Investment Products That Make Me Cringe
When we meet with new prospects and clients, they sometimes come bearing baggage and pain of making investment decisions that they regret. Many of these are related to inaction or errors of omission (e.g. “I wished I had started saving sooner”) and many are related to poor decisions or errors of commission (e.g. “I shouldn’t have put my money here.”) In our blogs “A Higher Calling: To Serve and Protect” we highlight how an adviser has the opportunity to guide clients through these decisions – serving and protecting them. In this blog, I want to dive into common “investment products” that have disappointed many investors, particularly when shown alternative solutions.
While some of the products I will mention may have valid roles, in my experience most were bought based on reacting to fear (that is, recency bias) or investor naivete (failure to apply rigorous financial analysis or explore all other options). In almost all cases, investors had little idea what they “bought” and, subsequently, were disappointed. The apparent losses of UBS’s “Iron Condor” risk management solution is an example of where investors may not have received what they hoped.
“Investment Products” That Have Disappointed
1.Whole/Universal/Permanent Life Insurance Policies
Buying life insurance can be an emotional decision as you consider how to provide for your loved ones. The challenge for the buyer (you) is that life insurance products can be incredibly complex in structure and very hard to understand, and the buyer (you) may only do this once in a lifetime.
Insurance offerings range from simple term life to many variations of permanent life (e.g. whole life, universal life), as well as others. Terminology, terms, restrictions, and fees are hard to understand and embedded in a 100+ page opaque disclosure document. For permanent life, the inclusion of features such as “cash value” and “tax-deferred growth” sound appealing but should be considered in light of other investment options, risks, and “terms and conditions.”
Mathematically, for most people, it is hard to justify any policy other than a low-cost, relatively simple term life insurance policy. Permanent policies, while offering some seemingly interesting “investment” features, are:
embedded with high commissions (typically 80-100% of the first year of premiums[1]),
high ongoing fees,
onerous constraints,
and risks that buyers likely don’t understand (like "guaranteed income" really isn't guaranteed).
A recent article in Wealth Management magazine ("When Is Whole Life Not Really Whole Life?") highlights a few of these (some of these investor stories are quite frightening!) and should cause you to proceed with caution.
While the investment feature may have been an interesting option 40 years ago, the emergence of tax-efficient, low-cost investments like ETFs, as well as the broad range of tax-deferred investment options (e.g. IRAs, 401ks, etc.) are eating away at the tax/growth benefits permanent policies might have once had. It really pays to look at your options carefully. This write up in Investopedia ("Is Life Insurance a Smart Investment?") does a good job of laying out the basics of an analysis and options.
Life insurance may have a critical role in risk management and estate planning. The important thing is to consider options prudently and seek an independent perspective of any proposed new policy versus all other options to address your goals.
2. Structured Notes
Since the increased market volatility from last fall, I get plenty of these marketed to me for our clients. I generally delete. Why?
Structured notes are basically designed to provide protection to investors from market volatility. They are typically “structured” with complex option strategies wrapped around a particular index. Marketed with “upside potential” and “downside protection.” While this is generally true, the costs and terms make most of these notes very expensive and less attractive than other investment options to achieve the same portfolio goal.
Like insurance above, these are often accompanied by hard to understand, 100+ page disclosure documents (term sheet, Prospectus). Some criticisms of these products are:
Significant upfront commissions, which puts the investor in the hole from the start
Callable term, which favors the product issuer over the investor
Callable price, which may not be market based and set by product issuer
Lack of marketability and/or high discounts if you need to exit
Often the lack of dividend inclusion in the underlying index, which is less return for the investor
This piece in Investopedia ("Structured Notes: Buyer Beware!") gives some more background.
For me, structured products are fun to analyze as the math is fascinating. Here is a defense for structured products to be fair ("A Critique of Structured Product Critics").I love his last line: “Not one of these factors is too complicated to be understood by investors.” Really? Good luck reading the Prospectus!
There may be a role for structured notes IF you are targeting specific risk management in a portfolio, but for most investors who are concerned with equity volatility and downside protection, it is simpler and cheaper to dial back the risk other ways (e.g. reduce your equity exposure and add fixed income).
3. (High-Priced) Annuities
Insurance News, citing a Winks’ Sales & Market report (3/20/2019), announced that in 2018, annuity sales smashed sales records. Volatility leads to investor fear, and the marketing and sales of annuities accelerate. Annuities promise “guaranteed income” and “life time income.” This sounds attractive, particularly after seeing the market bounce around. Yet, once again, these need to be assessed for what they offer relative to other options.
You may have heard the Ken Fisher’s radio commercials where he staunchly proclaims, “I hate annuities.” That should at least make the prospective investor curious and cautious. If you don’t trust Ken Fisher - or maybe don’t know who he is - just google “annuity criticism” and read the various views. The majority of positive views come from insurance agents and brokers (who make a living selling annuities). The majority of negative views come from “fee-only advisers” and “fiduciaries,” who have opted to not recommend annuities, or only use them very sparingly, because they are legally committed to clients’ best interests. Why the differences?
Like permanent life and structured notes, annuities are complex to understand and come in many forms (e.g. fixed, variable, indexed). Most investors don’t fully realize what they have purchased, and few read the dense prospectus. While annuities are targeting the delivery of income in the future, annuities:
are very sticky (hard to sell/exit),
are generally loaded with high up-front and ongoing costs,
can have unattractive tax and estate consequences,
and are usually embedded with significant inflation risks.
This short piece in Forbes ("Fixed Annuities - Unlike Variable Annuities - Can Be Attractive") does a good job giving an overview.
As with any “investment,” these need to be considered in light of other options and in the context of an overall financial and estate plan. Good news for investors is that huge, low-priced players like Vanguard, Fidelity, and Blackrock are entering this market. With the lowering of total costs, annuities may make more sense (I am still assessing).
Fiduciary Rule... almost... to the rescue.
It is important to note that historically the products I mentioned are rarely recommended by full-time fiduciary advisers. Instead, they are generally sold by brokers whose views may be biased by commission differences across products. For investors, this is a big deal and one thing the SEC was trying to address with the recent Reg BI ruling. However, it is still unclear how this new ruling will play out. Until then, it may be wise to get guidance from an independent fiduciary adviser before making any major commitment.
Recently, several states (e.g. New York, Nevada, New Jersey) advanced proposals for a fiduciary standard on advisers, brokers, insurance agents, etc. in order to provide more (much needed) protection for investors. They appear to be pursuing a more promising level of protection for individual investors than Reg BI. I am hopeful that these state-level efforts will advance and force some greater clarification and protection. Investors still need this.
This is a battlefield and Maryland recently tabled their efforts. Knut Rostad, head of the Institute for Fiduciary Standard, provided good commentary on this unfolding battle ("The False Claims by Brokerage and Insurance Lobbyists").Under a true and universal fiduciary rule, I suspect these products would either go away or change dramatically as it would be difficult, if not impossible, to justify the commission differences, and full disclosure of all costs may make these less appealing.
Until that day comes, ask the following questions before making a financial commitment:
“Given all my options, is this in my best interest?”
“What are the total fees and commission that you and your firm will earn off of me?”
“What other low-cost ways exist which can address my financial goals?”
It is ok to ask. And, if your “adviser” doesn’t want to have this discussion, maybe that is the warning flag you needed.
Conclusion
The investment and wealth management industry has an opportunity to respond to a higher calling by protecting clients from emotional decision-making and poor investments. Sometimes this not easy and means having hard conversations with a client, but it is a wonderful way to serve and add value. Our previous blogs focused on serving with a servant leadership approach and protecting them from poor investment decisions.
Serving and Protecting: a great way to add ongoing value to clients!
1 This 2015 article in Nerd Wallet www.nerdwallet.com/blog/insurance/life-insurance-agent-commissions helps explain commissions on insurance and gives some advice on saving money. They (as well as other sources), explain that commissions on insurance products generally amount to 100% of the total first year premium. That means for, permanent life insurance policies commissions are about 10x bigger than term policies.
