# The Investment Scientist

## Archive for the ‘Conflict of Interest’ Category

### An Empirical Study of A Client’s Equity Index Annuity Returns

Posted on: June 29, 2014

Typical Salesman’s Chart for EIA

Financial author Allan Roth once wrote an article called “Investment Trick – Annuity Style” where he asks a rhetorical question, “If the S&P 500’s total return is 12% in a given year, what do you think your equity index annuity (that is supposed to track the S&P 500) would return”?

1. 10%
2. 8%
3. 5.4%
4. 3.4%

Allan Roth goes on to explain why the correct answer is 3.4%. Boy, was he wrong! Read the rest of this entry »

### Variable Annuity: Bad Investment!

Posted on: June 5, 2014

Recently I was approached by two prospective clients. The husband is a very successful entrepreneur and they are also very frugal. As the result of that, they have accumulated substantial wealth – north of \$5mm.

The only problem? all of that money is in about 28 variable annuities they purchased over the years. In examining these variable annuities, I turned up the following problems:

1. Horrible returns

For each variable annuity, I was able to calculate its annualized return.

Out of the 28 variable annuities, only two have annualized returns above 4%. Seven have annualized returns between 3% and 4%. Six have annualized returns between 2% and 3%. The rest (13 of them) have returns less than 2% including a few that have negative returns.  The average annualized return? 2.12%. Not enough to beat inflation!

2. Horrible surrender charges

There is this one annuity they purchased from Jackson National Life in 2007 for \$200k; today it has grown to a “value” of \$245k, but if they should cash it out, they would only get \$221k since there is a surrender charge of \$24k. After seven years, there is still a surrender charge of 12%! This is just horrible! Read the rest of this entry »

### Financial Advisor Licenses: Series 65 vs Series 7.

Posted on: November 20, 2013

When I am approached by a prospective client, the question they always ask without fail is “Are you properly licensed?”

This is actually the wrong question. The right question should be, “Which license do you have?”

Generally, there are two types of licenses for people who call themselves a “financial advisor.” People who passed the series 65 test and people who passed the series 7 test. The nature of these two licenses are as far apart as heaven and earth.

Series 7 is a securities license. People who have passed this test can legally be a broker. They are actually prohibited by law to give financial advice, except incidental to the financial products they are selling.

### Investment Expenses: Small Numbers with a Huge Impact

Posted on: November 17, 2013

Recently a business owner asked me to review his investment portfolio. He is currently with an Ameriprise financial advisor and his gut feeling tells him something is amiss.

He is paying the advisor 1.6% in fees. First of all, this fee is quite exorbitant. For the size of his portfolio, he shouldn’t be paying more than 1% in advisor fees.

Adding insult to injury, for the fee that he is charging, this advisor puts his money into a collection of very expensive mutual funds like ODMAX.

It is very easy to check the expenses of a mutual fund. I just googled ODMAX and I found out it has a load of 5.75% and an expense ratio of 1.36%. (For those who don’t know, load is a one time charge to pay commision to the Ameriprise advisor who doubles as a broker. Expense ratio is an ongoing annual charge.)

ODMAX is a mutual fund that invests in emerging market stocks. If you use the low cost alternative, aka a Vanguard fund, you will pay no load and the expense ratio is only 0.33%, a saving of 1.06%.

Don’t ever underestimate these tiny savings. Because in ten years, the savings will be more than 10%, in twenty years, more than 20%. This businessman is in his 50s; he can easily live another 30 years. I asked him: “How would you like to be more than 30% poorer in retirement?” That is exactly what this financial advisor will make him.

### Will China Rise Peacefully?

Posted on: October 20, 2013

Two days ago I went to listen to a geopolitical lecture given by Professor Mearsheimer of the University of Chicago.

Professor Mearsheimer is a geopolitical realist. He has an intriguing theory about global political order which states that there is a 75% chance that the US and China will come into conflict.

I care about this subject because, being a Chinese American, I know that my life would not be too pleasant should that come to pass.

Professor Mearsheimer’s theory is based on the assumption that the global order is anarchic, by that he means there is no higher authority above states, and that each state will fight for a better position in the order.

The US, now being number 1, is not going to willingly give up the top spot, and China, if given the opportunity, is not going to settle for second best.

Professor Mearsheimer explains how the US became #1 in the first place:

### The Agony of The Landlord

Posted on: September 5, 2013

A physician client of mine called me the other day and asked my advice as to whether she should evict the tenant currently residing in her condo. This is advice I hate to give. Let me explain.

The tenant is a single mom with two young children, whose estranged husband just stopped paying child support because he is officially unemployed, but the tenant believes he is getting paid under the table.

My heart goes out to this tenant, I would never want her and her children to become homeless. But my head tells me that if my client lets her stay for free, she would most likely wind up staying for free forever and my client’s rental property would become a toxic asset.

So what should I advise my client?

### Financial Advisor Stealing From Father

Posted on: August 23, 2013

I read with disgust this news about a “financial advisor” stealing \$1.3m from his client who also happened to be his father!

I want all of you to know that not all financial advisors are the same. In fact “financial advisor” is a free term. There is no educational requirement nor legal requisite. Justin Bieber and his grandmother could call themselves financial advisors and begin dispensing advice – and they would not get into trouble for it!

In reality though, there are generally four types of people who like to call themselves “financial advisors”:

Read the rest of this entry »

### Captive Insurance: A Business Owner’s Heaven?

Posted on: July 29, 2013

Captive Insurance

I went to a conference for CPAs last week, and my biggest takeaway was a concept called captive insurance.

This is the concept of a business owner setting up an insurance company to insure the risk of his/her own business. Thus the name captive.

But what’s in it for one to have one’s own insurance company?

## Tax Mitigation

It turns out that Congress has created legislation to encourage captive insurance – some would call that a tax loophole. IRC 831(b) states that small insurance companies (\$1.2m or less in annual premium income) pay tax only on investment incomes. In other words, they don’t pay tax on premium income.

Can you see the tax loophole here? If a business pays its captive insurance company \$1.2m in insurance premiums, the premium is deductible to the business and yet tax exempt to the captive insurance company. Depending on the tax structure of the business, this could mean a tax saving of 40% to 70%.

But tax savings aren’t the only major benefit!

### Do you want to be Morgan Stanley’s production?

Posted on: June 11, 2013

Morgan Stanley Smith Barney

I went to a Morgan Stanley financial advisor associate recruitment meeting recently to spy on how they train their new financial advisors.

They have an extremely rigorous 36 month program. New associates are expected to pass series 7 and series 66 license testing in the first 12 months. These licenses enable them to charge both fees and (hidden) commissions. (Comparatively, my series 65 license prohibits me from charging commissions.)

As soon as they get the licenses, they are expected to go into “production.” The firm sets very tough production targets. If they fail the targets, they will be kicked out of the program.

### Why allowing hedge funds to market directly to the public is a great idea

Posted on: June 6, 2013

Is this your fund manager?

Securities and Exchange Commission Chairman Mary Jo White supports a new rule that would allow hedge funds to market directly to the public. I think that’s a fantastic idea. Let me explain why.

Between 1998 and 2010, hedge fund managers earned “only” \$379 billion in fees. Do you know how much they made for investors?

Before you answer that question, you should be aware that one-third of hedge fund money is channeled through funds of funds. Their managers need their cut too. Between 1998 and 2010, their take was about \$61 billion.

### Morgan Stanley Wealth Management Makes My Life Easy

Posted on: May 7, 2013

Morgan Stanley Smith Barney

Last weekend, I went to New Jersey to meet a potential client who is an executive at a pharmaceutical company.

He told me that, as part of the executive benefit package, the company refers executives to Morgan Stanley where they get “free” financial advice. I smirked and said: “Well, we will find out how free it is. One thing I know, though, Wall Street firms are not known for charity.”

It turns out that Morgan Stanley advised him to open several, separately managed accounts (SMA), each with a management fee of 1.5%. The reason for the multiple accounts?

### The reward of a financial advisor

Posted on: January 7, 2013

Recently, a client of mine fell, broke his hip and ended up lying on the floor for 20 hours before he was rescued. I went to visit him in the hospital a couple of times. The good news is: he is out of immediate life-threatening danger. The bad news is: he may be wheelchair bound for the rest of his life.

When John first came to me to seek my help with his personal finance, I looked at his overall financial big picture and was pleased overall. He worked at federal and state jobs and enjoyed good pensions. On top of that, he had a decent investment account.

But there was a gaping hole in his retirement security: he was turning 70 then, was divorced, and his children lived far away. That meant if he were to get sick, nobody would be there to take care of him; he would need to hire caregivers. Right then, I insisted that he buy long-term care insurance.

### The two most common ways investors lose money

Posted on: December 13, 2012

New Year’s investment resolutions

After working as a financial advisor for six years and after reading tons of research, I have developed a good sense about how the average investor loses money. As the New Year approaches, I think it’s good to share my insight so that readers can determine if they are making these mistakes.

Conflict of interest

I cannot emphasize this enough: Wall Street firms don’t work for you. If you have a Merrill Lynch or Morgan Stanley advisor, expect to give away 2.5% of your money every year – about half of it will be in explicit fees, the other half will be in hidden fees. If you invest through insurance products, expect to give up 3.5 percent of your money.

### Young Physicians: Do You Understand Your Employment and Buy-Sell Agreements?

Posted on: November 19, 2012

Young doctors need legal advice

When a young physician joins a practice, he will have to sign an employment agreement.

After a few years as an associate physician, he will make partner, or become a shareholder.

At which time, he will sign a buy-sell agreement.

These two agreements to a great extent determine the wealth this physician will accumulate.

If they are not done right, this physician will likely not see any of the wealth he creates.

I am not being an alarmist. Let me tell you about a client of mine….

### Wealth Management Round Up: September 2012

Posted on: September 25, 2012

Here is a selection of the best wealth management articles around the web for September:

5 reasons your portfolio is too complicated, by Kyle Bumpus

Why analysts are scratching their heads over QE3, by Robert Wasilewski

Is rebalancing market timing?, by Mike Piper

Choosing a mutual fund – Avoid these 6 mistakes, by Roger Wohlner

Fidelity’s new retirement saving guidelines, by Barbara Friedberg

Can I consistently outperform the market? by Ken Faulkenberry

Dividend reinvestment plans (RIPS) and their benefits, by Dave Scott

Questions to ask when picking a financial advisor, by Carl Richards

Get my white paper: The Informed Investor: 5 Key Concepts for Financial Success.

### Can a major Wall Street firm help you beat the market?

Posted on: September 6, 2012

New York Stock Exchange

When talking to prospective clients, I am upfront about what I can and can not do. I can NOT beat the market.

Recently, that straightforwardness caused me to lose a prospective client to a major Wall Street firm. Apparently, the financial advisor from that firm was able to convince him that with their exclusive location, expensive brochure, and nice Armani suits, they could beat the market.

This led me to do a mental exercise.

### Author

Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.

### Twitter: @mzhuang

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