Hosted by Creative Planning Director of Financial Education, Jonathan Clements and President, Peter Mallouk this month’s podcast takes a closer look into surprises clients encounter as Creative Planning onboards assets recommended by former advisors. Included is an in-depth discussion on suitability standards, used by most of the large brokerage houses compared to the fiduciary standard, used by Creative Planning all the time! Plus, you won’t want to miss each of their monthly tips! Join us as we explore tax law updates, tax planning strategies and ways to avoid surprises from purchasing investment products!
Jonathan Clements: Hi. This is Jonathan Clements, director of financial education here at Creative Planning in Overland Park, Kansas and with me is Peter Mallouk, the president of the firm, and we are Down the Middle. So, Peter, as an ex-journalist, I’ve noticed that you have some pretty tart things to say about the media. What is it that boils your blood so much?
Peter Mallouk: Well, I think the people watching the media, when they’re watching the financial media, and I think it applies to just the general news, they think that the media’s there to inform them and really the media is largely owned by publicly traded companies. Publicly traded companies do have a legal responsibility but it’s not to the viewer, it’s to their shareholders to maximize profits within the law. How do you maximize profits? You get viewers or readers. How do you get viewers or readers? You’ve got to be interesting. What makes things interesting? Scandal, suspense, intrigue.
That’s why when you watch cable news, there’s that clock ticking in the bottom right-hand corner. That’s why the headline to the story is… It’s called click bait. Just to get somebody to click on it so that they can get that credit for their advertisers, and so it’s always going to sound extreme or horrific. That’s why when you’re watching the weather channel, they’re not going to tell you it’s all clear, don’t worry about anything until that has long since passed because the second you hear that you’re going to turn the channel. Same thing with cable news, same thing with financial media.
But the viewer gets caught up in these narratives. The tariffs and the sequester and the fiscal cliff and the wall and whatever it is that’s going to make the market go down, the federal reserve and interest rate hikes. It’s this constant drumbeat of every minute of every hour for what we call a news cycle. It’s just called a cycle. We got to get a story, get it to run its course, and then we’re going to go on to the next screenplay.
But they need that maximum suspense. They don’t really have an incentive to have somebody that’s completely reasonable on and say, “Hey, you know what? This happens all the time. The market’s down half of days. Doesn’t matter.” And it’s down one in four years. Doesn’t matter to the long-term investor. Why would anybody watch. I do think there should be financial media obviously, financial journalism, and that a lot of it is good. But I think there’s so much hyperbole, so much click bait, that it draws people into this hysteria and what do they do with that? They do what all Americans do. They take action.
When you take action, you’re usually going to make a mistake because you’re saying, “Oh, I’m going to go to cash or I’m going to go to the sidelines, I’m going to wait out the election or I’m going to wait out the tariff war, or I’m going to wait out the government shut down or whatever. And usually when you’re waiting things out, you’re on the wrong side of the math, of being a successful investor. So, I actually think that someone some day is going to do a study and they’re going to equate how long someone watches financial media with their investment results. And I think that we’re going to find that the more time dedicated to watching financial media, the worse performance accompanies that.
Jonathan: So, the interesting thing is when you talk about the financial media, the next thing you hop to are the financial markets. I mean the financial media and the financial markets have this symbiotic unhealthy, but symbiotic relationship where the financial markets do something, and the media covers it to death. And yet as you and I both know what happens in the financial market’s day to day is immaterial. You think about market declines during your lifetime. Almost all of them are forgotten and yet in the moment we’re all engrossed. And one of the reasons we’re engrossed is not just because the market is dropped 200 points. But because the headlines are blaring… Armageddon is at hand, buy tin goods.
And I would argue, and I don’t think you’re going to give me an argument here. I would argue that when we get so obsessed with the financial markets, not only do we tend to mess up our portfolios, but also, we ignore parts of our financial lives where we can add so much more value. Whether it’s with estate planning, financial planning, managing taxes, insurance, and so on, these are all areas where a few simple steps can radically improve our financial lives. But because there is, no somebody’s going to die today. You better get a will. People don’t focus on it. They’ve focus on the fact that the market is down and how you can react to that.
Peter: Yeah. I mean, you’re right. Not only does watching the media, reading too much of it make things worse, most likely, but it’s time that could be spent on constructive things that most importantly you can control. We can’t control whether there’s going to be a government shutdown. We can’t control a lot of these things, but we can control, are all of my investments matching my current needs? Have my needs changed? Have I updated my estate plan under the new tax laws? Are my investments optimized? Have I talked to my financial advisor lately? I mean, these are things that we can control that can have some improvement on our lives, let alone taking the time you’re spending watching TV and actually earning money. Doing something that contributes to your financial wellbeing.
Jonathan: When I started financial journalism here in the US in 1986, one of the players in the mutual fund industry was a guy called Sheldon Jacobs. And he had this newsletter called the No-Load Fund Investor newsletter. And you subscribe to it because once a month, you could find out how your mutual funds had done. And that was a better era.
Peter: It was. Yeah, that’s all you needed. That’s probably more than you needed.
Jonathan: More than you needed. And today if you let yourself go and sometimes, I find myself doing it. You are looking at the market every hour. Where is the 10-year treasury? Where is the S&P 500? What’s going on today? And it’s not helpful. It’s information without insight. And if it just stays to that level, that’s fine. If it’s just entertainment, we’re cool. But when you get sufficiently unnerved or sufficiently excited that you act, then there’s a problem.
Peter: That’s right. And I think that’s the issue is, I mean, how can you take a typical American and you feed them a couple hours a day for a whole year. Now they’ve watched 700, 800 hours of financial media. Are they really going to conclude to do nothing from all of that? It just doesn’t really go together. So, I think that the budgeting of the time thinking about, what am I really getting out of this? Do I feel better after I watch it? Am I learning something that’s actionable? What happens if I take this time and I spend it doing something else? And not just to improve your financial life, maybe something to improve your quality of life. Go for a walk, meditate, read a book. Almost anything is going to be more productive than consuming so much financial media.
Jonathan: And I would just say before we move on to the next topic, this is actually true of so many other things. We have so much access to information that is information without insight. So, we find ourselves checking our emails. With my books I go, and I look at my Amazon ranking. I look at how many people are on my website at any particular moment in time. An hour later, I’ve forgotten and I’m looking again.
Peter: Yeah. I’m using Twitter and Facebook and LinkedIn, I’ll go in to post something, tweet something, whatever. And then an hour and 15 minutes later, I go, “Oh my God. What have I just done?” I just spent an hour and 15 minutes literally of my life I am never going to get back. Just wasting all this time navigating through those sites.
Jonathan: Yeah. Time is the ultimate limited resource.
Peter: That’s right.
Jonathan: You misuse it, you can’t get it back.
Peter: Can’t buy it back. Can’t get it back. Yeah.
Jonathan: Okay. Peter let’s move on to another topic. One of the issues we’ve discussed in the past, I think it’d be interesting to talk about it. Here is this distinction between fee only and fee based. Now Creative Planning is considered a fee based financial planning firm. That’s right. Why is that? And why aren’t you considered fee only?
Peter: Yeah. So, there’s basically, I’ll even broaden it. There are three categories. There’s commission based. So, you go to an advisor at an insurance company and what they’re going to do is going to be commission based. They sell you an annuity, they get a commission. There’s fee only you pay somebody a fee and they manage the investments and that’s it. There’s fee based where you pay somebody to manage the investments. And it could be fear commission, and there could be insurance that’s commission.
At Creative Planning we’re fee based but our investments are always on a fee basis. So, when we’re managing money and giving financial planning advice to people, we do not charge commissions on anything ever. It’s a fee. Client knows what it is and that’s it. But because we handle insurance. So as an example, we are big believers that most people need term life insurance, especially in their earlier years to protect their family if they’re gone. I have a lot of horror stories around this with clients early on, as I’ve seen these scenarios unfold in a bad way where they didn’t have the right coverage.
We fundamentally believe that not just does somebody need legal advice, like a will and a trust and so on and tax help, whether it’s preparation or advice and charitable planning, whether it’s a donor advice fund and investment management, but you can’t say all of that is wealth management and insurance isn’t. You ensure your home. You ensure your car. I’ve got life insurance as well as home and car and umbrella. Insurance is part of the wealth management. So as an organization, we have to make the decision, “Okay. Are we going to help people with legal and tax and planning and investments and say, go figure out the insurance or go somewhere else and do that?” We’re in the business of getting stuff done for our clients.
So now we don’t sell variable annuities or variable life. No one here is licensed to do any of those things. We’re not dually registered. We don’t also have a brokerage house. So, all of those sexy high commission investment products, we can’t even do them and insurance products, we can’t do either. But a lot of people do need life insurance especially term life insurance, which I would say is more than 99% of the life insurance policies that come through here. And I’m proud of the fact that we implement that for clients. And when you are doing something outside of, even if you are only investments, you’re only charging a fee.
If you offer something else that’s commission based and the reason by the way, that’s commission based is, to my knowledge, there is no fee only homeowners auto umbrella life insurance. And if it is, it’s certainly not a significant part of the marketplace. If you’re going to offer that, you use the words fee based. So, it’s very complex for the typical investor to understand because you’ve got people that work on commission. You’ve got people that charge by the hour and are fee only, or charge just a fee out investments. Then you’ve got fee based where people do investments that are commissioned and not.
Here we’re fee based investments. We only charge a fee and insurance obviously works on the commission side of things. And that, by the way is also less than one quarter of 1% of Creative Planning’s business. But I think it’s an integral part of delivering it for the clients that need it, but very confusing terminology in the marketplace.
Jonathan: So, the interesting thing here and something I hadn’t gotten to at all was that if you go to a financial planner, who is the only, what you’re not getting is you’re not going to get somebody who’s going to help you go and actually buy that term life insurance policy that may be critical. They’ll have to refer you out to somebody else because if they actually sell it to you, they are no longer fee only, they are fee based. So, in a sense, when you go to a fee only financial planner, you may think you’re getting something special, but actually you’re giving something up.
Peter: Yeah, I think you’re giving something up, but I think that their argument would be, “Hey, we are coordinating it still. We all go find the insurance person for you and we’ll send you to them and all of that stuff.” And to me, part of what you’re trying to do is you’re trying to make this an easy experience for the client. You’re trying to make it where let’s figure out what legal tax investments, charitable planning, insurance planning you need, and let’s get it done with for you. Let’s figure it out for you.
So, if you go to a fee only advisor, they’re not going to be able to implement those things. And they’d say, “Well, I don’t have an incentive to sell you a term life insurance policy.” That would be the counter argument to that.
But listen, this industry is full of incentives. If you’re charging by the hour, you have an incentive to take many, many hours to solve a problem. And if you’re charging a fee on the portfolio, you have an incentive for people not to pay off any of their student loans because that might come out of the portfolio. There are going to be conflicts, no matter what, what, what the client needs to do is they need to understand what the conflicts are and what am I getting and what am I not getting when I’m working with an advisor.
Jonathan: So not only do you make this distinction between the only and fee base, but also this distinction between a wealth manager and an investment manager. So why do you differentiate those two?
Peter: First of all, everyone uses all the words incorrectly. So, a person, even if they’re educated, can’t really look at the words and make sense of them. But an investment manager or money manager is someone who just manages investments. So, you might go to them. They might be a large cap value manager and that’s what they do. They’ve invested large value-oriented US stocks. They might be a bond manager, or they might be conservative or aggressive and you go to them and go, “Here’s my money and I buy into your strategy. Go manage my money.” That’s how a lot of the industry is set up.
A wealth manager basically is saying, “Look, I’m going to sit on the same side of the table as you. And I’m going to look at your overall picture, where are you? What are your goals and objectives, your tolerance for risk and what are we trying to do here? What are your values? How do I help you achieve those goals?” And then that wealth manager is saying, “What money managers should we use? Maybe we should use on the bond side. Maybe we should use this type of investment with large US stocks. Maybe we should use in index with emerging markets. Maybe we will use dimensional or some other investment.”
But they’re looking at each of those areas and saying, “What is the best way to invest in that part of the market?” And also, then going beyond that and accounting for taxes and estate planning and values and goals. That’s the difference between a wealth manager and an investment manager. Now the issue is many investment managers use the words, wealth manager, but it, you can figure out from what they’re going to offer you, are they a wealth manager, an investment manager? And if you’ve got an investment manager, you really need to have multiple investment managers because you might say, “Hey, I’ve got two investment managers. I’m diversified.”
Well, if they’re both large US stock money managers, you’re not diversified. With one wealth manager, you might have 20 different asset classes from real estate to some commodity to US stocks that are large to small ones to overseas and on and on and on. You’d be enormously more diversified with a wealth manager than to money managers. So, it’s helpful to at least understand what the offering is, but not to get too hung up on the terminology because on top of wealth manager and wealth advisor and investment manager and money manager, there’s financial advisor and all, all these other words that make it hard to navigate the space.
Jonathan: So, if you’re looking at potential wealth manager, investment manager, or financial advisor, whatever you’re going to call them, can you figure out what they are by looking at the designation that they have? Whether they’re a CFA or a CPA or a CFP or whatever it is?
Peter: It’s hard just from the designations because a CFA is focused on the investment component of things with the designation, but you might have a wealth manager who happens to have the CFA designation. And they just took that part of wealth management very seriously. Certified financial planners, practitioners, they tend to be people that are more planning oriented, but you might have somebody who just felt like getting the CFP designation. That’s just a money manager. But I do think that brings up another interesting topic, which is this alphabet soup of financial advice. There are over a hundred different designations. Probably 95 of them are worthless.
If you are trying to navigate this space that are really a couple of designations that someone should focus on. If you are trying to get planning help, is someone to help you with financial planning, a CFP practitioner, certified financial planner practitioner is probably the way to go. A small percentage of financial advisors have that designation. It shows they took at least a couple of classes on financial planning and passed an exam and follow some standards. And they take it seriously enough to have done that.
Jonathan: More than a couple of classes, it’s like three years to become a CFP.
Peter: Well, I think it might be five or six classes and a three year, I think waiting period or practicing period, but you’re not taking three years of classes. But it’s certainly a commitment.
Jonathan: Well, it’s not like some of these designations where you go and you sit in a hotel room in Philadelphia for the weekend, and then you come away with new seven initials.
Peter: That’s true. I mean, most of the designations are just a few hours online, and you’ve got a designation. I think we’re a way though from having what we have with accounting, where you have the CPA designation, which takes a lot of work and a lot of effort and a very big commitment. And if you’re using, I think that gets us too, if you’re getting tax advice, I think having it from a CPA is good too. And if you’re getting legal advice, obviously you want it to be from an attorney and believe it or not, there’s a lot of people doing a lot of estate planning that are not attorneys. So those are very helpful designations to have.
Now the person you’re working with doesn’t necessarily have to have those things. I mean, I happen to have those things, but I think the team needs to have them. You need to have on that team somebody who has those things, I think that’s helpful. I think if your advisor in a minimum, you’d be shocked how many people are giving financial advice to other people that have been personally bankrupt or don’t have a college education at all. And I think you at least look into a little bit about the education of the person that you’re working with.
Jonathan: Yeah. So just in the alphabet soup, the other designation, I think we probably should say is super valuable, is the CFA. Yes. You don’t need a financial advisor who is a chartered financial analyst, but if you meet somebody who’s a CFA, they’ve done some serious studies.
Peter: Yeah. That’s a very high threshold. So that shows a serious commitment to investments.
Jonathan: And that’s what you generally see when you see somebody who is an investment manager as opposed to wealth manager?
Peter: That’s right.
Jonathan: So final topic for today. We were going to talk a little bit about estate planning. When I first got involved in this business, people were like estate planning? Well, that’s really about avoiding the estate taxes. Isn’t that what estate plannings about? And it’s like… Well, it may have been at one point, but it sure isn’t today.
I mean, we have a federal state tax exemption that is over 11 million now. I mean the number of people who have to worry about the estate tax. I mean, if some of them are creative clients, but most creative clients do not have to worry about the estate tax, right?
Peter: Yes. I think we have an ultra-fluid practice that’s still very concerned about the estate tax here, but for that typical multimillionaire next door, no. They don’t need to be concerned. I’ve always looked at estate planning. Everyone always talks about taxes with that. And it’s the same thing with investments. People are very focused on taxes, and I think taxes are a key part, but they are never the first part. They should be the first part of investing or planning or estate planning. And when you look at estate planning, the number one objective of estate planning in my mind is what are your objectives for your family or your heirs? Whether it’s charities or kids or whatever, that’s the number one thing that we’re accomplishing with estate planning is making sure that vision is carried out.
Who is going to get your assets, which assets are they going to get? At what time in their lives are they going to get them? Are they going to be protected from creditors and lawsuits and divorces? Are we just going to give them the money because they’re grownups and they should be able to handle it? Those kinds of decisions and if you’ve got young kids, who’s going to raise your kids? These are things you have a moral responsibility to get done.
You spend thousands and thousands of hours accumulating, all this stuff, you can’t take two hours to decide who’s going to raise your kids and who’s going to settle your state and who’s going to get your money. You’re going to make your heirs figure that out with a court system that’s really punitive in terms of time and money that it takes. That’s the number one objective. It always has been. And in my mind, it always will be.
Jonathan: So, before we throw out the whole tax issue, though, I want to mention two things. One is, of course there are still certain states where there is state to state taxes and where the exemption is far lower than the federal exemption. Massachusetts right now it’s still a million dollars. So, if you’re in Massachusetts you do need to think about what impact state to state taxes are going to have on you.
And second, much more broadly applicable is that for most people, when they die the biggest tax that their heirs will face is the embedded income tax built on their retirement accounts. If you have a traditional IRA, you have a traditional 401(k) plan. When you die, the income taxes owed on their accounts will have to be paid by your heirs as they draw them down. And I’m sure for Creative clients, there are a lot of them who die with substantial IRAs.
Peter: That’s right. And it’s extremely complex. Sometimes they’re able to draw the IRA out over the course of their life. Sometimes it’s a continuation that’s shorter than that. And it’s very dependent on when the withdrawals started and who’s receiving the money and how many people are receiving the IRA. So, there’s a lot of planning that can come into play to make sure that works out as well as possible for the family. A couple key decisions can make that last many, many more years.
Jonathan: Yeah. The stretch IRA, they keep saying the Congress is going to kill it, but it’s still alive. So, if you have the good fortune to die in the near future, your heirs can still use the stretch IRA. The other alternative and just to mention it in case somebody wants to discuss it with their advisor is you may have an opportunity to convert part of your traditional IRA to a Roth IRA. And if you do that, when you die, that embedded income tax bill on that Roth IRA is gone and your heirs will essentially have this tax-free pool of money, which they can actually leave to grow as long as the rule stays, they currently are.
And for certain people might have a chance in their life where they can do large amounts of Roth conversions and pay relatively little in taxes. If you find a year when you’re out of work, you just retire, you not yet subject to a required minimum distribution, you’re not yet throwing social security, you may have periods when you’re in a very low tax bracket, and that’s a great opportunity to convert part of your money to a Roth IRA, and then just hang onto that account and leave it to your heirs.
Peter: That’s exactly right. And I think that’s the planning you that really has a lot of implications around. What is your income today versus next year? The year that you convert can make a very big difference and do you convert all of the IRA in one year or not? And for some people it never makes sense to convert. So, it’s a very planning, intensive decision to make. I think it’s unfortunate because most people are not going to ever understand all of those things. So, something that’s applies to so many Americans, to me, it’s healthcare and social security. These are three of the most complex areas in all of planning and they impact everybody almost.
Jonathan: And one of the problems, particularly when it comes to things like doing conversions to a Roth or making that social security decision or buying a home, these are things that we might only do once or twice or three times in our line. So, we simply aren’t experts and it’s so easy to mess up. And that’s why these are situations where it’s really good to have people to talk to and get some expert advice.
Peter: That’s right.
Jonathan: All right. I think we’ve rambled on for long enough, Peter. So usual end of the podcast. What’s your tip for the month ahead?
Peter: Well, since we’re on IRAs, I would say to all of our listeners to go pull your IRAs and 401(k)s and take a look at who your beneficiaries are. A lot of people think their will governs everything, but if your will says, “I give everything to my wife or my kids,” really the beneficiary on the IRA and 401(k) is where things are going to go for those assets. So, make sure that those beneficiaries are up to date, that we’re not leaving money to an ex-husband or to somebody that’s passed on or a friend, that’s not a friend anymore. Let’s make sure that those beneficiaries are who they’re supposed to be.
Jonathan: And my tip for the month ahead, drop a wish list. We all know that we make impulsive spending decisions then we later regret it. We go to the auto dealership, and we buy the car that we really shouldn’t have bought. We decide on the kitchen remodeling that maybe we didn’t really want to spend money on. Drop a list of the major expenditures you want to make in the years ahead and put it on the refrigerator and then revisit that list regularly. And if you revisit the list regularly, you’ll start to fine tune in the list and figure out what it is that will deliver you maximum happiness for the dollars that you’re spending. And that way you’ll be a lot smarter than if you make impulsive decisions.
So that’ll wrap it up for today. This is Jonathan Clements here with Peter Mallouk and we are Down the Middle. Thanks for joining us.
Disclosure: This commentary is provided for general information purposes only and should not be construed as investment tax or legal advice. Past performance of any market results is no assurance to future performance. The information contained herein, has been obtained from sources deemed to be reliable, but is not guaranteed.