The other night, we hired a limo van to take our staff to our office christmas party. The driver (a retired cop) was a nice man. He said he wanted us to know that the night before the 12 mental health workers who had won the 21 million sat in our very same seats as they went to collect their winnings. They were so happy he said and nice, level-headed people: “They already had their financial advisor and everything. They had me drive them from picking up the cheques straight to deposit them cheques into the right hands.” The driver was so happy for them.
I shuddered at the thought of these trusting, gullible souls getting a lump sum probably for the first time in their lives, trying to do the responsible thing and carefully handing it off to a financial advisor. An advisor who will almost certainly have it ploughed into commission generating equities and mutual funds by week’s end–just in time for the next global recession and cyclical bear market. Worse, there is more than a 50% chance that the advisor will recommend that they pay off their mortgages with the money–only to then borrow it back as an “investment loan” so that they can keep more money “working for them in their portfolio”. [Working for who?] Most of them will also probably be told they can stop working now that they are millionaires as they are counselled to set up (unsustainable) withdrawal rates from the money of 6- 7- even 8% a year. Sadly, the 1.7 million each has a tiny chance of lasting and serving them well for the rest of their lives. That truly is a tragedy.
For anyone who has already won, earned, saved or amassed a lump sum or might receive one in the future, please consider this free, valuable advice that will serve you and your family for the rest of your life:
1. Pay off all your debt and never borrow money again.
2. Place at least 50% of the money you have left into guaranteed deposits in your home currency with some coming due every three months for the next 3 years. As each note comes due roll it back over for a similar term.
3. Do not buy any fancy financial products like tax shelters, limited partnerships, insurance investments, or levered margin accounts. Insurance should be bought when you need to insure a risk, not as an investment type.
4. Do not take your advice from a financial advisor that is paid to sell you financial products or from a firm or manager who receives a higher fee from the capital that they have you allocate to the equity side over the fixed income side. This type of fee structure is the norm in the business and it places the advisor’s best interests in direct conflict with your best interests as a client. I cannot stress this point enough.
5. During a secular bear market like we have been in since 1999 and are likely to be in for a few more years, stock markets must be carefully timed in order to make any net returns. Putting cash in when ever you happen to get money– trying to buy and hold for the long run, or increasing equity exposure and risk to make more, buying “blue chip, dividend-paying stocks”–all rubbish likely to result in permanent capital losses for you.
6. Do not buy mutual funds, wrap and “fee based” accounts unless you or the manager have an established rule set about when to buy and sell risk exposure. There is no diversification benefit in products that keep you constantly invested in every market climate and at every level of price risk.
7. Realize that in order for this money to last and serve you for the rest of you life, you cannot safely withdraw more than 3-4% maximum per year. On 1.7m, this means you should not withdraw more than 50,000 to 68,000 gross of tax maximum per year. If you cannot meet your spending needs or wishes on this level of income, do not quit working yet!
8. Realize that most people have very little money, so many of those around you will think that you are rich and expect or hope that you will share the wealth by giving them loans, help, gifts. Be extremely careful with how much you give away, keeping in mind the 3-4% withdrawal rate noted above. In other words each 10,000 you give to others is 300-400 less income per year for you. There is a direct connection between how much you give away and how much income you will have to support your life.
9. Don’t start “living like a millionaire” with lavish spending and purchases. The only true millionaires today are those who have a million dollars in income coming from safely invested capital. To get 1 million in income, properly invested to protect capital, a person needs to have 25,000,000 in their investment accounts. Those who have 1 million of assets in the bank should live like they make 40k a year.
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Danielle, this is some excellent, basic money management advice. Thanks.
I can’t say enough on how important it is to rely on an advisor you can trust, meaning someone who has no incentive to place their gain above your investment interests. Also, managing fees is key to long-term returns, as fees can make a huge difference–one reason I got out of mutual funds.
You are also one of the few advisors who is not afraid to admit we are in a bear market. I think the only charts of stock indices that should be used to measure long-term returns are ones that show inflation adjusted prices. Many investors would blanche.
Suggestion for future topic: the risks of re-hypothecation for Canadian investors.
Maybe your best blog post ever! If BNN ever finds out about this post they will never let you within a hundred meters of their studio……..lol.
point 1: There are some advisors out there that are doing the right thing for the client like you say you do. Not all financial advisors out there are bad….sure there are some…but most are not.
point 2: I am not sure of what your firm charges to manage clients money but maybe in the interest of full disclosure you can let your readers know what you charge to manage bonds and T-bills and what your past performance has been after your fees have been taken?
http://www.venablepark.com/Fees.html
Rick, I realize this can be upsetting, facts speak for themselves.
Point 1. I never said that most advisors are bad. Most are nice people. They all believe or rationalize that they are doing the right things for their client.
Unfortuantely most of the time they are simply not. The buy and hold, passive allocation advice has not been right since this bear market started in 1999, and yet that is all that most advisors have to offer. They are not paid to see the truth about this. They are not paid to see the risks. Many do not even realize this, as they do what they are told by the head office and strategy teams and hope for the best. I know this all first hand as I spent the first 6 years of my training on the sell side of the business. I know this devil well from the inside out. Yes I was a nice person when I worked on the sell-side. Yes I tried very hard to put my clients first; and I did better than most. But the system is stacked in favour of profits for the sell side firms and not in favour of protecting the client from losses.
Point 2: Everything about our firm is a matter of public record and has been since inception. You can read about our philosophy, approach, fees, results, 8 years of monthly articles and interviews–it is all here on http://www.venablepark.com.
The short answer is that we charge one low, transparent, flat-fee based on the assets in a clients accounts. We charge the same regardless of how much is allocated to any one of the asset classes at any given time, so we have no incentive to keep clients more in one thing over another, and make our tactical weighting shifts based on our risk assessment rules. We designed it this way from the outset because we knew it was the right way to do it for the client. We do not sell any products or underwrite any securities. We do not collect any funds or trailers from anyone else. And our results have been no negative years with a compound net return of greater than 4% net of all fees since inception, with 1/3 of the buy and hold volatility.
I am sure you would agree the first two lines of paragraph 2 isn’t exactly flattering to any advisor out there…good or bad. Mutual funds also include cheap fixed income funds which have done very well. You’ll be happy to hear that fee based accounts, though not the majority now, are more and more common with the 1% fee.
I enjoy your blog. thanks
3. Do not buy any fancy financial products like tax shelters, limited partnerships, insurance investments, mutual funds, wrap accounts, or levered margin accounts.
Can you explain the wrap account hazards. Is this the same as what is offered in my 401 through a major fund company as an interest account earning 3% that is called a wrapper? Thanks and I read your blog dailey .
Hi, I realized from your question that I had not been clear enough on this point, so please reread the article now revised there. The problem with mutual funds and wrap accounts, as I explain in my book, is that they are usually mandated to a static and constant asset allocation through a full business cycle. This means the managers never downsize equity or their sector focus and move to cash, so they lose perfectly with each downturn while charging a few layers of fees for no valuable risk management. No service worth the fee. You would be better to sit out of capital markets altogether and stick with short term deposits at your bank or credit union than hold long always market risk products during a secular bear market.
Excellent article.
The best one I have read on your blog for the past 3 years.
You hit every nail right on the head.
Thanks.
I received an email this morning from an insurance agent/advisor who I have known through mutual clients over the past few years. He had this to say about my post:
“Danielle I agree w/ your overall outlook and the premise for each of these points. You get paid a commission or whatever word you want to use as I do. However there are some good life insurance agents. There probably are even some good stock brokers, mutual fund brokers or exempt market dealers. You sell you and you do a great job of it. I subscribe to your way of thinking and your delivery of your message. However there are some other good professionals out there no matter what we believe.”
My reply is as follows:
Thanks for the message. We all have to be paid for our work if we are going to be around to offer services to people. At our firm we are paid a fee from our clients to manage the risk, but not sell them products. We fought hard and gave up a lot of revenue streams at the outset in order to set ourselves up with a completely unbiased fee structure. On the sell side at our old firm, we were registered to sell every kind of investment and insurance product as well as lucrative new issues which paid large commissions. Today at our annual flat rate approach (between .5 and 1% per year depending) it takes us years of diligent service to make what most financial “advisors” make in one up front sales commission of 2 to 5%. And we are proud of the way we have set this up because it was not easy to do and we believe it is without question best for the client. It is also in my view, best for the advisors in the long run as they develop a loyal following of clients that provide a steady, annuity like income stream, without the need to have to keep selling them things. Slow and steady wins our race.
I know that there is a true need for insurance and I am all for good insurance agents. I do have a problem with cross-selling insurance as investments, which has largely been based on unreasonable assumptions over the past few years. Now with the flat and near zero yield curves I think that insurance companies are going to have a tough time meeting all of their promises.
We have been through an era where financial engineering and complexity were the flavour of the day. I think we are going back to a time of more separate divisions between banking and investing, between advising and selling, with more transparency, and lower industry fees. The KISS principle makes sense in this field now more than ever.
I look forward to the financial industry giving up unfair advantage and entitlements in favour of more honest service to their trusting clients. And I encourage all the good people working in the financial industry today to lead the change we need. A lot of work must be done in order to regain the public’s trust. As in all things, we have to give to get, and this was never more true than in financial services.
Thank you for the advice. I just wish your message could be heard by everyone who invests their hard earned money.
This is the best list of financial advice I have seen summarized in one place.
Anyone who follows it who has a windfall/lump sum/inheritance will be more than well served. I would recommend only three additions, for those who do not have a large amount of capital yet, and they are:
Addendum to #1
Once debt is paid for and you want to make a new large purchase save for it in advance as much as you can. For cars (and large expense household items like a new roof) begin making the payments on the next one you will buy the day you make the first purchase… by saving. You will pay no interest and have a little yield to boost the savings rate so you can accumulate what you need faster.
Addendum to #7
Recognize that when you buy something it is with after tax income, and you will be paying tax on the item itself. Many people spend their salary not their after tax salary (“I make $70,000 a year so thats how much I spend – you actually make only $54,720) and when buying things don’t consider the price after the sales tax so everything is 13% more expensive than it seems (eating out is 28 to 30% more expensive than the prices on the menu with tax and tip).
#10 Save enough. This means assuming a modest rate of return on your savings not the overly optimistic amounts many advisors assume. Also contrary to what many advisors say most people do end up spending in retirement about what they make in their working lives – they do not factor in the high costs of health care in the later senior years. The best way to save is to do it automatically by having your pay deducted and deposited to a saving account to be later invested as conditions merit. Budgeting doesn’t work so save a minimum of 10% automatically, while probably more like 20 to 25% is what is required if you have not saved already. If you make $60,000 a year you may need to save 10 or more times this amount over your working life depending on your pension (if any) and government entitlements.
Point 5 is absolutely brilliant. Professor Zvi Bodie and others have written research
papers that show empirically that the longer you hold stocks, the higher the risk. If you don’t believe the research, all you need to do is look at the cost of insuring a stock portfolio with Put options. The longer the holding period, the more expensive the Puts become. The reason the equity risk premium exists is that it may not materialize when you need it most. Point 2 is great too, but I would have 80-90% in cash, and 10% for speculative investments. This allocation is more robust than the typical “medium” risk asset allocation of 60% equities/40% bonds.
Thanks for the great advice, just what I need!