or even eliminate fees.
Except in years 2010+. If you earn over $100,000. And are doing a Roth conversion. That's because of a little known provision called "re-characterization". Here's why. Suppose your Traditional IRA is currently worth $100,000 and you decide to convert the whole thing to a Roth in 2010. The entire amount is taxable as ordinary income, but, you get to spread that out over two years. Your tax bill is, let's say, $19,000 each year.
This winter, the market crashes. Again. Your new Roth is only worth $60,000 now. So your effective tax rate is 38/60 or 63%! Oops. Conversion was a bad idea. Well, you can "re-characterize" back to a Traditional IRA at $60,000 & then re-convert to a Roth, thereby reducing your tax hit to $11,400 per year, a savings of $15,200. Cool.
But what if some of your funds did really well? Doesn't matter. You have to re-characterize the whole account.
Therefore, it would make sense to convert to several Roth accounts, each in a different asset class according to the Asset Allocation model you and your adviser designed. Then you get to keep the gainers and re-characterize only the losers.
Sounds more complicated that it is. Easy to do, pays big dividends.