When you read the title to this article your mind immediately processed the words as unfamiliar and not particularly logical. After all, how many pregnant men do you see and how many tattooed aristocrats do you run into? The title was actually taken from the book, Thinking, Fast and Slow by Daniel Kahneman. I’m currently in the middle of my third time through the book and it seems like each time I read it I gain valuable insight as to how our minds work and how we perceive things.
Most notably, these words stuck with me as a way to inform our readers of other financial words and pairings they may encounter and to make readers aware that these word combinations will seem and are illogical. The goal is to help inform readers that should they see some of the following phrases, they should immediately realize that something doesn’t seem right – and is likely illogical.
High-powered Roth – If you ever encounter this phrase it is very likely in reference to a variable universal life insurance policy (VUL). These policies offer policyholders a method to invest the cash value of their premiums into underlying stock and bond mutual fund subaccounts. The cash value grows tax-deferred and may be potentially available tax-free to the policyholder. However, they are not even in the same ballpark as Roth IRAs. VULs carry high fees, expenses and surrender charges and should only be used when the underlying need is strictly life insurance, not an investment. Only in the most-rare of circumstances do they make sense for anything other than their life insurance component. If you have a salesperson who disagrees with this, ask them to use the terminology in front of a rep for the SEC or FINRA.
Life insurance as an investment – While certainly an investment in your family’s piece of mind and well-being after your death, life insurance is not an investment in the sense that it should be used as a vehicle for accumulating retirement savings or college savings. As noted above, these policies have “insurance drag” which means that the investment performance is hindered by the actual cost to insure the policy holder’s life in addition to the normally exorbitant expense ratios of the underlying sub-accounts. Additionally, it takes a very long time for the cash value to build. Max out your 401k and IRAs.
Beating the market – Beating the market is exceptionally difficult for even the most skilled fund managers. Generally, if a fund manager beats the market (very rare) it is even more difficult to consistently beat the market (extremely rare). To see how difficult this is, click here. Also note that managers that report they beat the market do so before fund expenses and fees are accounted for; hardly an apples to apples comparison. Active management is a zero-sum game. When one fund wins, another has to lose; and that’s usually the fund you’ll own.
Free lunch – This should be obvious. As they saying goes – there’s no free lunch. For that matter, there’s no free dinner or breakfast either. Often these free meals are touted to individuals to entice them to come to a seminar which is really a sales pitch. Postcard invitations to these events should be immediately thrown away. What these salespeople are preying on (or praying for) is the quid pro quo of giving you something free so you’ll feel obligated to do business with them. It’s how good-natured people get sucked into bogus investments schemes and time-shares.
Unlimited income potential – This is more directed to new or seasoned advisors looking for greener grass. Many job descriptions in the financial services industry brag about unlimited income potential as an enticement to “be your own boss” and “be in business for yourself but not by yourself”. Malarkey! In theory, this can be true. But it would also mean there’s an unlimited number of prospects, clients, hours in the day, etc. Theoretically, a stock can have unlimited potential and rise infinitely, but that has yet to happen. Your income is limited.
Downside protection, income locks (guarantees), and forecasting – These phrases are often used to sell riders and endorsements on specific products such as annuities. Downside protection generally refers to indexed annuities that offer caps on returns in exchange for protection from losses when markets go sour. However, the downside protection does not imply there aren’t fees.
Income guarantees are provided on annuities as rider to guarantee a certain withdrawal amount subject to anniversary dates and amounts in the annuity. Naturally, these are not free and the expenses of such riders need to be carefully considered before entering into such contracts.
Finally, forecasting (or any attempt thereof) the market really boils down to an educated (or ignorant) guess. However, both educated and ignorant guesses can devastate portfolios and be very expensive. Forecasting has an element of luck; and a lot of hindsight bias. It’s easy to brag about a forecast when it comes to fruition. If you hear forecasts and predictions, think of the wise words from Mark Twain, “It ain’t what you know that gets you into trouble. It’s what you know for sure that just ain’t so.”