General advice for an imaginary average person

Personal finance advice comes in many forms, running the gamut from Dave Ramsey’s philosophies on getting out of debt to Suze Orman’s no-nonsense anti-stupidity spending advice. Opinions vary wildly as you stroll down the promenade from the broker, a salesperson, to the financial planner paid by the hour rather than commission. Mass media, however, must appeal to the masses, so unless you’re working individually with a professional, the advice you receive is geared towards the average individual.

I don’t know any average individuals. This concept is a fictional statistical human being, an amalgamation of a sample population, with no defining characteristics. Mass advice cannot cater to the most diligent or intelligent of the crowd, because invariably less apt individuals overestimate their abilities, attempt techniques designed for the more able, and fail. Thus, advice is often “dumbed down” or simplified to meet the lower qualifications of a larger group.

Take, for example, the case of the best way to pay off credit card debt. I call it the “Debt Avalanche” but it certainly wasn’t my invention. While there are exceptions, this method of debt repayment calls for credit card debt always being paid off by focusing on the debt with the highest interest rate first. But people don’t always want to take this approach. They may receive more “satisfaction” by paying off the debt with the lowest balance first, which they believe will motivate them to continue paying off debt. Money, after all, is emotional more than it is mathematical.

Unfortunately, it’s this mindset which helps many people fall into debt in the first place (or repeatedly), and it is not correct. The best way of reaching a specific financial goal will always be the mathematical way. If not, your true goal is not purely financial. For example, is your true goal to get out of debt quickly and efficiently or is it to feel good about your debt situation? You’ll feel better in the end knowing you took less time and spent less money to get out of debt. If not, then perhaps you haven’t learned much of anything and will find yourself succumbing to the “emotions” of money again.

There are legitimate places for emotions when dealing with money, but debt reduction is not one.

Self-limiting philosophies and beliefs

You may hear that “doing what works for you” is the best way to approach a financial situation, but it’s often not a good idea. Doing what works the best mathematically is the ultimate approach. Other approaches may help you reach your goal, but not in the best way possible. “Doing what works for you” is an admission that you feel you have no need to improve yourself. This philosophy tells the world that you’ve learned everything you need to learn and are satisfied with your choice, even though you know it may not be the best. Or worse, if you have not learned all you need to know about your situation, you may not even realize that what you’re doing is in fact “not working.”

“Doing what works for you” is one of a number of self-limiting philosophies, excuses that people will use to convince themselves that they don’t need to strive for excellence. Here are some others:

“Luck and chance affect me more than my effort and skills.” Do you attribute a missed career opportunity to bad luck or not enough hard work? When you received a good grade on a college exam, was it due to the ease of the test or your preparedness? Those who attain their goals are more likely to be those who believe their own decisions and actions affect outcomes, good or bad. Those whose philosophy of outcomes is built around an internal locus of control have been shown to reach their goals more often.

“Anything is better than nothing.” When it comes to saving, reducing debt, and investing and planning for the future, I agree, you have to start somewhere. It is only a start. But if you believe that your financial condition in the future is important, the minimum is not enough. Don’t stop at “anything,” even if it is better than “nothing.” This is like saying it’s fine to feed your children one meal a day because one meal is better than no meals. Everyone is busy, but if the minimum is all you have time for, don’t expect results.

“At least I’m better than average.” The New York Times recently cited the Federal Reserve Board with an “average household credit card debt” figure of $8,565. Owe less than that and you’re in good shape, right? It’s unclear how that figure is determined. It may in fact be the average credit card debt of only households that have credit card debt. Include debt-free households in the calculation and the figure will drop. A number this high lulls many people into a false sense of security with the belief that with their balance of $6,000 in credit card debt, they’re “doing better” than most of the country.

This “security” leads to inaction and, in this case, to the glee of credit card providers, merchants, and manufacturers around the world.

Getting over it

The result of a lifetime with these beliefs is guaranteed mediocrity. While removing self-limiting philosophies doesn’t guarantee excellence and the ability to reach every goal, keeping these philosophies guarantees that you will not do your best. I do not know any man or woman with children who is satisfied with being anything but the best father or mother he or she could possibly be, so why are so many people satisfied with being an average personal financial officer?

There is usually a perfect mathematical solution to financial goals, like the Debt Avalanche mentioned above. Although Dave Ramsey says that most people have more success with a different, more expensive and time-consuming technique, that doesn’t mean you shouldn’t strive for the better solution. Just because perfection is not always attainable doesn’t mean that it’s worthwhile to stop striving for that approach and settle for lackluster results, especially if the better approach is not more difficult than the alternatives.

If you’ve found something that “works for you,” don’t assume that there isn’t something else that works better for you. Follow the best examples, not examples set by the fictional average individual. If your financial security is important to you, don’t settle for mediocrity. You won’t always reach your highest goals or always be excellent, but you’ll never be excellent if you limit yourself.

Consider a hypothetical popular financial adviser with $30 million in investable assets. Her (or his) primary clients may average $500,000 of liquid reserves ready to be directed in any manner as instructed. The typical advice these clients may receive likely involve investing mostly in equities through stock index funds. They have low expenses and are poised to provide decent returns with average risk. This advice may include special consideration of asset allocation, with a slide towards lower risk once in retirement to help provide more reliable income while maintaining capital.

This is sensible advice for the average client, though a financial adviser has the responsibility to tailor his advice to the client’s unique situation.

Let’s take a look inside the portfolio of a $30 million adviser. In fact, it just so happens we have some details on one particular famous financial adviser with television and radio shows, books, and a strong brand image, so let’s use her portfolio as reported in 2007.

Suze Orman has a liquid net worth of $25 million, which doesn’t include her $7 million in real estate. Only $1 million, or 4% of her liquid net worth, is in equities. Suze, whose advice is over-simplified and dumbed down to be understood by the most idiotic of callers and is usually accompanied by “motivational” words of empowerment bordering on mean, doesn’t follow her own advice. Far from it. As of 2007, Suze invests almost exclusively in municipal bonds, favoring “safe,” lower returns over the risk of the stock market. Out of her entire portfolio, Suze invests only what she can afford to lose in equities.

Does her asset allocation and refusal to follow her own rules mean she is a bad financial adviser? While there may be several reasons to seek personal advice elsewhere, her own portfolio isn’t one of these reasons. Her advice is not directed at people with $25 million to invest. While some of the general tenets of her advice, like pay off debt, spend less than you earn except in some circumstances, and avoid costly commissions, hold true universally, some of the specifics like asset allocation are directed toward a certain type of client.

Suze’s personal choice makes some sense. With $25 million, you can afford quite a bit of flexibility. With $24 million in bonds, you may be generating a yearly income of $720,000. (Add to that seminars, royalties, appearance fees, and endorsements, and you’re doing pretty well.) One might levy criticism that she is not securing the future for her heirs, but I’m not convinced of that argument. Personally, I have no idea if Suze has any heirs or future plans, but I would think that she would want to do something with her accumulation when she dies, either provide for a family or provide for a foundation. And I would also think that she wants to build as much as possible to do the most she can to help whatever cause she chooses. So in that sense, she may not be doing all she can to allow her funds to grow.

But her current wealth puts her in a position where she can still reach her goals, and give herself a better chance of doing so by backing off and choosing less risky investments for a major part of her portfolio. You and I, her average clients, can’t afford to forgo the potential for higher returns and must therefore take on higher risk.

The first fallacy is the idea that one piece of financial advice fits all people all the time. The other fallacy is that one cannot give advice without following that same advice. A stunt man can advise an actor not to jump out of a moving car. A parent can advise a child not to handle knives. A police officer can advise a civilian to put down the gun. Suze—or any other financial adviser—can advise her average clients with not much investable assets to invest as much as possible in equities for the greatest return, regardless of her own portfolio.

But when Suze yells at callers, placates the lowest common denominator, or is otherwise condescending, I change the channel. I tend to think her recommended allocation for the average caller is a little on the safe side. However, she’s free to do whatever she likes with her money, and it doesn’t affect the quality of her advice.

Information on Suze’s portfolio from Outing Sue Orman’s Investments, Chuck Jaffe, MarketWatch, March 8, 2007.

I like the new columns from Money Magazine featuring “The Mole,” an undercover financial planner. Like me, The Mole prefers to write anonymously to protect his or her identity. While my reasons for doing so pertain more with my desire to post sensitive personal information, The Mole maintains incognito status because he tends to speak out against the practices of his contemporaries and associates.

Some time ago, I considered publicly becoming a financial adviser or planner. Eventually, I decided it wasn’t the path I wanted to take, but the resulting discussion was interesting. So what does a would-be financial planner need in order to be hired and trusted by customers?

Perhaps a certification. The Mole says “maybe.” He has good things to say about Certified Financial Planners (CFPs), as he is one. This is a quality certification program with stringent requirements. Unfortunately, not all certifications require rigorous education and some have a loose grasp on ethics and fiduciary responsibility.

Now by my last count, there were more than 100 financial designations. Many, like the CFP, take a significant amount of time and expertise to master before the designation is awarded… Unfortunately, many of the others require nothing more than brief courses geared toward sales techniques; how to use emotions to sell annuities to seniors is a popular one.

A strong designation would reduce the chances your financial planner turns out to be sleazy like these annuities salesmen profiled by Dateline NBC.

However, even a designation like CFP does not guarantee the quality of the planner. Regardless of the designation, it’s best to get referrals from satisfied customers before selecting your financial planner. Don’t know anyone who is retaining financial advisory services? You can get referrals from the Financial Planning Association or the National Association of Personal Financial Advisors.

With referrals in hand, research your potential advisers with the North American Securities Administrators Association.

Walter Updegrave, another columnist for Money Magazine, submits the following:

I’d be wary of any advisers who contact me unsolicited, and doubly wary of ones who run free retirement-planning lunches or seminars. Many times such sessions are just a come-on to sell high-priced investments.

The lesson is to remain skeptical. If your adviser isn’t listening to your goals, suggesting products that are right for you, or trading frequently, it may be time to fire him or her, regardless of the adviser’s certification.

Do I Really Need a CFP? [Money Magazine]
Cracking the mysterious code of financial advisers [Money Magazine]

I often rail against “financial rules of thumb” for their overly simplistic view of what are often complex situations. There is far too much potential for snappy catchphrases to lead people to refuse to think and evaluate situations on their own. Rules of thumb don’t take into account individual circumstances and even the most popular ones are simply incorrect.

Kiplinger asks about the usefulness of twelve financial rules of thumb, particularly when some can be harmful if blindly followed. What do you think? Which “rules” are true and which are false?

1. You should always close credit card accounts you no longer use. (See How to Best Handle Old Credit Card Accounts.)
2. Save and set aside an emergency “rainy day” fund to cover at least three months’ worth of your expenses. (See Always Be Prepared: The Unexpected Job Loss.)
3. The percentage of stock in your portfolio should equal 100 minus your age.
4. Always go with a fixed-rate mortgage—especially when interest rates are rising.
5. Save 10% of your income each year.
6. Buying a car is always cheaper than leasing.
7. A Roth IRA is better than a traditional IRA.
8. Never buy a house that costs more than 2.5 times your annual income.
9. Make sure your own retirement savings are on track before you save for your kids’ college education.
10. If you carry a balance, you want a credit card with a low interest rate.
11. If you need life insurance to protect your family, your coverage should equal eight to 12 times your annual income.

1. With a nest egg of $1 million, you can retire comfortably. (See Does This Number Impress You?)

   Some of the answers may surprise you. Leave your thoughts in the comments or take the quiz at Kiplinger.com. Also, take a look at 25 Rules to Grow Rich By.

In 2007, I actually sought a financial advisor, developed an asset allocation model, and started to track my finances more closely than ever. All good moves, but after reallocating some of my investments, I made my third mistake:

3. Underutilizing Financial and Tax Advisors

I mentioned that I developed an asset allocation model with my new advisor (after lots of meetings and questionnaires, mind you). Nowhere did I say I actually read it.

I skimmed the hefty report, then tossed it aside. It’s hard to explain this incredibly lax behavior on my part. I called my advisor and asked her to summarize, then acted on what she said, yet the report remained shut. I am reading it this week, because after admitting my behavior here I am sufficiently humiliated. Shame on me.

But not reading the report led to even more bad behavior. Read the rest of this article »

You would think that the roles and responsibilities would be clear and there would be a strong line between individuals who call themselves financial advisers and those who call themselves stock brokers. The obvious answer is that advisers give impartial advice based on the best interest of the client and brokers sell products as a third party.

Advisers are sworn to put their clients’ interests ahead of their own, thanks to the Investment Advisers Act of 1940. This Act defines an adviser as, “Any person who, for compensation, engages in the business of advising others, either directly or through publications or writings, as to the value of securities or as to the advisability of investing in, purchasing, or selling securities, or who, for compensation and as part of a regular business, issues or promulgates analyses or reports concerning securities.” The Act also precludes brokers from being considered investment advisers.

In that case, what is a broker? The act also provides this definition. A broker is, “Any person engaged in the business of effecting transactions in securities for the account of others, but does not include a bank.” The key word is effecting, which astute readers will realize is not the same word as affecting. Brokers make the trades happen. Today’s brokers are “broker-dealers,” meaning they make the trades happen, and they sell financial products to customers for a fee.

While advisers must act in their client’s best interest at all times, brokers do not face this requirement. Brokers must understand their client’s complete financial picture and must direct them towards appropriate products.

Generally, investment advisers sell their services with a fee; perhaps hourly or per service, either flat or as a percentage of assets (to make financial advice in reach for those without millions of dollars to investment). Brokers should be earning a commission for each product that they sell, just like your car salesman.

Here’s where the line gets blurred. Brokers have been offering a product called a “wrap account.” Basically, the broker takes care of all the details, selecting investments, making the trades, and charging a flat quarterly or annual fee to the client. The theory with these accounts is it will reduce unnecessary trading by the broker, because she is not collecting a commission for each purchase or sale of a security.

In the past, fee-based services were held in the domain of only investment advisers, but the SEC granted an exception for wrap accounts. Recently, a court ruled that brokers who are involved with wrap accounts must register as financial advisers. This would hold these brokers accountable for making only investment choices best for the investor.

Brokers say that wrap accounts have saved clients billions in commissions. Even if that’s true, it doesn’t mean brokers are always making the best decisions for their clients. The New York Post cited a suit to bring wrap accounts to the public’s attention, citing an example:

Last December, then-New York State Attorney General Eliot Spitzer charged UBS with devising a system to lure unsuspecting clients, even when there were lower-cost and more suitable options available. The suit cited an 82-year-old woman who paid $24,000 in fees but only made one trade.

It’s difficult to know who to trust, and blurred lines between advisers and brokers don’t help the average person to make informed decisions.

Money Magazine is sharing an interesting piece of advice in their September issue. This comes from “The Mole,” the magazine’s “underciver financial planner.” If your financial advisor or broker tells you there are no fees for a particular investment or no risk for some product, ask to confirm in in writing.

Even though my clients relied on these promises [of no fees and no risks from other advisors] when they chose investments, they had nothing in writing to prove it. In fact, within minutes of making those misleading statements, the adviser probably had the client sign a multi-page disclosure document that contained language (buried deep inside) directly contradicting the oral promise. Advisers know no one is actually going to read all the disclosures before signing.

Here’s an easy solution. When your adviser makes an extreme-sounding claim, send him a nice, friendly e-mail articulating your understanding of what he said.

Ask him to confirm it in writing. If the statement is accurate, he should have no problem. If he backpedals, dismisses your request by saying “That’s in the disclosure document” or just calls you up to repeat his oral promise, get very suspicious. If he won’t write, something’s not right.

The Mole’s reports take a look at what happens behind the scenes in the world of financial planning. The more someone has knowledge of what goes on on the “inside” will be in a better position to make good decisions. This piece from The Mole is advise is quite clever; theoretically, an advisor knows better than to formally document a lie and will avoid that at all costs.

On Friday, August 17 and Thursday, August 30, the National Association of Personal Financial Advisors and Kiplinger’s Personal Finance are presenting free one-on-one discussions with professional advisors.

To get your questions answered, either call 888-919-2345 on one of those two dates between the hours of 9:00 am and 6:00 pm or email your questions in advance to jumpstart@kiplinger.com.

Their press release was sent to me with my permission, and the event is worthy of mentioning. Free solicited advice from unbiased (or reduced-bias) professionals can’t hurt. NAPFA promoted fee-only financial advisors, a method of compensation that reduces conflicts of interest.

If you do take advantage of this service, email Consumerism Commentary’s tips mailbox with your question and the advice your one-on-one advisor offered, if it’s not too personal. We’d like to see some examples.

Jump-Start Your Retirement Plan Days [Kiplinger’s Personal Finance]