Rudyard Kipling declared that “Words are, of course, the most powerful drug used by mankind.” Words, like all drugs, only have efficacy if they are used appropriately and can have harmful side effects. There are a few words in the financial planning business that frequently are delivered and usually incorrectly prescribed. Since I am concerned for your financial health, let me lay some out for you.
When Nassim Nicholas Taleb wrote “The Black Swan,” he was attempting to show how our need to put things in order makes us overlook the highly improbable. These events have significant consequences, in part because of their surprise. With the election of Donald Trump, I have several clients calling me asking me about the black swan event that we may confront — a trade war with China, huge tariffs on our trading partners, even a military war someplace? It is reasonable to ask questions regarding what is possible, but none of these would be black swan events. Why? It was the election of a reality television star with no prior elected office who came from outside their party that was the black swan event. Now, for example, if the Democrats nominated George Clooney for president, that would not be a black swan event. We have seen that this can happen, so the surprise and subsequent consequences have been muted.
The trade war, tariffs or military war discussions are important to consider, but they are no longer black swans. They are possible scenarios that have at some level been factored in by the capital markets. They could provide a lid on potential market growth if they become more likely, just like the president’s business background and team of advisers make potentially positive market scenarios like deregulation and tax cuts more likely. Black swans are things that are almost impossible to see — the Lehman Brothers bankruptcy, for example. Once we are talking about them we are preparing for them.
Clients who are fearing these fake black swans are wanting to sell their stocks. There is nothing wrong with making small changes to try to reduce the risk in your portfolio, but to do so in the extremes can be quite costly. When there is a lot of uncertainty, you want to take action. Here are some strategic ways of doing so. You should have a minimum of two years spending in cash when you are living off your portfolio. If you are extremely nervous, add another year. Then think of your money in terms of three buckets: a cash bucket that will handle two to three years of expenses, a bond bucket that can handle another two to three years minimum, and a stock bucket that you would not need for between four to six years. If you have a lump sum but are reluctant to invest in the market, take a two-pronged approach: break the lump sum into 10 installments and invest every three weeks or every time the markets fall by 3 percent. The time trigger means that you will get invested if the markets don’t fall, the price trigger means that you will never invest everything at the top of the market.
Another word that is misunderstood is fiduciary. A fiduciary is someone who puts your best interest ahead of their own. There are two ways in which this word is confusing. One is that some people think that a fiduciary does not have a conflict of interest. That is not true. Conflicts of interest arise in almost every interaction. Fiduciaries are allowed to be compensated as long as their compensation is reasonable. Let’s imagine that you are working with a fee-only planner whose compensation is based on assets under management. This arrangement is not conflict-free. If you pay off your mortgage rather than invest, the planner’s fee will drop because there are fewer managed assets. A fiduciary may still appropriately have you maintain a mortgage for a number of reasons. The conflict isn’t the problem, it’s inappropriate action around that conflict that is the issue.
The second aspect, though, is that someone who will not say that they are a fiduciary is not obligated to put your interests first. It doesn’t mean that they are going to give you bad advice, but it means that you will not be sure that your interests have been advanced ahead of your adviser’s.
When you are about to work with an adviser, ask whether they will be acting as your fiduciary. If they will, ask them for examples of potential conflicts of interest. If they won’t, then ask how they are getting paid on any advice that they recommend and ask what other lower cost options would be available. Value tends to be more important than costs, but higher costs mean that the value has to be clearly established.
Another word that is inadequately prescribed is insurance. Insurance should be used to protect things that you can’t afford to protect on your own. Having high deductibles should lower your cost of insurance. Life insurance is useful when you are trying to build your assets, but is less important once you have assets (or no longer have large expenses). Make sure that you are not over insuring things that you can absorb.
Understanding words will mean that even if you make a financial mistake, you should be able to recover.
Ross Levin is the founding principal of Accredited Investors Wealth Management in Edina.