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The Failures of the Financial Advice Industry! March 23, 2009

Posted by shaferfinancial in Finance.
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Over the last couple of generations the financial advice industry has come to an almost universal set of beliefs about personal finance.  These beliefs, when it comes to risk management, are totally wrong according to the data we have had available for the last 30years.  It doesn’t matter if the financial advisor is a fee based planner, commission based, working for a equities based company or an insurance based company [they all carry complete lines of products now], jabbering on the internet, in the financial magazines, or cable networks or belong to the local Knights of Columbus or your kids baseball league, almost all of them prescribe the same theories of personal financial management.

These are some variation of save, invest in mutual funds for the long term [usually 30-40 years], term insurance [and maybe permanent insurance when it can be afforded], pay down debt including your mortgage, and as you get older reduce your risk by moving from equity funds to mixed funds to bond only funds.

The truth is that we have much evidence on how this strategy fails most folks who try to apply it to their lives.  As I pointed out in my book,  there has been very few in the industry that has bothered to look at the reams of data pointing out this failure. 

Here is the main issue.  The mainstream theory is that younger folks can withstand market downturns that will attack their mutual funds because they have much time before they will use the funds.  The reality is totally different, younger folks have less reserves to withstand job losses, and the other events that happen to us that force us to use our reserves for everyday living.  The other issue of course is that older folks for the most part are trying to play catch up with their money and buy into the idea of staying in the market as long as they can to maximize their returns.  This is also the result of faulty strategies that assume folks will invest for 30-40 years when in reality folks only really invest with any money for 15-25 years.  The younger set generally are busy saving for a home, stabilizing their careers, starting a family, dealing with an economic climate that puts the worker last in line for business profits.  Little is left for investing after all that and what they do invest is periodically needed to get through to the next job, career, place, etc.  The older set, didn’t get their financial house adequately arranged to have a base that will carry them if all else fails and are making decisions based on fear rather than sound thinking.

Knowing all this does it make sense to advise folks to invest most of their money in mutual funds inside tax deferred wrappers where there are hefty penalties to get to ones money?  Now I have blogged on why I dislike mutual funds before, but not directly about the risk folks are taking on by investing in these funds.

Has anyone had their companies’ 401K advisor, a personal financial advisor, cable TV talking heads or any of the financial magazines discuss the risk of locking your money away into a 401K/IRA or the fact that when you are most likely to really need it, a layoff for example it is likely to have gone down considerably [recessions create stock market drawdowns and well as increased chance of layoffs]?  Has any of them told you that about every 10 years or so there is a 40% drawdown in the stock market  that you need to be prepared for?  Has any of these advisors talked to you about when it is appropriate to take on risk and when you need to manage it down?  Or do they just show you those charts with an average return of the stock market of 10-12%?  Do they send you to their fancy websites that have lots of useless information on it?

Here is the reality.  There is only a short period of time when folks should be investing the majority of their funds into equities.  And when they do this they should not be investing into mutual funds which don’t reduce the systemic [market] risk, but do reduce your opportunities for double digit returns.   When investing in the stock market you should not be looking for what is the best risk/return ratio [i.e. asset management], but what is the best pure return you can get.

When you start your investing life, you should never invest more than 50% into the stock market.  The younger you are the less should be invested into the stock market.  The time to invest a larger amount is when you have significant reserves to get you through the tough times whether its market downturns or layoffs or sickness or any other combination of events that will occur.  Young people with families generally don’t have these reserves.  There are many products that can be used to create those reserves, of which I have spoken about in the past.  Now I not talking about 6 months of basic living expenses as adequate reserves, but 2-3 years of true living expenses in a conservative environment that if all else fails will provide for you.  When you have that accomplished then you can start investing higher percentages in more aggressive ways.  I have posted before about these types of investments too.

So here is the bottom line.  Early in life you create your financial base in financial products that are fairly liquid and don’t have negative returns.  After you have created that base you slowly increase your percentage going into higher risk investments, searching for the best pure returns you can find.  Because you have your base established, you can afford the mistakes you will make and the downturns that will happen.  Evidence is that you will get better at investing and find a place to make those double digit returns that will drive your wealth upward rapidly.  Success will come to you as long as you keep your base growing, account for taxes, and improve your investing accumen over time.  Investing in mutual funds inside a 401K/IRA is exactly the wrong thing to do [with the possible exception of gaining a company match] throughout much of your adult life.



1. matt - March 28, 2009

This blog’s great!! Thanks :).

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