Alternative Investments (“alts”) and The Flight to Safety – Part II

Jim Lorenzen, CFP®, AIF®

In my last post, a talked about how the financial planning profession has changed dramatically since I opened my first office in  1991; but, the financial services industry – not to be confused with the profession that operates alongside it – seems to have changed little, though it’s changed a lot.

I talked about how the financial product manufacturing, marketing, and sales channels represent an industry that exists alongside – not necessarily a part of – the financial planning profession.  It doesn’t help, of course, that anyone can call themselves a financial planner – but I digress.

Alternative investments (alts) represent one example, which I discussed in the last post.  Another alternative investment is deferred annuities.

People love guarantees.  Marketers know this and the use of the word virtually always gets investors’ attention – particularly those who’ve amassed significant assets and are contemplating retirement.

The media – always on the alert for something they can hype or bash for ratings and typically lazy – find it easy to highlight high costs and shady salespeople.   And, there’s some truth to that.  Guaranteed income or withdrawal riders and  equity indexed annuities do tend to have high costs.  Often the guarantees that are less attractive than those presented.

The cost-benefit argument could, and probably will, go on forever.   I have other issues.  The first is, does an annuity make sense at all?  – Any annuity.   There’s no tax-deferral benefit if used inside an IRA and it limits your investment choices.  They also often have surrender charges that enter into future decision-making; but, even when there are no surrender charges, the withdrawals can harm performance or even undermine the guarantees that were the focus of the sale.

For me, here’s the big issue:  the annuity creates something most of my clients no longer want any more of – deferred income (who know what future tax rates will look like in 10-15 years as government deficits climb?  Deferred income comes out first and is taxed at ordinary income tax rates.

Deferred income in non-qualified annuities (outside IRAs, etc., funded with normally taxable money) is income in respect of a decedent (IRD) and does not get a step-up in cost basis at the death of the holder – someone will pay taxes on the earnings and they may be in a higher tax bracket or the IRD may put them there.

There may be other ways to invest using alternative strategies.  Options can work, but they also carry additional costs and risk.

Talk to your advisor –  a real one would be a good idea – to see what your plan should be.

Jim


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Jim Lorenzen, CFP®, AIF®

Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER® professional and an ACCREDITED INVESTMENT FIDUCIARY® serving private clients since 1991.   Jim is Founding Principal of The Independent Financial Group, a  registered investment advisor with clients located across the U.S.. He is also licensed for insurance as an independent agent under California license 0C00742. The Independent Financial Group does not provide legal or tax advice and nothing contained herein should be construed as securities or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.

Alternative Investments (“alts”) and The Flight to Safety.

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The more things change, the more they stay the same.

Jim Lorenzen, CFP®, AIF®

The financial planning profession has changed dramatically since I opened my first office in  1991; but, the financial services industry – not to be confused with the profession that operates alongside it – seems to have changed little, though it’s changed a lot.  What?  I’ll explain.

The industry, comprised largely of product manufacturers and their sales arms (these days it seems anyone can say their a ‘financial advisor’), has a long track-record of constantly packaging new products to take advantage of a demand among investors that the product manufacturers create through their marketing.   New ‘issues’ (created by marketing) give rise to new products to be sold to fill a marketing-driven demand.  Changes in product innovation to generate new sales is the constant that never changes.

This doesn’t mean it’s all bad; it’s just that it can be difficult for spectators to recognize the game without a program.

Alternative investments get a lot of press these days – especially if there’s a perceived risk of a down or bear market… a perception that’s  convenient to exploit at almost any point in time.  The media likes ratings, so profiling people that called a market  top or decline – and made money – is always good for attracting an audience.  And, since there’s  always someone on each side of a trade, finding someone on the right side  isn’t difficult.

I’ve always felt that many fund managers operate like baseball free agents.  Being on the right side of a call gets them on tv, which in turn attracts new assets, which in turn leads to bigger year-end bonuses.  I could be wrong, or not.

Many captive “advisors” are putting their clients into “alts” these days because their employer firms (the distribution arm for the product manufacturer) are emphasizing them.

My sales pitch for alternatives:   With alternatives, you can have higher costs, greater dependency on a fund manager’s clairvoyance, less transparency, low tax-efficiency, and limited access to your money!  What do you think?

Don’t get me wrong.  It’s not a black and white decision.  They can have a place in a well-designed portfolio; and, while many endowment funds and the ultra-wealthy do tend to own alts, most of us aren’t among the ultra-wealthy and risk mitigation is important.

What can you do?  What should you consider instead?  Well of course that depends on your situation – everyone’s different.   But, I’ll have a few thoughts you can chew on – and discuss with your advisor – in my next post.

Jim


Subscribe to the IFG Ezine!  Just click here!


Jim Lorenzen, CFP®, AIF®

Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER® professional and an ACCREDITED INVESTMENT FIDUCIARY® serving private clients since 1991.   Jim is Founding Principal of The Independent Financial Group, a  registered investment advisor with clients located across the U.S.. He is also licensed for insurance as an independent agent under California license 0C00742. The Independent Financial Group does not provide legal or tax advice and nothing contained herein should be construed as securities or investment advice, nor an opinion regarding the appropriateness of any investment to the individual reader. The general information provided should not be acted upon without obtaining specific legal, tax, and investment advice from an appropriate licensed professional.