The financial advice industry has gotten plenty of bad press in the past and rightfully so. The industry is not isolated from criminals, deception and plenty of products that mislead people. I have been a part of the industry for the better part of two decades and there are aspects of the industry that I dislike as well, which is why I decided to write about five that drive me crazy!
In full disclosure, I have been in the financial industry as an advisor for the better part of two decades and have sold some of the products below. There was even a time when I was drinking whole life Kool-Aid! My experiences with product sales and working for different companies has led me to where I am today – an independent advisor that is paid for giving advice versus product sales.
The Whole Life Salesman – This individual has been around forever and one that almost everyone has had an experience with. Whole life insurance is not a terrible product and something that can be a fit in certain situations, but it isn’t the solution to every financial problem. Some insurance companies do such a good job brainwashing their agents that they believe everyone should own whole life insurance.
Have you ever experienced this scenario?
A young man comes to your house and offers to provide you with a free financial plan. When he comes back to present his analysis, he recommends that you buy a big whole life policy. Before he leaves, he persuades you to give him 12 names of friends and relatives that he can contact, even if it means pulling one or two of your teeth to get those names from you.
Yes, product salesmen have an agenda: to sell their products!
There are two big problems with whole life insurance:
- The bigger the premium, the higher the commission for the salesman
- It is not an investment product but often is misrepresented as one
Annuities – The problem with annuities has become complexity. Annuities used to be much simpler; you could buy a fixed annuity that pays a 5% interest rate for 5 years. THAT is what I call simple!
The most common annuities that I see today are Equity Indexed Annuities (EIAs) and Variable Annuities (VA). The EIA has so many crediting options that many insurance agents don’t fully understand how they work. Indexed annuities are an insurance product and not a direct investment in an index, although investment returns are typically tied to an index like the S&P 500. The reason that is important to know is that dividends typically account for about 40% of stock market gains. Insurance products don’t receive any dividends. Therefore, if we look at 10% as an average for market gains and take away 40%, now you are down to an average of 6%.
That’s not all. Next you have a participation rate or a cap. If an EIA has a cap of 4%, then 4% is the most you can make in a year. If your EIA has a participation rate of 60% and the index is up 6%, then 3.6% is the most you can make that year. Those numbers are both before expenses as well. Many EIAs have expenses of approximately 1% so you would have to deduct the 1% from any annual gains you earned. If you are considering moving your TSP to an EIA please read this article first.
Variable annuities can be deceptive as well. Common fees on variable annuities are mortality and expense, income rider fees, death benefit rider fees and sub account fees. A variable annuity can have multiple different values called your account value, income base and death benefit. The account value is the actual money that you have access to.
It is somewhat common for the income base to be above the account value. For example, you could have an account value of $100,000 and an income base of $150,000. If your income rider fee is 1% then you will pay $1,500 a year even though that is 1.5% your account value. Are you confused yet?!
One annuity that can make sense in some situations is a single premium immediate annuity. Immediate annuities are very simple, you pay an inital premium and the insurance company guarantees a payment for the rest of your life. For federal employees, I don’t believe that immediate annuities are a good fit though.
Yes, annuities are hard for everyone to understand, even for the professionals selling them. The bottom line with most annuity sales is this – they are great for the people selling them and not so great for those buying them. I receive emails weekly talking about “hot federal employee leads” and how I can make $50,000 a month selling annuities. No thanks, I prefer to sleep at night.
The “No Fee” Salesman – This is my absolute favorite! “Oh, I won’t charge you anything for financial planning.” Does this sound familiar? These charitable advisors are the best, so much so that they aren’t worried about feeding their families or making any money.
It’s odd that their ‘free advice’ always points to a product that they happen to sell. Coincidence? I think not! They also happen to sell products that have no fees. Did you hear that? A product with no fees?!
The truth is there are fees involved in any product that you buy. With the “no fee annuities,” the annuity holder usually gives up market upside as well as dividends in their annuity. If the market goes up 15% and the annuity holder only gets 4%, who do you think gets the other 11%?
The Highway Robber – Yes, I think these people get away with highway robbery! Who are they? Advisors that sell variable annuities and then charge an asset management fee are what I refer to in this category. Let me explain.
When an advisor sells a variable annuity, he is paid an upfront commission of 3-7% and usually an annual commission of 0.25-1%. In comparison, if you pay an advisor to manage your money, he will usually charge around 1% of the total assets managed on an annual basis.
If an advisor charges a 1% asset management fee on a variable annuity, the fees can be so high in the annuity that it’s almost impossible for the annuity holder to make any money. Annuities have a mortality and expense charge of around 1.3%, sub account expenses for the investments, and many annuities have rider charges of 1% or more. If you add another 1% management fee, now the fees can easily be north of 4%! Wow!
One thing that is evident in this scenario is that the advisor is paid really well if he gets a 7% upfront commission on top of a 1% asset management fee a year!
The Benchmark Advisor – These advisors are all over the place. They are normally employed by large wire houses, insurance companies or banks. What I mean by benchmark advisor is that the company the advisor is employed by requires him to meet specific benchmarks every quarter, or possibly every month.
Why would that matter? Because when you have to meet a certain production level to keep your job, or achieve a higher income, you may do things differently than if you were not required to do so. For example:
An advisor once told me that a prospect that reached out to him probably should have been placed in a managed account, but the advisor’s production numbers weren’t very good that quarter, so he suggested a product that produced the most commission.
This is simply the nature of the beast. When advisors are forced to meet production goals, they may not always do the best thing for the client.
While I agree that our industry sometimes deserves the negative connotations associated with it, I firmly believe that a good advisor is well worth the money. If you would like to schedule a call with an advisor who is a fiduciary, works in the best interest of his clients, is only paid a disclosed fee and does not sell products you are welcome to schedule an introductory call with Brad.
Brad Bobb, CFP® is the owner of Bobb Financial Inc, and an expert in retirement planning for federal employees.