The Dumb Things Smart People Do with Their Money: Thirteen Ways to Right Your Financial Wrongs - Softcover

Jill Schlesinger is an Emmy-nominated and Gracie Award–winning Business Analyst for CBS News, a weekly guest on NPR’s Here and Now, and a Certified Financial Planner™. She writes a weekly syndicated column, Jill on Money, and serves as the host of the nationally syndicated radio show Jill on Money.

DUMB THING #1

You Buy Financial Products That You Don’t Understand

Let’s say you’ve got $800,000 in a low-­cost retirement account, and you’re also lucky enough to have a pension. One day, your investment guy calls you up, invites you to golf, and suggests that you put your $800,000 nest egg into a variable annuity. As he explains, this is a “unique” kind of investment that resembles an IRA but offers special tax benefits. You will pay no tax while your money grows. Later in life, when you’re at or near retirement and in a lower tax bracket, you can take withdrawals and pay Uncle Sam his due. Not only that: You’ll have many options for accessing the money and for creating an income stream later on when you need it. If the stock market falls, you’ll be protected, and you’ll be able to leave the money to your heirs in a seamless fashion. Your very own, personal pension! Sounds great, right?

You drain that Arnold Palmer you’re drinking, and without a second thought you tell your adviser to transfer all of your money into that shiny new annuity. You go about enjoying your life, confident that your nest egg is not only secure, but growing. A year later, you glance at your account statement and receive an unpleasant surprise: It’s got only $786,000 in it. How could that be? The market is up, yet your account is down.

You look into it, and discover that this annuity your golfing buddy/adviser recommended actually came with some pretty serious fees—­about 2 to 3 percent a year, as compared with a quarter of a percent for the plain vanilla index mutual funds in your IRA. An annuity might have made sense if the money flowing into it came from a taxable account, but in your case, the money was already coming from a tax-­advantaged retirement account. What you did, in effect, was pay for a tax benefit you didn’t need. You took money from a retirement account that had relatively low fees and plopped it into an expensive retirement product you didn’t understand. Not such a great move after all. In fact, a $14,000 mistake.

Smart people get snookered into financial products they don’t understand all the time. It’s not just annuities, but any number of other products. Smart people sink a hefty portion of their savings into gold bars or coins, thinking it’s a “safe” investment that will allow them to ride out tumultuous markets. The truth is that precious metals are volatile investments, can lose value, and are hard to get out of if prices fall. Smart people take out reverse mortgages, looking forward to a beautiful little income stream coming to them every month from the equity they’ve built up in their homes. A few years later, when they realize they need to move, they face high interest and fees they hadn’t expected. In some cases, because they and their heirs didn’t understand the fine print, they lose their ability to pass on property to the next generation. And then there’s hedge funds. Those big boys sound sexy, and they are—­for billionaires and institutional investors who have access to the 10 percent of hedge funds that actually perform well. The rest of us schmucks would do much better sticking with our boring old index funds.

In this chapter, I’ll probe the hidden downsides to these financial products, parsing some of the small print you might not have taken the time to read, and frankly, that your broker might have hoped you’d gloss over. I’ll also present a sophisticated method you can use to prevent yourself from ever again buying a financial product that you don’t understand. You won’t learn about this method anywhere else, not at Wharton, not at Stanford, not at Harvard. Are you ready? It’s called . . . asking more questions. I know, obvious, but so many smart people don’t do it! We spend more time researching our upcoming vacations, or a restaurant for next Saturday’s date night, or the organic, dry-­aged, grass-­fed steak we eat at said restaurant than we do the financial products on which our futures depend. If you value your money, you’ll start asking tough questions right now—­not because you want to, but because it’s in your own best interest.

No More Looking for Mr. Goldbar

Let’s talk gold. On late-­night television, you’ll often see commercials with faded actors hawking gold coins or bars. The first thing you say to yourself is: “Is that guy from Knots Landing still alive?” Then you hear him warn that it’s a dangerous world out there, and you need a way to keep your money safe, no matter what might transpire. Buy gold coins and gold bars, and you can rest easy. If the stock market crashes, gold will still retain its value.

Do me a favor: Don’t make investment decisions late at night from the guy on Knots Landing. Just don’t. And this comes from a former gold trader, so pay attention!

Gold sounds like a reasonable investment. We do need to protect ourselves against unstable financial markets, and particularly against inflationary periods when money loses its value and prices rise. For generations, our forebears have turned to assets like land, oil, and gas, or commodities for such protection, since the prices of these assets rise as prices in general rise. Of all these assets, gold has long reigned as the ultimate “safe harbor.” Entire countries used to link their currencies to the price of gold, or as it’s known, the “gold standard.” So why not put some sizable portion of your nest egg into gold?

I’ll tell you why. Gold isn’t nearly as “safe” as it seems. All commodities are volatile. Gold can stagnate or lose value over long stretches of time. In fact, over the past two centuries, there have been many five-­ or ten-­year periods in which gold proved a poor investment. The period 2012–­2017, for instance, saw its share of economic difficulties, as well as of traumatic moments when the stock market lost value. Politicians in the United States took us to the edge of disaster with their negotiations over raising the debt ceiling, the eurozone nearly collapsed under the weight of the Greek debt crisis, British voters elected to leave the European Union, and as recently as the beginning of 2016, stock markets corrected early in the year as crude oil plunged on worries that the global economy was slowing. Despite these vicissitudes, the S&P 500 rose 82 percent during this period, while gold was down 47 percent. If you had listened to the doomsayers and plowed, say, half your portfolio into gold, you would have gotten shellacked!

On a number of levels, gold is just so wrong. Unlike stocks or bonds, gold doesn’t create income by paying interest or a dividend (nor do other precious metals, like copper and silver). On that basis alone, most investment pros steer clients away from it. If you want to protect against market instability, you’re better off buying an exchange-­traded fund (ETF) that places bets against the stock market, so that when it falls, you make money. Wealthy investors with large portfolios can also buy options to protect against dangerous markets. If inflation is your concern, any of us can buy inflation-­protected bonds, like I Bonds or Treasury Inflation-­Protected Securities (TIPS). There just isn’t any need to invest in gold.

If despite my dire warnings you absolutely must buy gold, do yourself a favor and limit your exposure to less than 5 percent of your total portfolio. And for goodness’ sake, stay away from bars or coins. Infomercial pitches for these products have big commissions built into them. There is insurance and storage to pay for (what, you think you’re going to store that gold in your mattress?). Also, if you ever want to sell your gold, you likely won’t get the actual market price for it, since it’s not easy for ordinary people to access large secondary markets like the New York Stock Exchange or a commodities exchange, where financial products based on gold are bought and sold. You own the physical metal, also known as the “underlying,” not a financial product based on that product. So instead of trying to get the competitive best bid for your gold, all you can do is walk into a dealer’s place of business and try to unload it. It all adds up to a seriously bad deal.

Invest instead in a gold exchange traded fund. An ETF is an investment that looks like a mutual fund, because it is a pooled investment. Yet it trades more like a stock, because you can sell an ETF at any point during the trading day, rather than having to settle for the end-­of-­the-­day price, as most open-­end mutual funds require. The first-­ever gold ETF (“GLD”) was introduced in 2004, and it allowed investors to participate in the gold market by purchasing a pooled asset that reflected the price performance of gold bullion. If you buy into a gold ETF, you can’t redeem your shares for a pirate’s trove of gold bullion. On the other hand, you escape the underlying costs and logistical problems that come with owning a precious metal. As an alternative to an ETF, you could also invest in a gold stock (equity in a company that mines precious metals). At least you can sell those easily if they are losing their value. But remember, no more than a smidge of your portfolio.

Look, as I said, I’m a former gold trader, and I still wouldn’t touch the stuff. Did I mention that gold saved my step-­grandmother’s life? Valerie, or “Valley” as we called her, grew up in Hungary after World War I. During the early 1940s, when the Nazis were marching into her village, her mother handed her a pile of gold jewelry and said, “Hide this, and get out of town!” Hawking the gold bit by bit, Valley managed to buy her way out of Europe, making it to London and then Australia before migrating to the United States after marrying my grandfather. Gold protected her during tumultuous times. But that doesn’t mean it offers the best protection for you. Back away. It’s usually a crappy investment.

Why You Should Probably Back Out of That Reverse Mortgage, Too

While you’re up watching late-­night television (probably because you’re worried about money and can’t sleep), you might also spot commercials for another financial product that has ensnared its share of intelligent people: reverse mortgages.

Let’s say you own your home outright or carry just a small mortgage balance. Reverse mortgages, available to homeowners over the age of sixty-­two and overseen by the Department of Housing and Urban Development, will pay you a portion of your equity either in a lump sum or monthly installments. You can access your equity now, without having to sell your home. Down the road, when you die or no longer live in your home, the bank recoups its money (usually by the sale of the house), as well as interest and finance charges.

Reverse mortgages can work well for older people who might have accumulated significant equity in their home, but don’t have a lot of other retirement income to draw on month to month. With a reverse mortgage, you don’t need to move out of your home and find something cheaper; you can stay and age in place. When death comes knockin’ at your door, your home is sold, and your heirs get whatever equity remains in the house after the lender is paid off.

So, what’s the problem? A couple of things. Sandy Jolley, a consumer advocate and national expert on reverse mortgages, can tell you hundreds of horror stories of consumers preyed upon by predatory lenders who assess extravagant fees or go to extraordinary (and sometimes illegal) lengths to foreclose on borrowers’ homes. Even when lenders are behaving reasonably well (and the industry has been cleaning itself up of late), many borrowers or their heirs sustain massive losses because they don’t understand the complex terms and requirements of these loans.

One Florida woman whom I’ll call Bonnie learned that her recently deceased mother had taken out a reverse mortgage on her home.1 Bonnie’s mother had intended for Bonnie to pay back the loan upon her death and keep the property in the family. Bonnie wanted to do so, but she didn’t realize that she had to file papers and become formally recognized as a legal representative of her mother’s estate before the bank would even tell her the loan’s outstanding balance. According to the terms of the reverse mortgage, Bonnie had exactly six months after her mother’s death to pay off the loan if she wanted to keep the house. Becoming a legal representative was a costly process that took months. Once Bonnie had finally taken care of that and the bank told her the payoff amount, Bonnie had to apply for a loan herself in order to pay it off, since she didn’t have the money. The loan didn’t come through within the six-­month period, and the bank foreclosed on her mother’s home. There was nothing Bonnie could do.

Besides running afoul of the terms and requirements, many people take out reverse mortgages without analyzing whether they really should stay in their homes. What if you suffer a health setback and wind up needing expensive care? Would your income stream with the reverse mortgage suffice, or would you still need to move?