FINANCIAL PRODUCTS ARE NOT A FINANCIAL PLAN

Unfortunately, the world is laden with financial advice and products that are simply terrible for individuals. There is an understanding/misinformation gap between the person selling the product or service and the person buying it. The agent or “financial advisor” (by name only) pockets the commission and the client is stuck with a product that is expensive and complex.

In the future, this newsletter may examine how to choose a financial advisor. For now, we point to two important tips: 1) understand how the person giving advice is compensated (e.g., you do not want to pay commissions) and 2) ensure the advisor’s interests are aligned with your best interests (e.g., you do not want to receive biased advice).

For now, let’s examine some common pain points where individuals are left holding a bag of vile financial products.

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Mutual Funds with High Expense Ratios

My wife recently started a new job where she has access to a 403(b). She is 23 years old, a nurse, and has little to no background in investing or financial planning. The hospital’s funds are managed by a third-party provider and employees are able to forward questions to a consultant working for the provider.

The matching percentage and vesting schedule are unnecessarily complicated but that is a topic for another time. The recommended/default portfolio was a 2065 target date fund. This mutual fund has a net expense ratio of .75% or 75 basis points. (A basis point is 1/100th of 1% or .0001 and common terminology in the investing world).

The makeup of the fund can be seen below.

The expense ratio is high and the allocation too conservative for someone who won’t retire for over forty years. An alternative within the list of mutual fund options and a widely available mutual fund in many 401k and 403b plans is an S&P 500 index fund.

It is a worthy, less expensive substitute with an expense ratio of only 2 basis points.

By using the FINRA Fund Analyzer, it is obvious which fund is more aligned with an investor’s long-term interests. (Fund Analyzer Criteria: Initial Contribution = $1,000, Rate of Return = 8%, Holding Period = 20 years, and Annual Contribution = $5,000)

This is a pretty significant difference by making a simple modification that took approximately 10 seconds and does not drastically change the actual assets in the account.

I did not include specific ticker symbols for compliance purposes, but the general idea is clear. The expense ratio matters! Investigate the default option in any retirement plan and opt for a comparable, less expensive alternative if the default is too conservative and/or too expensive.

Whole Life Insurance

Many people have been taken advantage of by a college friend turned “financial advisor” who suddenly sees insurance as the answer to every financial problem. In nearly all cases, the friend receives a commission to sell the whole life insurance policy and part of the monthly premium will be paid as a commission in perpetuity.

At face value, whole life insurance sounds like a good idea. “Wait, I can receive a benefit if I pass away and my monthly premiums will be invested to accumulate a cash value I can access eventually? Wow!”

Unfortunately, it is not so simple. There are three key points that make whole life insurance a terrible product for most people.

1. The monthly premium is significantly higher for whole life insurance than for term life insurance.

Whole life insurance is prohibitively expensive, often 6-12 times more expensive than a term life policy with the same total coverage.

2. There is no transparency about the ultimate destination of your premiums.

What portion will be invested? What portion will go to service the policy? What amount will be paid to the agent in premiums? You may never have a clear answer to these questions.

3. The rate of return on the invested portion of premiums will be low compared to a Roth IRA or 401k.

Most policies experience near-zero or negative returns for the first 10 to 15 years. After this excessively long period, the invested amount may earn a positive return but likely will not keep pace with a broad market index.

Specifically for young people, a dollar invested in your 20s has huge potential. A whole life insurance policy quickly wastes the advantage of your time and ultimately dollars.

Whole life insurance isn’t necessarily an outright scam, but it is rarely aligned with someone’s best interest.

HSA Debit Card

Most people assume that the HSA is simply a tool to pay for health expenses, but it is also a seriously powerful investment vehicle.

Contributions to an HSA are pulled directly from the gross amount of a paycheck and are not taxed. These funds can be invested through a third party provider. Any withdrawal used to fund medical expenses will be tax free, including the portion from investment gains. This is a great benefit.

The magic of the HSA comes when funds are left invested until age 65. After this point, any invested amount can be withdrawn tax free and used for general expenses (not just medical expenses).

Whenever you open an HSA, a debit card is created so that you can access the funds. It isn’t inherently bad to utilize the money for medical expenses. You won’t be penalized for doing so.

That being said, spending from an HSA means that your contributions will not experience the gains from being invested. Only 9% of individuals are investing within their HSA, which means that the vast majority of people are missing a significant opportunity to make the most of these triple-tax-advantaged accounts.

If the easy-access card did not exist, perhaps more people would invest and allow the contributions to grow up to the point of retirement.

Anything You Don’t Understand

This advice comes from famed investor Warren Buffett, “Never invest in a business you cannot understand.” Now, the advice transcends any single business and expands into any investable asset.

Web3 investments, cryptocurrencies, and other recent developments are clear examples of products that may be tempting but are difficult to understand. Other, legacy financial products also fit in this category.

The aforementioned insurance products (e.g., whole life insurance, variable and indexed annuities, etc.) are common offenders of this rule. Option contracts, futures/forwards, and other financial contracts are incredibly interesting but also complex.

There are many complicated investment and financial products. In nearly all cases, simple is best.

Anything You See on Daytime Television

If an old celebrity appears in a commercial and attempts to sell some financial product, it probably is not worthy of your time and money. If it appears between ads for Flex Seal and gold coins, it may not fit within your overall financial plan.

A more modern example is derived from the advertisements we see before the Youtube video launches. The courses, investment ideas, and products promising serious financial gain are often misleading (at best) and fraudulent (at worst). You can't skip these fast enough because your dollars can be better utilized elsewhere.

You get the point. Any financial advice should be sourced from a reliable outlet.

Anything Without Price Transparency

You should always know how much something costs. It is unfortunately the case that sometimes the price of a product or service is unclear.

There can be complicated layers of fees, variable fees, or complex contract language to hide fees. I used the word “fee” three times in the last sentence to make a point. The financial services industry is useful and provides value to society, generally speaking, yet there are countless examples of products where the industry benefits more than the individual.

The amount you pay should be abundantly clear. If the price of the product or service is not obvious, there is a reason. It’s best to find people, services, and products that are aligned with your best interest. Fees have a way of making this plain.

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Not all financial products are bad, but none of them are a worthy substitute for a financial plan. Unfortunately, there are many examples where the product is created to line the pockets of a company or salesperson instead of benefit the individual.

It is always worthwhile to carefully screen a product or service to determine if it will fit within your greater financial plan.

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Have you been lucky enough to avoid these and other terrible financial products? Do you know somebody who might need help steering clear?