Earlier this year, I was contacted by a financial advisor from a large insurance and financial planning company. He had received my name from a former colleague of mine. Typically I say no to people trying to sell me something, but for some reason I decided to hear him out. At this point in my financial life, I hadn’t yet started to take control of my financial future. I’ve always practiced good spending and saving habits. I had constantly contributed 15-20% of my paycheck to my 401k, and after 10 years, I was on track to have a nice chunk of change when I reached retirement age. Having been in my new position as CFO for several months at this time, and making more money, I thought it would be a good idea to take a more active approach in investing for my future.
I had several follow up phone calls with the financial advisor after our first discussion. He set up a nice plan for me that showed how they could optimize my asset allocation. Additionally, the plan laid out how much I needed to set aside each month to reach my goals, and what other investment vehicles were at my disposal. I liked the guy and the plan he had put together, but then we started discussing fees. For his services, I would be paying a fee of 1.5% of my total assets under management by them. Ouch!
This was something I couldn’t get over. I could see there was real value in the plan he was presenting me. But what about after that? I’m not going to be needing to make big adjustments to my investment strategy on an annual basis, so what would I be paying for year after year? I asked him this question, but didn’t like the answer he provided. I’m a numbers guy. If I have say $250,000 under management with them, that’s a fee of $3,750 per year. Would I be receiving value that outweighs this fee every year? Again, I asked him this, and again I was given the same boilerplate nonspecific answer. It was like listening to a presidential candidate answer a debate question.
Pushing Permanent Life Insurance
This financial advisor also tried to push permanent life insurance on me as a safe investment alternative. I had told him that my wife and I hold a $300,000 term life insurance policy. We have no kids and both have jobs, so we feel comfortable with this amount. Plus, being a member of the AICPA, I get this policy for next to nothing. My wife and I pay a total of $19 per month for this policy. This amounts to an annual premium of $228. In addition, I receive a cash refund from the AICPA Trust each year, which they have paid out for the past 65 years. The refund amounted to $163 this year. So why exactly would I want to stop paying $65 net per year for my $300,000 policy? Oh, so I can get a more expensive whole life policy that provides way more insurance than I need? Doesn’t sound too good to me.
He provided me with some charts that showed the annual dividends paid out to their permanent life insurance holders over the past 100+ years. He pointed out that their policies had paid out dividends of 8-10% on average over the past 30 years. Never during this time had the dividends dropped below 5%. Sounds great, unless you’re like me who thinks the returns sound too good to be true and start to dig into the numbers.
Not What You Think
I asked the financial advisor for a sample policy so I could dig into the numbers. I found that the dividend rate they’re quoting is on the cash value of the investment, not the total premium paid by the policy holder. In a permanent life insurance policy, a portion of the premium is paid toward the death benefit. The second portion of the premium goes to cover the insurance company’s operating costs and profit. The remaining portion then goes to the cash value of the policy. At the end of the policy year, if the company has lower than expected death claims, lower costs than expected, and/or higher than expected returns in their general account, then they pay this out in the form of a dividend to policy holders.
For example, you sign up for a policy with a $1,000,000 death benefit and premiums of $1,000 per month. Of this premium, $200 goes into the cash value portion of the policy (I’m making up numbers here), and the rest goes to insurance costs and profit. At the end of the year, the cash value of your policy is $2,400. You then receive a dividend from the company of $192. Sweet! That’s an 8% return on my cash value! Except for you paid an additional $9,600 in premiums that went towards the cost of insurance, so the return on all of the money you’re putting into the policy is just 1.6%. Again, these numbers are made up, but you get the idea.
What Are My Needs?
The reason I point this out, is that many financial advisors try to sell the investment benefits of permanent life insurance. Even if you tell them you don’t need that level of insurance, they’ll continue to push it by throwing out dividend percentages that are misleading. And why do they do this? Because they earn a nice commission on selling these policies.
Some people may have higher life insurance needs. There is no right amount, as it’s dependent on each individual. These policies do offer tax advantages such as tax deferred growth of the cash value and in many cases, but not all, dividends are tax free as well. Additionally, the percentage dividend you receive will grow as the cash value of your policy grows. But at the end of the day, permanent life insurance didn’t meet my needs.
Better Options Available
In the end, I didn’t see the value in the fees I would be paying. I think the financial advisor was a little peeved that he had spent a lot of time on me. I really was interested in hearing what he had to offer. He helped motivate me to take more control of my financial future. Unfortunately for him, he helped me realize there wasn’t value in paying him 1.5% year after year.
Personal Capital is one tool I really like that acts as a financial advisor for me. I can get recommendations on asset allocation based on my risk tolerance and retirement needs. I can also see the total fees I’m paying and how much they’re costing me over the long run, and use their Retirement Planner Tool to see if I’m on track to meet my goals. And instead of paying a hefty fee, it’s free! Check out my review of Personal Capital here.
If you have some financial knowledge, using free tools like Personal Capital is the way to go. I would definitely go that route over paying a high fee for very little value year after year. Even if you’re new to investing, I still wouldn’t recommend paying someone 1.5% a year. Start off investing in low cost index funds and utilize the many tools available to you to learn. In the end, you’ll fair just as well as you would with a financial advisor who is likely using similar tools to develop your plan.
Readers, what are your experiences with financial advisors? Are you for or against paying the additional fee to get some human advice?