Monday, March 31, 2014

Flash Boys: A Wall Street Revolt

No doubt you might have watched 60 minutes last night when author Michael Lewis said that Wall Street was rigged against the individual investor. No surprise to me what he had to say. However, individual investors really are not the ones getting hurt as bad as institutional investors.

If you are an individual investor and you want to buy 100 shares of a stock, then the electronic exchanges are not really making anything to speak of from your order. You as the investor are not going to be hurt by their order routing practices nearly as much as an institutional investor. For example, let's say that a big mutual fund company wanted to buy 20,000 shares of a stock at a limit price of $40 a share. According to Mr. Lewis, these electronic exchanges would have a millisecond of advance knowledge that the mutual fund company placed that order. If the electronic exchange has the opportunity, it will buy the same 20,000 shares at $39.95 and then turn around and sell it to the mutual fund at $40 a share, thus netting the 5 cents a share difference.

Is this really any different than the market maker on the floor of the NYSE? I don't think so. Every stock that trades has a bid (sell) and an ask (buy) price. The difference between the two is the spread. The market maker keeps the spread. He is a middle man in effect.

The electronic exchanges do the same thing. They jump in the middle of trades and attempt to make money from buyers and sellers of a stock. The companies are in business to make money. They are not in business to simply pass through orders without some compensation.

However, I want to give Mr. Lewis the benefit of the doubt and I have purchased his book and will read it for more details. I promise to report back to my readers the findings.

For a good read on what happens to clients when they sit down with financial advisors of banks, insurance companies and Wall Street firms, then look no further than my book, "Meet Wally Street. The Reason You're Stupid." My book is available for a limited time for $3.99 at Apple's iBooks, Amazon's Kindle and Barnes & Noble's Nook devices. This book is more relevant to individual investors.

Thursday, March 20, 2014

A New Twist on Guaranteed Income or More Shenanigans?

As mentioned in my book, Meet Wally Street. The Reason You're Stupid, I talk about my dad's favorite saying when it comes to insurance companies. "That was the old deal. This is the new deal." Generally, as my dad and I were keenly aware, insurance companies often come out with new products that for a time are good for clients. Their typical modus operandi is to make the new product very appealing to clients. Further, they make sure the compensation appeals to the insurance agents who sell it. Both of these factors are the key to the product's development. Later on after they have clients on the books, they jack up the fees that they charge, because you failed to read the fine print. With this in mind, let's delve a little deeper here, shall we?

Most RIA firms like mine are totally against Variable Annuities that are loaded down with commissions and fees. Therefore, insurance companies realize that they are missing out on the cream of the crop of financial advisors which are these RIA firms. So, they got their actuaries to design a product that would appeal to RIA's, or at least that is what they think. What they are really going after are the dually registered representatives who are also registered as an investment adviser with their broker-dealer's RIA firm.

Totally independent RIA's are not easily swayed by a new product from an insurance company. However, you cannot blame the insurance companies for trying. The goal of the insurance company is to put in place a disruption in the marketplace where those advisors who do not fall in line with the herd will be left out in the cold. That's the thought process anyway.

Here comes a new twist on a guaranteed income rider for RIA firms and their clients. Normally, these guaranteed income riders are attached to Variable Annuities. However, now you can attach them to any account with some limitations. You can have an account at your favorite custodian, like Schwab, TD Ameritrade or Fidelity and attach the rider to your brokerage or IRA type accounts. You can invest the account with a select list of no-load mutual funds or ETF's by popular fund families like Vanguard, Schwab, DFA, iShares and others. The taxation of those accounts stay the same. The guaranteed income rider does not change their existing tax status.

The supposed appeal is that you can add this guaranteed income rider to your account or accounts and then you are guaranteed an income stream no matter what happens to your account during the withdrawal phase. Well there are a lot more details to it than that simplistic explanation, but in a nutshell this will work for explanation purposes.

Let's take an example to make some more sense of this strategy of adding a guaranteed income rider to your brokerage account or IRA type account. Assume for a moment we have $500,000 in our brokerage account. The first mistake in making future assumptions is that returns are not consistent. In other words, if we assume a 5% return, then this is something that will never happen. Some years there will be negative returns and others there will be positive returns. No one can accurately predict the return of a $500,000 account over the next 20 years. So, what people do is just assume a flat number like 5%. With this awareness in mind, we will go ahead with the faulty 5% assumption.

$500,000 at 5% per year growth (net of advisor fees) will grow to $1,356,320.14 at the end of 20 years assuming monthly compounding. Let's assume that at the end of that 20 years, we will now turn on the income stream to provide us with 5% in income per year. We continue to earn 5% on the account, but since we are taking out 5%, this means we have a net growth of 0%. The amount we pull out each year will be $67,816.01. We can pull this out for 20 years before we run out of money. So, we grew it for 20 years to $1,356,320.14, then we pull out $67,816.01 for an additional 20 years until we are out of money. This is 40 years of use for the original $500,000. This is what you can assume WITHOUT the guaranteed income rider.

Now let's look at what happens when we add the rider. What will be the benefit of paying the extra fee for the rider? Let's give the fee for the rider the lowest available amount. At $500,000 you eligible for a 0.05% fee reduction from their lowest fee of 0.95% making the fee for our assumption 0.90%. The maximum rider charge could be as high as 2.35% depending on your financial advisors choice and the insurance company guarantee.

Let's take a look shall we? We start with $500,000, but because of the fee, we must subtract 0.90% from our 5% growth which nets us 4.1% per year. (Keep in mind that I am assuming the absolutely lowest fee.) At the end of 20 years, at 4.1% our $500,000 has grown to $1,133,664.34. We want to pull out the same that we grow each year so, pulling out 4.1% will net us $46,480.24 per year making our money last 24 years. However, we are already short $21,336.61 per year in income ($67,816.01 - $46,480.24) just for paying 0.90% for the rider.

The rider guarantees your ability to pull out 4 - 5.5% for the rest of your life if you are age 60 at the time you lock in the rider guaranteed. If we assume 5.5% withdrawal rate, then this would up our guaranteed income stream to $62,351.54. We are closer to our WITHOUT rider annual withdrawal of $67,816.01, but still $5,464.47 per year short. Of course, this assumption assumes that at age 40, you had $500,000 to grow for 20 years. Typical insurance company shenanigans. How many people do you know that have $500,000 at age 40 that they can invest for 20 years with no withdrawals allowed? No withdrawals allowed?

Yes, no withdrawals allowed or your guaranteed income amount is reduced. Also, that fee of 0.90% can be increased by another 0.75% to 1.65%. This knocks our annual income down to a 3.35% withdrawal rate if they raise the total rider fee to 1.65%. As I say in my book, "Remember what my dad said about insurance companies? That was the old deal. This is the new deal."

What if you were 60 years old when you invested the $500,000 and bought the annuity? It would grow as normal, but you can pull out more money in 20 years with the guaranteed income rider. Now that you are 80 years old (typical life expectancy for most people) you can pull out 7.5%. Well, if you are changing the assumption from age 60 to age 80 for the guaranteed income rider, then you have to do the same for WITHOUT the rider. At age 80, do you really need to pull money out for 20 years or more. You are already at life expectancy. The insurance company wants you to believe that you will live to age 100 and you can pull out 7.5% each year guaranteed no matter what. That $1,133,664.34 will last for 13 years pulling out $85,024.83 (7.5% per year), so what your guaranteed rider is assuming is that you will live past age 93 and they will agree to pay that $85,024.83 for the rest of your life. What is the rest of your life assuming you live to age 93? What is the insurance company's risk? Not much in my opinion.

WITHOUT the rider, if at age 80, we pull out the same $85,024.83, then our money will last to age 96. So, our $500,000 grew to $1,356,320.14 at the end of 20 years and we made it to age 96 by withdrawing the same $85,024.83 per year. Why do we need the rider again? We gave up a minimum of $222,655.58 in account growth over 20 years and have to cross our fingers that we never take a withdrawal, plus hope the insurance company doesn't raise the cost of our rider. Plus this also assumes that we do not want to leave our heirs a penny. Idiotic assumptions, are they not? Typical insurance company shenanigans. Since the whole driving force behind this is the guarantees, how good of a deal is this? Damn it man. I got you again, didn't I?

My dad always said, "You're like an Airedale dog. You are a whole lot smarter than you look." That goes for the people who read my book, by the way.

Friday, March 14, 2014

Looping Back Around

The United States Securities & Exchange Commission (SEC) has let loose of some of the areas that they will be looking at during upcoming examinations. Of course, the majority of their examinations appear to be directed at dually registered brokerage firms. These are firms that are both a registered broker dealer and also a registered investment adviser. I warned about these dually registered brokerage firms in my book.

Apparently, the SEC is realizing that a customer with a brokerage account who is suddenly moved to a investment advisory account may be getting the shaft. I call this "looping back around."

Looping back around is when the financial advisor has sold you a bunch of high commission and high expense products and then realizes that you probably are not interested in buying any more products of this kind. Therefore, they "loop back around" to sell you an investment advisory account that pays them an annual ongoing management fee. These advisors have already taken you to the cleaners on the products that they sold you, but because of the extreme pressure they have to meet their annual $250,000 revenue quota, they need to squeeze more revenue out of you. As a result, they "loop back around."

I talk about this in my book, Meet Wally Street. The Reason You're Stupid. These financial advisors want to be registered investment advisers like me, but they cannot give up the lure of big commissions from inappropriate product sales. After all, if they sell a Variable Annuity or a Non-Publicly Traded REIT, then they can make close to 10% with some of these products. On a $100,000 investment, that is $10,000. If they went straight to an investment advisory account when they first met you, then they might have only made $375 per calendar quarter.

When their revenue quota is $250,000 or more per year, then what they do is sell you a bunch of crap that helps them get closer to their revenue quota. Think about it. If you can make $10,000 or make $375 off of a new client, then which one will you choose? This is why the sub-title of my book is "The Reason You're Stupid." I am not trying to be insulting, but somebody needs to wake people up. They are getting this rip off treatment every day by Wally Street. About 85% of Americans are doing business with Wally Street. Sad, but true.

The SEC is not liking the fact that they "jacked you up" for $10,000 in commissions, then later turned around and put you in an investment advisory account. Their viewpoint apparently is that you should stay in one or the other and not be moved from one to the other. In my opinion, the SEC is missing the boat on this one. Instead of focusing on this shifting sands approach used by Wally Street, they should eliminate the inherent conflicts of interest that favor banks, insurance companies and Wall Street firms in the first place.

What if everyone who received investment advice was never sold high commission and high expense products with inherent conflicts of interest in the first place? Why doesn't the SEC work with Congress to eliminate this crap? These banks, insurance companies and Wall Street firms sell this crap and then all other investment advisers like me are tainted by the actions of Wally Street.

Why should people have to fear that being sold a bunch of crap every time that they need investment advice? Sometimes the simplest answer is right in front of your nose. In this case, the SEC's nose. Get Congress to change the laws and eliminate commissions altogether. Wouldn't that be nice?

The only way that you could get your financial advice would be from people who charge a fixed fee, an hourly fee or an assets under management fee. Fully disclosed in writing and no possibility of selling you crappy products loaded down with commissions. Perhaps, one day we might see the SEC or Congress take action on this issue. However, I have my doubts since the politicians pockets are full of Wall Street money.

Until then, the best that you can do is read my book and learn about using Independent Registered Investment Advisers instead of that rip off artist Wally Street.

Wednesday, March 5, 2014

Ponzi Schemers May Be At It Again

Ponzi schemers, I believe, feel a lull in regulatory oversight and are out there soliciting money in any way that they can. I own a company with the words "Family Office" in it and as a result, I get inundated with emails from so called investment managers who are looking for easy money. My "Family Office" email is on a list of family offices and is sold to these email spammers as a legitimate place that they can market their investment management "expertise." Most of these emails are basically the same. They showcase their returns and how they always seem to beat the dog do-do out of the S&P 500. Well, in my opinion, it is dog do-do the returns that these firms are showing.

Another thing that they do is call themselves "Alternative Money Managers." You see, they cannot appeal to family offices with boring old investments likes stocks, bonds and mutual funds. So, what they do is give themselves a unique category of investment expertise in an area where no one else is involved. In fact, a lot of times, they create their own benchmark index to compare themselves against. These strategies are often referred to as "hedge funds."

Here is what these idiots do not know. I subscribe to Morningstar Office. They wrote the book on research and they just so happen to have all the hedge funds that are registered in their system. Just for fun, I like to look up these "hedge funds" that beat the dog do-do out of the S&P 500. Of course, what I always find is that they are not covered by Morningstar research. If they are not covered by Morningstar research, then in my opinion they are not really hedge funds at all.

Hedge funds that sell to accredited investors have to be registered with the SEC, unless they meet an exemption. However, these idiots who are marketing to my family office are not registered with the SEC as a hedge fund, in almost of the cases that I research. They might be registered with a state securities department or the SEC as an investment adviser, but not as a hedge fund. So, right there you have to wonder what in the hell is going on. They are calling themselves a hedge fund, but yet they are not registered as one. Of course, these idiots have no idea that you cannot do that, yet here they are firing away with their emails. All they really care about is getting some fool to respond to their email solicitation, so they can buy that new Lamborghini.

They prove themselves to be idiots by their email in the first place. Any family office worth its weight is going to have someone like me guarding the door. The last thing they are going to do is respond to an email where a so-called "hedge fund" beat the S&P 500 by 250% over the last five years. These family office guardians are smart people and like me, know that the odds of that spam email being accurate is slim to none. In addition, these family office guardians, like me, do their own research and know where to find legitimate research on hedge funds. They are not going to invest a nickel based on some stinking email. How freaking stupid are these idiots that send out these emails anyway?

The main point that I wanted to get across is that do not respond to email requests from "Alternative" money managers who beat the S&P 500 by 250% over the last five years. Odds are they are full of dog do-do.

Be careful out there folks. Ponzi schemers are out there everyday trying to steal your money.