The salespeople (not fiduciaries) at the bank or brokerage firm can hurt you in many ways. I will just focus on six ways they can hurt you.
1) They are not Fiduciaries
They are salespeople and can sell you whatever benefits them and the company they work for, such as high commissioned products like variable annuities and non-traded REITs. We have to unravel a lot of disastrous recommendations when some clients come to us for planning. Do not make the mistake of planning your future with a salesperson.
2) They use the Asset Allocation Pie Chart
Bankers and brokers use the Modern Portfolio Theory asset allocation pie chart to diversify client assets and try to reduce your risk. The pie chart is an accumulation plan appropriate in your 20s, 30s, and 40s built to grow assets. However, if you use this plan when you are over 50 years old, you may destroy your retirement. Their buy and hold strategy doesn’t protect you from stock market drops, and the bankers and brokers tell you to put your safe money in bond funds. When interest rates are at all time lows, bond funds are not safe!
People over 50 need a distribution plan that helps you see how much income you can draw for as long as you live. It helps you see if you can retire or not, and it visually shows you your sources of income and how your portfolio pays you income for the rest of your retirement. Clients wonder why everyone is not doing it this way. The distribution plan is a common sense approach that provides a template for most all things you need to see in your retirement plan.
3) Interest Rate Risk
Interest rate risk is the risk that your bond funds will lose money. Bankers and brokers tell you to put your safe money into bond funds using the Rule of 100 for diversification. The Rule of 100 says that if you are 60 years old, you should have 60% of your portfolio in bonds or bond funds and 70% if you are 70 years old, etc. The problem is that interest rates are at or near 100 year lows. That means that you are not making any money on 60% to 70% of your portfolio. Ridiculous! But, the worst part of the banker’s or broker’s advice has to do with interest rate risk. When interest rates eventually go up, and they will, you can lose huge amounts of money in your bond funds, since bond funds lose money when interest rates go up. It’s a mathematical fact. It’s financial malpractice, in our opinion, to recommend bond funds when interest rates are at record lows and call that safe money. Absolutely not true.
4) Credit Risk
Credit risk is the risk that your municipal bonds fail to pay off completely at maturity. Almost every state in our country has signed on to pension obligations they cannot possibly pay back. There may be a day of reckoning and reorganization for all of this debt, and municipal bonds may be a part of that disaster. As fiduciaries, we cannot recommend our clients hold municipal bonds until after that reorganization is done. Until then, there is an easy way to watch to make sure your municipal bonds are okay. Watch the price.
In a low interest rate environment, there is only one reason for bond prices to drop below par ($100.00) on your monthly statement. The reason is a loss of investor confidence in the municipality’s ability to pay principal back at maturity. Once your municipal bond price drops below par, we hope you pick up the phone and just sell it. We saw this with Puerto Rican bonds a few years ago, and we are seeing Detroit, New Jersey, and some California bond issues dropping below par. We would recommend you sell those issues to preserve principal from large losses.
5) Bankers and Brokers use a Buy And Hold Philosophy
They will tell you to stay 100% invested and take those -30%, or worse, stock market hits, which take many years to recover from. Why would they advise you to do something so ridiculous? One reason; bankers and brokers do not get paid their fees and commissions if you are not invested in risk assets. Why are all of your retirement funds invested in risk assets such as stock and bond funds? Not because it is in your best interest. It is clearly not in your best interest to have all of your money at risk in retirement. However, it is in their best interest to keep your funds at risk because that is how the bankers and brokers get paid their fees. They don’t make money if you are safely in cash when the markets drop.
6) The 4% Rule
The 4% rule, in our opinion, is the most devastating, destructive piece of financial advice out there and is responsible for destroying more people’s retirement in this country than any other piece of financial advice. Here’s how it works: a banker or broker will tell you that the stock market has averaged a return of about 8.5% in the last 100 years and that bonds have averaged a return of about 4.5% in the last 36 years. So, let’s be really conservative and just draw 4% from your portfolio for the rest of your life, and you will be fine. The problem with that strategy is that it works beautifully in a bull market cycle. However, when we get in a flat market cycle, where portfolio return can be flat for 18+ years, like the cycle we are in right now that began in January 1, 2000, then the 4% rule can destroy your portfolio!
Let’s demonstrate using math. Assume you inherit $4 million dollars January, 1 2000, and you retire with the banker’s advice using the 4% rule to distribute your income of $160,000 (4% X $4 million) for the first year. The problem is that the stock market dropped by over 50% in 2000 to 2002. However, on top of a 50% loss you drew out 4% a year for the first three years. You now start 2003 with a stock portfolio loss of 62% (50% market loss plus 3 years of drawing 4%). The good news is that stock markets double from 2003 to 2007, but the problem is that you don’t get all of those gains since you are drawing 4% per year. Then, you take that monster hit in 2008, and you draw 4% on top of that for your income, and now you have destroyed your retirement! You can no longer stay retired. We all saw the gray haired people going back to work at banks, fast food, Walmart, etc in 2009. They had to go back to work since their retirement was destroyed.
The guy who invented the 4% rule, William P Bengen, said things have changed, and his strategy does not work when rates are this low. He said that he himself would not use it and warned retirees that it is dangerous to use since it can destroy your retirement. So, the guy who invented the rule warned you not to use it, called it dangerous, and said that he himself would not use it. How about the bankers and brokers? They still use it to map out how much money you can draw from your retirement, while they keep all of your money at risk. This doesn’t make sense. Common sense says that if you draw income from a fluctuating account you will compromise gains in an up market and accentuate losses in a down market.
