Michael Evans on how your wealth can benefit from the oversight of a "personal CFO."
Feb 17th, 2017
“Wishing makes dreams come true only in Disney movies; it’s poison in business.” – Warren Buffett, Berkshire Hathaway 2012 Shareholder Letter
As a successful professional or someone with a similar mindset, how are you handling your personal wealth?
With all due respect to Mr. Buffett, even he would probably agree that there’s nothing wrong with a little wishing and dreaming … in the proper context. Successful professionals usually ground their endeavors in a vision – a dream – for how they can bring value to others’ lives and be appropriately compensated in return.
That said, those same successful professionals would probably also agree that, eventually, you must get down to the business of turning your flights of fancy into working reality. Those who thrive and grow in their businesses or a high-powered career have paid their dues: working hard, being open to change and taking calculated risks in pursuit of greater rewards.
The Business of Managing Your Career
Successful professionals also know that being a rugged individualist will only get them so far. As their dreams take shape, they know when it’s time for teamwork. As their business or their career thrives, they are glad to partner with an experienced chief financial officer (CFO) who knows what it takes to quantify the team’s long-term goals, leverage everyone’s time to maximum benefit and ensure that everyone can contribute his or her best work to the greater whole.
The Business of Managing Your Money
Now, back to my opening question: As a successful professional or someone with a similar mindset, how are you handling your personal wealth?
Too often, I see heads of households failing to apply the excellent lessons they’ve learned in orchestrating a successful career to the “job” of managing their money. “I’ve made all the right calls in my career,” they may tell themselves. “I can take care of my own financial affairs.”
Sure, you may “do it yourself” by turning to an assortment of brokers, insurance agents, estate planners, accountants and other professionals to tend to the details. And their work may be quite competent. But who is keeping them efficiently focused on your core values and your unique vision of what you want to do with your wealth? (But first, have you got those values and vision defined to begin with?) How do you know if you’re truly leveraging each of their best skills to the greatest potential, in coordinated contribution to your greater whole?
Just as a well-run professional team benefits from the oversight of a CFO, so can your personal wealth.
Why Hire a Personal CFO?
Being a Personal CFO requires a distinct skillset like any other endeavor, calling for leadership, relationship management and other specialized experiences. It’s also a lot of hard work. Not only are busy professionals often a little too close to the subject to oversee their own financial well-being, but most have better things to do with their limited free time.
There are a number of ways a Personal CFO can lighten your wealth management workload. He or she can:
How to Hire a Personal CFO
Bottom line, when searching for an effective Personal CFO, you’re looking for someone who (1) offers good advice, and (2) knows how to help you realize the steps you resolve to take upon receiving that advice.
In evaluating what qualifies as “good advice,” I’m reminded of these words of wisdom from Seth Godin’s aptly entitled post, “Good advice …”:
“Good advice is priceless. Not what you want to hear, but what you need to hear. Not imaginary, but practical. Not based on fear, but on possibility. Not designed to make you feel better, designed to make you better. Seek it out and embrace the true friends that care enough to risk sharing it. I’m not sure what takes more guts – giving it or getting it.”
These are qualities I try to bring to my business in the wealth management arena. I know of other colleagues who bring similar values to their own independent, fee-only Registered Investment Advisor firms. It’s a business model that tends to lend itself well to this definition. I especially like the fact that an RIA firm is required by law to be a fiduciary to its clients, always acting in their highest financial interests (as Seth describes above).
To help you follow-up on advice received, experience is important too, as is the demonstrated ability to put together an effective team. Just as in a business, no one person can “specialize” in everything. Look for an advisory firm that employs a team approach to making the most of your family’s far-reaching financial interests. Do they have access to credentialed team members – professionals holding CFP® or CFA designations, CPAs, JDs and so on? Does your prospective Personal CFO have broad, hands-on experience in the business, with working knowledge of skill sets ranging from investment management and tax planning to estate planning and charitable giving and even to business succession planning and risk management?
A Personal CFO Can Simplify Your Life
So, do you need a Personal CFO? If you like the idea of simplifying your family’s financial complexities by aligning your durable wealth with your clearly articulated goals – without having to put in too much hard labor of your own – then, yes, you probably do. In the same way your business or career can benefit from working with a CFO, so too can you and your family thrive in such a relationship, connecting the wealth you’ve worked so hard to earn with everything you want to accomplish in your life.
Learn more about Michael and The Cogent Advisor
By clicking on any of the links above, you acknowledge that they are solely for your convenience, and do not necessarily imply any affiliations, sponsorships, endorsements or representations whatsoever by us regarding third-party Web sites. We are not responsible for the content, availability or privacy policies of these sites, and shall not be responsible or liable for any information, opinions, advice, products or services available on or through them.
The opinions expressed by featured authors are their own and may not accurately reflect those of the BAM ALLIANCE. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.
© 2017, The BAM ALLIANCE
One of the most well-known and most beloved forms of literature is the fairy tale. Although not every fairy tale is actually about fairies, they do tend to be fictitious and highly fanciful tales of fabled deeds and creatures. They are frequently derived from oral folklore based on myths and legends. And fairy tales are usually intended for children.
One of the most popular fairy tales is the Grimm Brothers’ Snow White. In the story, to eliminate her competition for “fairest in the land,” the evil Queen Maleficent disguises herself as an old woman and offers Snow White a beautiful, shiny red apple. Despite a stern warning from the Seven Dwarfs, Snow White cannot resist the temptation of the apple. She takes the bite that sends her into a deep sleep.
Adult Fairy Tales
Wall Street’s product machine is continuously pumping out fairy tales. Indeed, its product innovations can also often be called “fanciful tales of fabled deeds.” The only difference is that they are designed for adults. Like the poisoned apple, they have shiny features designed to entice naive investors.
Despite the wide variety of “fanciful tales” available, nearly all of them have one thing in common: Although they look appealing to investors, they have attributes that make them much more attractive in reality to the seller than to the buyer. Typically, these products fall into the category of what are referred to as “structured products.”
Structured products are packages of synthetic investment instruments specifically designed to appeal to certain needs that investors perceive aren’t being met by other available securities. They are often packaged as asset allocation tools that can be used to reduce portfolio risk.
Structured products usually consist of a note and a derivative, meaning the product derives its economic value by reference to the price of another asset, typically a bond, equity, currency or commodity. That derivative is often an option (a put or a call). The structured note pays the interest at a set rate and schedule, and the derivative establishes payment at maturity.
Because of the derivative component, structured products are often marketed to investors as debt securities. Depending on the variety of structured product, full protection of the principal invested is sometimes offered. In other cases, only limited protection may be offered, or even no protection at all.
Over the past decade, structured investment products, also known as equity- or index-linked notes, have become increasingly common in the portfolios of retail investors. The 2016 Greenwich Associates survey of structured products reported nearly $60 billion worth are now being sold each year, and that suppliers are forecasting strong growth in the future. Among the biggest suppliers of structured products are HSBC, J.P. Morgan, Barclays, Goldman Sachs, Credit Suisse and BNP Paribas.
And this is not just a U.S. phenomenon. In some countries (such as Switzerland and Germany), approximately 6% of all financial assets are now held in structured products. Unfortunately, they remain “popular” for the same reasons many financial products are popular: either they carry large commissions for the sellers, or they so greatly favor the issuers that they are pushed on unsophisticated investors who cannot fathom the complexity (but are assured by the salespeople and advertising collateral that these are good and often safe products).
A Question Of Exploitation
Fortunately, there’s a substantial amount of research on structured products. We know, for instance, that sophisticated issuers create them because they lower their costs of capital and generate profits. Thus, whenever an individual investor buys a complex instrument from Wall Street, you can be sure they are being exploited.
The reason is simple: If the issuer could raise capital more cheaply with a straightforward, simple debt instrument, they would do so. Thus, the question isn’t whether or not an investor is being taken advantage of. The only question is: How badly is the investor being exploited?
Stefan Hunt, Neil Stewart and Redis Zaliauskas contribute to the literature on structured products through their March 2015 paper, “Two Plus Two Makes Five? Survey Evidence That Investors Overvalue Structured Deposits.”
The paper was written for the U.K.’s Financial Conduct Authority (FCA), which is “committed to encouraging debate among academics, practitioners and policymakers in all aspects of financial regulation.” Hunt and Zaliauskas are in the chief economist’s department of the FCA, and Stewart is a professor at the University of Warwick’s department of psychology.
The authors begin by noting: “Innovation in retail financial markets has led to increasing product complexity over the past two decades, but there is little evidence of a comparable increase in consumers’ financial capability. Over the same period, there have been numerous instances of mis-selling that have led to regulatory action in the UK. When examining whether the market for a particular complex financial product is working well, one of the things regulators need to ask is whether consumers can understand and adequately assess the products they consider buying.”
Later, Hunt, Stewart and Zaliauskas write: “The FCA has repeatedly fined structured product providers and voiced concerns about market practices, indicating that the market is not working well for investors. The fines imposed on a major provider of retail structured products, in 2011 and 2014, were related to failings in sales of structured capital at risk products and to misleading promotions of structured deposits.”
In other words, the purpose of their paper was to investigate how well consumers understand and value structured deposits, whether there are systematic biases in investors’ evaluation of the expected performance of the structured deposits, and whether providing targeted information improves this evaluation.
A Study Based On A Survey
Hunt, Stewart and Zaliauskas conducted a survey of 384 retail investors who had relatively well-diversified portfolios and who had previously bought or would consider buying structured deposits or other structured products. The authors showed the investors hypothetical examples of five popular types of structured products with returns linked to the performance of the FTSE 100 stock index.
To distinguish between expected returns driven by overall optimism about the market and difficulty in understanding how structured deposit returns derive from an underlying index, they asked investors about their views on the performance of the FTSE 100 index over the next five years.
The authors then compared investors’ expectations about FTSE 100 returns with the returns they expected from different structured products. This allowed them to calculate bias in how investors evaluate the structured deposits relative to the index. They next asked investors to rank the structured deposits against a range of fixed-rate deposits, taking into account the risk of the different structured deposits. Finally, they looked at whether various types of disclosures altered respondents’ valuations. Following is a summary of their findings:
The authors also noted that “an FCA analysis of a large sample of UK retail structured products, including but not limited to those based on the FTSE index, suggested that products issued since 2008 and that had a maturity of three to five years on average underperformed National Savings & Investments five-year deposit rates.”
Hunt, Stewart and Zaliauskas concluded that behavioral biases, combined with features of structured deposits that can exploit these biases, lead investors to possess unrealistically high expectations of the products’ returns and impede their ability to evaluate and compare structured products to each other and against other deposit-based alternatives.
What’s more, these products’ design and distribution strategies (often using commission-driven salesforces) exploit consumer weaknesses, likely leading consumers to make mistakes in comparing the options and, thus, buy overpriced products. Sadly, they also concluded: “Our findings suggest that there are limits to how much can be solved just by providing information.”
The authors’ findings are entirely consistent with prior research on structured notes, which we will explore in more detail in upcoming articles.
This commentary originally appeared December 5 on ETF.com
By clicking on any of the links above, you acknowledge that they are solely for your convenience, and do not necessarily imply any affiliations, sponsorships, endorsements or representations whatsoever by us regarding third-party Web sites. We are not responsible for the content, availability or privacy policies of these sites, and shall not be responsible or liable for any information, opinions, advice, products or services available on or through them.
The opinions expressed by featured authors are their own and may not accurately reflect those of the BAM ALLIANCE. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.
© 2016, The BAM ALLIANCE
My adopted home of Charleston might have been ranked the “Best City in the World,” but the state of South Carolina is earning a less distinguished label as a harbinger of the country’s worst pension crises. And yes, that’s crises—plural—because U.S. state and local government pensions have “unfunded liabilities” estimated at more than $5 trillion and funding ratios of just 39%.
What does that mean, exactly?
When a company or government pledges to pay its long-term employees a portion of their salary in retirement—a pension—the entity estimates how much it (and its employees) will need to set aside in order to make those payments in the future. An underfunded pension is one that simply doesn’t have sufficient funds to make its promised future payments.
Corporate pensions in the United States are in trouble, with the top 25 underfunded plans in the S&P 500 alone accounting for more than $225 billion in underfunding at the end of 2015. But states and municipalities are in even worse shape. This week, the Charleston-based Post and Courier estimated that South Carolina’s shortfall alone was at $24.1 billion, more than triple the state’s annual budget!
How did we get here?
There are two glaring reasons for our current pension crisis: poor investment decisions and greedy assumptions.
Pension actuaries assume that contributions to the plan will grow by investing the principal in stocks, bonds, mutual funds, hedge funds and private equity investments. Just like retirement planning for a household, the prudent investor assumes a conservative expected growth rate. But, almost universally, the big pension plans assumed more aggressive rates—because that permits them to commit less of their own cash to the plans.
As pension expert Andrew Biggs points out, this problem is especially pronounced with state and local governments. Compounding the problem of higher-than-responsible rate-of-return assumptions, the investments have performed poorly.
While some of this performance is certainly attributable to the whims of unpredictable markets, we also see evidence of a highly technical syndrome that plagues institutional investors known as knuckleheaded decisions. Its most notable symptom, trying to outsmart the market, all too often results in buying high and selling low.
This brilliant chart courtesy of The Post and Courier says it all.
Why did states, municipalities and companies do such a poor job?
The institutions on which financial laypeople have relied to help solidify their retirements simply have fallen prey to the same behavioral biases that affect each of us, individually, in investing.
Wishful thinking led to unacceptably high growth assumptions and therefore lower-than-necessary contributions. Then, highfalutin’ investment managers made poor portfolio decisions that were further compounded by failed attempts to bail out their bad choices. Honestly, a humble DIY investor with common sense could’ve done better.
What can you do about it?
You’re not going to be happy about this, but it’s your only option: When doing your retirement planning, consider underweighting any pension payments you expect to receive, especially if yours is underfunded.
There is an independent federal agency, the Pension Benefit Guaranty Corporation (PBGC), that effectively insures many pension plans—but it is not guaranteed by the full faith and credit of the U.S. government. Oh, and the PBGC is also underfunded, itself.
And if the U.S. government has to get involved in bailing out an “expanding and escalating” pension crisis, it could have broader (less-than-savory) implications.
If you have a pension, examine it. If you’ve not yet retired, most pensions give you an opportunity to elect how your pension will be received. If you have the option to receive a lump sum payout on the front end instead of a pledged stream of income in retirement, you may consider that option seriously. But please remember—if you or your investment advisor makes the same knuckleheaded investment decisions that we’ve seen evidenced in the pension fund debacle, you may be in even worse shape than if you relied on the pension’s stream of income.
Then, whatever decisions you’ve made, we can all do well to consider the South Carolina state motto: Dum spiro spero.
While I breathe, I hope.
This commentary originally appeared December 9 on Forbes.com
By clicking on any of the links above, you acknowledge that they are solely for your convenience, and do not necessarily imply any affiliations, sponsorships, endorsements or representations whatsoever by us regarding third-party Web sites. We are not responsible for the content, availability or privacy policies of these sites, and shall not be responsible or liable for any information, opinions, advice, products or services available on or through them.
The opinions expressed by featured authors are their own and may not accurately reflect those of the BAM ALLIANCE. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.
© 2016, The BAM ALLIANCE