This is a big topic with a lot to discuss. I’ll be treating it in segments, this being the first of multiple posts over time. My intention is not to discourage you, but to inform on the issues and offer substantive ways to steer clear of the bigger snares designed less to enrich you and more to separate you from your hard-earned money. With that said, let’s proceed.
Mark, Get Set, Go!
If you spend any appreciable amount of time watching CNBC or listening to the typical financial planner, you’d quickly get the impression that there are only three viable options for investing: the financial markets (NASDAQ, NYSE, OTC, CME, etc.), banks and insurance companies.
There’s a reason for that. Most financial planners earning opportunities are tied to these three segments of the investing world. They can earn handsome commissions - without disclosing it to you - tied to the selling of these products regardless of how your investment performs (there’s an exception to this, so if you’re hopping up and down, screaming that I’m not fairly representing financial planners, hold your horses, I’ll get to that). Step outside of these markets and their opportunity to make money off your money quickly diminishes.
Legislation and tax law force you to use an even narrower rigged segment of the financial markets known as mutual funds if you want to take advantage of employer-matching funds in saving for retirement. What is a mutual fund? It is a mix of stocks and/or bonds and/or other financial instruments managed by an individual or group of individuals on your behalf. Multiple fees can apply to these funds, including marketing costs, commissions, and management fees.
Some of these fees are understandable, as there is a cost for their employees to select, buy and sell the assets in the fund, complete and file required regulatory and legal documents like the prospectus and issue statements to fund clients. Do they deserve more than the administrative costs? If you win, perhaps, but what about when you lose?
100% your money, 100% your risk.
Mutual fund fees can range widely. There are ultra-low-fee index funds like Vanguard’s VFIAX fund, which mirrors the Standard and Poor 500 market index, with a total expense ratio of 0.04%. There are also higher-fee actively managed funds like Invesco’s Balanced-Risk Commodity Strategy BRCAX fund, which uses a collection of other Invesco mutual funds and treasury bills in the hopes of delivering returns with less volatility. This fund has a front-load charge of up to 5.5%, that money going to pay a commission to the financial planner that put your money into the fund - can you say winner, winner chicken dinner? The planner that put your money here certainly can! They get this bounty right off the top, so from day one of your investment, you’ll have as little as 94.5% of the money you started with before dropping it into this fund. In addition, the annual expense ratio for this particular fund is around 1.4%, so this fee is charged each and every year regardless of performance. The maximum load charge by current (FINRA) law is limited to 8.5%. The maximums for other fees (redemption, marketing, management, etc.) can vary by type of fee.
These fees are incredibly lucrative for financial planners and fund managers. So much so that many live a much better life than the average investor whose money they’re sponging off of. They have nice homes, fancy cars, fat expense accounts, and in some cases a vacation home in the Hamptons or other fabulous locations, and they don’t even have to outperform a brainless index to keep their jobs! Here's a link to a classic book on this very subject called "Where Are the Customer's Yachts?"
Their “Social Justice”, Your Money
Odds are, you will gravitate to index funds for the benefit of low fees and assurance of performing in line with the markets they are aligned with. But these days there’s a hitch, and it is no small matter. In this era of social justice, the largest of the index fund managers have decided that they speak for the trees (that being you) and that YOU want progressive policies. Ya know, those initiatives declaring anyone who opposes them to be racist, homophobic, transphobic, anti-climate, cruel to barnyard animals, baby seal clubbing types – okay I made the last two up – but you get the idea. Your money invested in these funds is increasingly being used as a cudgel to force companies to adopt policies you may have no interest in supporting. True story.
Before the era of retirement funds, the typical publicly traded company had thousands or tens of thousands of investors. The biggest shareholders always had an outsized say in the direction the company should take, but they always held a direct and personal stake in the company, so any action they forced that did damage to the company did damage to them.
Today, there are still thousands or tens of thousands of investors. But once your investment in that company is embedded in a mutual fund, it is the mutual fund manager who has gained an outsized say in the direction the company should take. So, you may ask, how is that any different? Here’s how: The mutual fund has no or very little direct risk in the company. If they push the company to adopt an initiative that harms the company, they will get paid no matter what. You might argue that if the fund doesn’t do well, it won’t have as many investors’ funds, and that may be true to a point, but the fact is, they are far more insulated from the damage they do to a company than any direct investor.
This leads me to the second principle of my financial investing: the further you are removed from the ability to influence an investment, the less certain you can be of getting the desired outcome.
This can be applied to a range of investment types. The bigger a fish you are in any given investment, the more control you have over what happens to that investment. If you buy a house with your cousin, and each of you puts in half the funds to acquire it, you each have half the say in how the house is improved, maintained, utilized, and disposed of. If you buy it outright, you have total say (the authorities having jurisdiction notwithstanding). When you buy stock directly in a company, you may not have much say, but you do directly vote on board of director appointments and have the right to attend annual meetings and voice your opinions.
When you acquire your shares of the same company through a mutual fund, you cede those rights to the parasites sponging off your money. Okay, that may be a tad harsh…but there is no denying this system is not designed to enrich you nearly so much as it is designed to enrich them using your money.
So, what to do about this conundrum?
I can offer a few suggestions.
Light a Match
First and foremost, where company match money is available, take it. For every dollar you save in the plan (usually a 401k plan – 401(k) being the section of the IRS code that allows these plans to exist), the company agrees to match some portion of that dollar. It can be a 50% match, a 100% match, or in some cases, even better. If this is available to you, bite the bullet and invest enough of your money to max out the matching funds made available to you through your employer’s retirement plan. Employer 401k retirement fund options are typically lower in fees and do not have loading for commissions. Company matching makes this one of the more lucrative investment returns you can find.
Do a little internet sleuthing to see if the fund manager/company has been pushing policies you disagree with. If so, and a viable alternative exists, take it. If not, your conscience will have to guide you on whether to invest money with them. I promise to devote an in-depth post on retirement investing through your employer in the not-too-distant future, so stay tuned.
Find a Good Planner
Second, there is a certain type of financial planner called a fiduciary (certified financial planners are fiduciaries) who will agree to be compensated as a flat percentage of the money they manage for you and not collect any other commissions or compensation from the companies they place your money with. They are also obligated legally to do what is in your best interest over their own interest (but understand this nuance breaks with natural law and natural law trumps law). For instance, if they manage $100,000 for you and earn a 1% fee, their total compensation from you amounts to $1,000. The only way they get to make more money off your money is to help you grow your funds. If you win, they win. If you lose, they may not lose, per se, but their compensation drops.
You may ask, “Isn’t it basically the same as the mutual fund manager since their fee is based on a percentage of the money they manage for you?” Sort of. The differences are twofold: (1) You have no access to the fund manager through the good, bad, or ugly. You can (and should) give your financial planner an earful with every failed investment. Closer proximity gives you more influence over their actions with your money. (2) Non-fiduciary financial planners are earning undisclosed commissions and/or fees off your money in addition to what the fund managers are getting. With fiduciary (in theory) they are obligated to act in your best interest and you know the total compensation they are getting for managing your money.
Two tips on selecting a good CFP. (1) If they tell you something they want you to invest in is too complicated to explain in terms you can understand, move on to a different CFP. Good CFPs educate their clients and never ask a client to invest in something they can’t understand! (2) Don’t hire a relative to be your Financial Planner. Select someone you won’t have to see at the family holiday dinner party after an unfortunate October surprise.
Have a Look Around
Third, educate yourself on investments not acquired exclusively through the financial markets, banks, or insurance companies. Real estate is one, direct investment in a non-public company is another, cryptocurrency is another, and collectibles are yet another. The list goes on and on. Realize these other options will have a different set of risks and pitfalls. I’ll be exploring many of these other alternatives in-depth in future posts, so hang in there and I’ll aim to expand your mind on other ways to put your money to work for you.
There is much more to discuss about the rigged nature of the financial markets, but don’t lose heart. It doesn’t mean you should not participate, only that you should become more aware of where and how they can take advantage of you. I’ll delve deeper into investment products/opportunities offered through banks and insurance companies in later posts.
That’s enough for now.
Until next time, may peace and prosperity be with you.
The Natural Economist
Next up, a look at assets…will they hinder or lead you to financial independence?