I Wrote This Article…5.5 Years Ago. The conclusions? Unchanged.
This Article Shows The Shortcomings of Journalism
This article appeared in the New York Times on February 10, 2017, it is titled “The 21 Questions You’re Going to Need to Ask About Investment Fees. (link)” It is, as usual, partially correct. The questions in the article are not groundbreaking. You can find this set, or a very similar subset of these questions anywhere, or everywhere. Most alarming is the primary objective of the article, which is to make the point that
“The best way to understand what the fiduciary debate is about — and to protect yourself — is to view this discussion through the lens of fees.”
NOPE, NOT EVEN CLOSE. This is wrong because it completely ignores what the client is actually trying to achieve, and what the appropriate cost of accomplishing those objectives may be. Instead, this looks only at the cost, which is short-sighted, and that is the nicest possible description, and not nearly critical enough. The word “hackery” comes to mind (yes, I am aware that “hackery” is not a word).
Fiduciary Standard Is a Higher Standard
Strictly speaking, “fiduciary” standard is the idea that an advisor puts the client’s interest above his/her own. OK, that should be obvious, and if you are worried about this, then you need to gain further comfort with your advisor. There’s a reason that GH2 Benefits will charge a percentage (0.5%) per annum for portfolios. We have never engaged in any “sales contest” or whatever is stated in the article. We are compensated by carriers for financial products, such as insurance or annuities, on a pre-determined schedule. Last point, our business is too diverse to concentrate on a single carrier, we pay no attention to sales contests, etc (they do exist, at least the facts of the article are correct). Back to the article.
Question #1 is NEVER ASKED
As stated in a related article here on GH2 Unfiltered, “Are Annuity Haters Right or Wrong? Yes,” the questions that should’ve been asked is whether or not the advisor and client agree on what the actual financial objective. Second, the real question regarding fees, and the amount of fees should be, “Could you have done this yourself without the the fee?” This is entirely absent from the NYT article, and it needed to have been the first question, the remainder of the article is asking secondary questions, without addressing the first. So now, you, the reader, can easily be led down the wrong path.
That is especially true in the case of annuities, where there is a stated return which can be guaranteed by the issuer (the company issuing the annuity). This article, and most articles that criticize annuities, ignore that:
- There are guarantees regarding return of principal after a given point in time, which can vary wildly, depending on the structure of the annuity.
- These guarantees are highly complex, you need TEAMS of people, including traders and attorneys, in order to create the language that correctly states what you will get, and under what conditions. You would need to have the knowledge and experience to execute derivative contracts in order to guarantee the performance embedded in an annuity, especially those that guarantee return of principal. Notably, it is the case that some annuities do not require the full extent of derivative knowledge (fixed annuities with Market Value Adjustment, MVA), and thus, the fees are lower, just as it should be.
- Most financial advisors and even most hedge-fund managers are NOT qualified to simply create a portfolio that can replicate or beat the terms and conditions of an annuity.
- Even if you could replicate this strategy in theory, you will need ENORMOUS size in order to practically replicate the portfolio with the promised return of an annuity ($1,000,000 would not do it for an indexed annuity, no chance). If anything that will increase the cost, on a percentage basis.
Instead, this article focuses on the hot-take of “fees are bad.” Instead, the point of this, and all articles regarding fiduciary responsibility, should be “specialty-sized fees for run-of-the-mill service is bad.” To simply say “all fees are bad” displays that the author isn’t qualified to make ANY of the bullet points made above, much less attach a price to any of those bullet points, so instead, she makes blanket statements that lead readers, wrongly.
These Are the Questions to Ask
That doesn’t mean that all fees are reasonable. There is a reason that ETFs have skyrocketed in popularity. Lower cost, similar or superior performance, lower tracking error. To math geeks, this is the simplest exercise of mean/variance optimization. So, the questions should be:
- If your advisor says “I can choose securities well, systematically.” Define “well” should be your question. Compared to what? If the advisor doesn’t have a benchmark, and cannot show you that how he keeps track of the performance against that, then you should run, not walk, away.
- If your advisor can choose securities well, systematically, when compared to benchmarks that can be measured in the market, then you can simply ask him to show you the results. Better yet, he should be able to show you examples of how his process will work to adjust your portfolio.
- “Is there another way to create this same performance or superior performance, that meets my objectives, at a lower cost?” Now THAT is the question to ask.
Now, you can ask the questions from the NYT article. Only now.
with Art Lewis, legendary radio talk show host. He asks practical questions that everyone can understand, as usual.