Financial Planning Archives January 2009

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January 28, 2009

The Student Loan Crisis: How Bad Is It?

The student loan industry is a giant scam if you ask me. Parents and students alike don’t realize the slanted arrangement they are about to take on when applying for these loans. Society places such a strong emphasis on education (for good reason) that the education industry and especially the lenders behind it stand to benefit tremendously. It’s a shame that so many of these organizations view a young person’s desire to better educate themselves as an opportunity to rip them off, but I can’t say I’m surprised, not after listening to the news for the past six months. The only way to come out on top and not cost oneself a fortune in interest and penalties over the years is to never miss payments on student loans and, when possible, pay considerably more than the minimums. This can be hard to do at a time when jobs are scarce and higher education is wildly expensive.

At the root of the problem are big banks which have lobbied Congress successfully to remove bankruptcy protection on both federal and private loans. What does that mean? For starters, lenders can charge steep penalties on late and missed payments with the reassurance that they’ll eventually get their money back, even if the borrower files for bankruptcy. The lenders can also be more amenable to deferment and forbearance options for students who can’t make payments immediately upon graduation. This makes the lenders look like good guys who offer extended grace periods but the reality is quite the opposite. Deferring your loans is perhaps the worst thing a borrower can do for their future. All the interest gets tacked on to the back of the loan most likely with added penalties and fees. Deferring a private loan is like paying the minimum on a maxed out credit card: ultimately the lender wins. Hopefully Obama can do something sooner than later about this system which cripples young workers and saddles them with debt.

I’m getting off topic here. My original goal for this article was to discuss the potentially negative effects the credit crisis may have on the student loan industry this year. Even with the one-sided loan agreements which currently exist, lenders will have no choice but to tighten their belts even more during 2009. Regardless of bankruptcy protection and the advantages to the lender of having some students default, there are major costs and headaches involved with excessive default rates. For that reason, lenders will continue to toughen up their borrowing standards and increase interest rates to offset an increase in risk. This effect will probably be most obvious in the less regulated and more risky private loan industry, rather than through federal loans programs such as Stafford and Perkins.

Rumors of private student loan providers asking for ‘government bailouts’ has already caused plenty of chatter. Do we want to support an industry that is poorly regulated and rips off students? Some say yes because at least they afford people the chance to get more education who don’t qualify for federal loans. If they do get help from the government, borrower protection clauses will likely be part of the bargain. Plenty of graduate students, particularly in the legal and medical professions have maxed out their ability to borrow federally subsidized loans. If private loan providers tighten their belts too much, it could dramatically limit access to funds or make them too expensive. It’s an unfortunate situation because many of these students can’t afford to get higher educations without these loans. Even so, lenders have to compensate for increased default risk by charging higher rates of interest. That’s not a great solution in my eyes because it saddles new workers with higher debts and monthly payments, resulting in lower rates of home ownership and, obviously, more stress in general.

On a positive note, federal loan programs have, for the most part, been successful over the last decade. Popular student loan programs such as Stafford, Perkins, and PLUS (Parent Loans for Undergraduate Students) have continued to increase higher education rates and often subsidize interest while students are in school. Even as the cost of borrowing from the government eventually rises, the strength of the programs has been a huge step in the right direction. While credit has dried up in most sectors of the shrinking economy, federally backed student loans actually grew 18.6% year over year in 2008.* The gloomy economy has encouraged a lot of people to go back to school, get more degrees, and hit the job market at a time when the opportunities are a little better.

I had to get all of this off my chest today. I keep reading articles about the effects of the credit crisis on the student loan industry. It just seems like any way you cut it, loans or no loans, high rates or low rates, the student gets the short end of the stick. While the government is busy bailing out the losses created by years of fraud and deception on Wall Street, how about we do something good for the people who will eventually control the economy of tomorrow.

As always, feel free to e-mail me with any questions or comments.

Russell Bailyn
--
Wealth Manager
Premier Financial Advisors, Inc
14 E 60th Street, #402
New York, NY 10022
P: 212-752-4343 *31
F: 212-752-7673
rbailyn@premieradvisors.net

Securities and certain investment advisory services offered through: First Allied Securities, Inc., a registered Broker/Dealer. Member: FINRA/SIPC. Premier Financial Advisors, Inc. is a Registered Investment Advisor. First Allied Securities & Premier Financial Advisors are not affiliated entities.

* Wall Street Journal: January 9th, 2009

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January 21, 2009

Financial 'Life' Planning

I often explain financial planning to my clients as a science whose applications aren’t terribly difficult. It boils down to creating a savings and investment program within the framework of your income and assets. Discipline is undoubtedly the most difficult component to implementing one’s long-term financial plan. Further, the more emotion we can remove from the investment process, the better off we will be. Buying low and selling high is rarely what happens when emotion meets the stock market. Lately, however, emotion has taken on a different and more important purpose as the economy dips into recession and investors are witnessing an unprecedented amount of volatility.

Normally when a client calls in worried about his or her investment performance we have a discussion about staying the course and not worrying about short-term market volatility. However, the level of stress experienced by some clients over the past few months reveals at least two things: first that many clients do not understand what their actual tolerance for risk is; and second that ‘staying the course’ might not be the best advice. If a client is losing sleep over a struggling portfolio they may be better off taking some losses and going to cash for a little while. Money is obviously very important but heightened stress levels--especially when they are avoidable--are probably a bad idea. If you are worried enough that you’re checking stock prices for the first time in your life and obsessively watching CNBC, it may be a good time to re-analyze your risk tolerance. I’ve had multiple discussions with people over the past few months about getting out of the market for a few months, even at the expense of missing the first 10% or so of a market rebound. A surprisingly large number of clients are in favor of this arrangement because it allows them the comfort of knowing their money is stable at a time when the markets most certainly are not.

One underlying component of whether this ‘going to cash’ idea could work is considering the income needs of the client. For people who truly may never need all of their investable assets to live, the idea is very feasible. Even if an advisor is opposed to the idea, at least call your clients and explain that none of us can predict exactly when the market rebound will occur and they should plan around more uncertainty. Throw the ball in their court and get an honest reaction. Your clients will appreciate it and you can worry less about having angry and/or disappointed clients.

Along similar lines, Roy Diliberto wrote a feature in December’s issue of Financial Advisor magazine in which he urges advisors to consider whether they are money managers or financial advisors. He writes that money managers should feel less compassion and empathy with clients because their ‘clients’ are really the portfolios they manage and not the clients who invest in those portfolios. Financial advisors, particularly those who emphasize the planning side of the business, need to be more interactive with clients to determine how unusual market volatility may alter their financial plan. Money managers need to realize that gathering assets is what they do best and clients shouldn’t expect you to sit down and analyze their personal balance sheet if you never have in the past. They can pay another advisor an hourly fee for that sort of service.

Financial advising has tied itself into life planning now more than ever before. People need money to reach their long-term life goals. Good advice about saving and investing can save people a giant headache when they are older and less capable of generating an income. Be as open and honest as possible when speaking to your financial advisor. If you feel uncomfortable having that relationship with your advisors, consider finding someone who can truly appreciate your situation and give honest and objective feedback.

As always, questions and comments are welcome.

Russell Bailyn
--
Wealth Manager
Premier Financial Advisors, Inc
14 E 60th Street, #402
New York, NY 10022
P: 212-752-4343 *31
F: 212-752-7673
rbailyn@premieradvisors.net

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January 15, 2009

A Discussion about Independent vs. Wire House Brokers

As you may have imagined, the past few months have been stressful not just for individual investors but for financial advisors as well. Many advisors get paid a percentage of the assets they manage so when asset prices cheapen, as they have recently, it indicates pay cuts for advisors, portfolio managers, insurance professionals, etc. One change which has been widely commented on in industry publications lately is the movement of assets away from large wire house firms such as Merrill Lynch and Smith Barney into smaller, independently owned advisory firms.* This move is not strictly the result of clients seeking a better relationship with their advisors. It’s also the result of advisors working at firms which have been plagued by the credit crisis looking for a change of scenery.

From my recent discussions with clients and friends who maintain accounts with both wire house brokers and independent firms, a common understanding seems to be that smaller accounts, particularly those valued between $50,000 and $250,000 get very little attention from wire house advisors. This sentiment was confirmed by a friend of mine who recently left his post at a big firm to go out on his own. He explained to me that the majority of sales training he went through was oriented towards going after high net-worth individuals and institutional investors. Along similar lines, I have a client who maintains roughly $200,000 with a wire house broker who told me that he didn’t receive one personal e-mail or mailing from his advisor during 2008; just mass e-mails which provided generic market updates. I would argue these guys aren’t just missing the point about what they actually get paid to do, but they’re also risking an obvious source of future business.

It seems logical that focusing strictly on gathering assets while putting clients into pre-packaged financial products will ultimately alienate them. Time and attention dedicated to client retention undoubtedly leads to better relationships and referrals. Further, smaller accounts, perhaps those worth $100,000-$300,000 have the potential to turn into larger accounts as clients advance in their careers, marry, receive inheritances, etc. Nurturing existing client relationships should be an important (and obvious) tool for growing any money management business. Unfortunately, implementing what could be considered the absolute best idea for a client can often be at odds with generating the most profit for financial firms. As we’ve learned all too well throughout the various Wall Street crises of 2008, many people ultimately focus on their jobs and bonus schedules over their deeper moral beliefs of what is right and what is wrong. The above examples, most of which involve differentiating what is good for a business and what is good for a client, help to explain why some people are seeking out smaller, more client-centered firms at a time when honesty and transparency are lacking.

Some of the same reasons explain why advisors are ditching big firm culture as well. One of the primary reasons for this is that independent firms allow advisors to design their own business models. Advisors can choose an independent firm which offers products and services that complement their style of doing business. They can also focus on getting clients at their own pace and in their own way. Granted many advisors leave big firms and take large books of business with them, but an advisory practice may change and evolve over the years. It’s a breath of fresh air for most advisors when they stop trying to climb the corporate latter and start running their own business.

What’s interesting and somewhat shameful is how difficult it can be for wire house brokers to move their businesses to independent firms. One of the most common methods used by large firms to retain employees are deferred compensation plans. Some of these arrangements go out so many years that advisors risk hundreds of thousands of dollars if they switch firms.** Beyond that, it’s even difficult for smaller producers to move. Some firms now charge transfer fees ranging from $50-$100 per brokerage account transferred out of the firm. Because the charge is actually made against the client’s account, it puts the advisors to the decision of discussing the issue with clients and risking losing the account, or eating the transfer fees themselves, resulting in a major penalty for what could potentially be doing the right thing. Big firms also have the advantage of offering bonuses and commission advances to existing and new advisors. If they sense an advisor is considering a move, especially at times like now when many advisory businesses are failing, the bonuses can be quite generous.

Independent firms cannot compete in the way of offering up-front bonuses to advisors who jump ships. What they can offer, and what I’d argue is far more important if you’re trying to build a long-term successful advisory practice, is the ability to run your own business without product pushing and having to explain the mistakes made by your parent company.

All things considered, I think many clients and advisors prefer to work in an independent setting. It may not be possible for younger people entering the business and less successful advisors to start out at independent firms, but once they learn the business they can certainly make the transition. Speaking as an independent advisor, I can say my practice is centered on my clients and my ability to evolve with the profession has been quite satisfying.

Russell Bailyn
--
Wealth Manager
Premier Financial Advisors, Inc
14 E 60th Street, #402
New York, NY 10022
P: 212-752-4343 *31
F: 212-752-7673
rbailyn@premieradvisors.net

*Revenge of the Wirehouses – Financial Advisor Magazine: January, 2009

**Golden Handcuffs -- http://www.leitnersarch.com/trans/golden.pdf

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